Gambling Sector: Immoral But Profitable

Hussain is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As internet gambling, online poker and casino gaming continues to increase massively, this sector provides investors the best opportunity to scoop the jackpot. Compelled by the huge profits, the industry players are looking forward to expanding their business in new regions, especially in Asia and Africa. Following the footsteps of others, Bally Technologies (NYSE: BYI) made an acquisition to expand its business in new geographic regions and entering new segments. In this article, I will analyze the impact of this acquisition on the company’s financial health and then, compare it with the acquisition made by Bally’s competitor, Scientific Games (NASDAQ: SGMS).

Which acquisition will provide more benefits?

Bally Technologies is a diversified, worldwide gaming company in designing, manufacturing, distributing and operating gaming devices and computerized monitoring, accounting and player systems for gaming devices. The company recently declared the acquisition of one of its competitors, SHFL Entertainment (NASDAQ: SHFL), which operates in legalized gaming markets across the world and provides value added products in five distinct categories. Bally will purchase all the outstanding shares of SHFL for a per share price of $23.25 in cash, representing a total enterprise value of $1.3 billion, including $8 million debt and $41 million cash as of April 30.

Both companies expect that by joining hands they will become a top-notch end-to-end gaming technology innovator with the most assorted and unparalleled collection of products and successful brands for casino floors. This acquisition will increase its diversification across the key geographic regions, especially in Asian and Australian regions, where SHFL has considerably higher market share than Bally. It will diversify the sources of revenue generation and will increase revenues of Bally in proprietary table games, electronic table systems and utility segments. The combined recurring revenues are $644 million: $520 million from Bally Technologies and $124 million from SHFL Entertainment.

This merger will achieve an additional EBITDA of $30 million due to synergy derived from economies of scale, supply chain, regulatory licensing, public company fees, marketing and tradeshows and some other facilities. The combined LTM adjusted EBITDA is $445 million: $327 million from Bally, $88 million from SHFL and an additional $30 million coming from the synergistic benefits to be achieved.

The transaction is anticiapted to provide a gradual growth in diluted EPS and free cash flow in the first twelve months after closing. Additionally, the acquisition will strengthen the development infrastructure for land-based, online and mobile distribution channels, build a strong team with the addition of best-in-class artistic and product development talent and significantly enhance the company’s intellectual property and content portfolios.

Now, lets have a look at the acquisition made by Scientific Games. The company acquired WMS Industries (NYSE: WMS) for approximately $1.5 billion or $26 in cash for every common share. Together, these two companies will become the worldwide leader in lottery, gambling hardware and software, and one of the largest B2B and B2G gaming supplier.

The increase in EBITDA is anticipated to be $90 million, and the anticipated synergy arising from savings in capex is expected to be $20 million. This integration will diversify the revenue generation sources of Scientific Games by adding the gaming segment in its current portfolio. It will also provide geographic diversification.

The forecasted revenues for WMS for fiscal years 2013 and 2014 are $107 million and $108 million, respectively. These figures indicate that the revenues of Scientic Games will increase. This acquisition will also provide cross-selling opportunities and extensive operating cost savings. This transaction has also reduced the proportion of debt. Previously, it was 5 times the attributable EBITDA and after this transaction, it came down to 4.4 times. This purchase is also anticipated to result in cash flow savings of $110 million on an annualized basis: $90 million from cost savings and $20 million from capex savings. From 2014 to 2017, over $100 million cost savings are expected to be achieved due to the extensive usage of NOL’s.

Conclusion

Both acquisitions are expected to benefit their respective acquirers by providing them additional growth potential. The transactions will also provide a diverse customer base and will improve the margins of these companies. The combinations will result in value creation for the customers, shareholders and employees of both the companies.

The EBITDA margin of Bally is 33.4%, and SHFL has a margin of 33.1%, which is higher compared to the industry average of 30.7%. Similarly, the margins for Scientifics Games and WMS were reported to be 42.1% and 33.3%, respectively, in the most recent quarter. The margin of Scientific games is the highest in the industry.

So, I would take a buy stance for both stocks.

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Hussain Asghar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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