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Different Roads

Analyzing the gaming supply market

Different Roads

There are many investment styles.

Any, if practiced with skill, can lead to profitable ends. Or, as Warren Buffet most famously says, there is more than one way to get to heaven. The same can be said for building growing and profitable companies.

There are companies that choose to grow by building their core businesses. They grow organically, as it’s called.

Other companies choose to grow through merger and acquisition.

A lot of attention in the gaming technology space has gone to the second kind of company in the past year or two, thanks to a series of mergers that have created two global supplier-lottery conglomerates—Scientific Games and IGT.

There are others, however, that have fixed focus on growing their core businesses, such as Konami Gaming and Ainsworth.

Aristocrat is among those sticking to its core business of slot games and systems, though it has made acquisitions.

One acquisition, VGT, extends Aristocrat into Class II gaming in the U.S., but still in the slot business. Aristocrat also has made acquisitions into the interactive space such as social gaming, and is open to purchasing more companies.

But it isn’t going to wed a lottery operator or buy a table game company, so its business model remains focused on core areas.

The reasons for the mergers rested on one big trend and one big reality.

The big trend is convergence. Technology has created the ability to distribute game content beyond the slot machine box. It now goes online and in lottery products. It goes into gambling games and it goes into free-play and social games. And it can serve customers who cross over various platforms.

Thus, the company that can serve customers comprehensively can sell comprehensively, opening the opportunity for growth in even a static market.

The big reality is cost. Where there once were three dominant slot machine companies in North America, there now are many more. Each supports its own game development operations. Each supports R&D efforts. Each supports maintenance staffs, corporate staffs, sales staffs, etc.

Not all of those companies can afford those kinds of expenses to compete with the giants, again in a basically static market.

But even for the giants like SGMS, the ability to consolidate operations permits a cost-cutting that allows profits to grow. Obviously, it is cheaper for SGMS to have one sales department, for example, than for itself, Bally, Shuffle Master and WMS each to have one.

Of course, buying companies has run up one expense—interest, as money has been borrowed to finance the acquisitions. This has brought greater risk—and urgency to achieve promised cost cuts. SGMS has a debt-to-EBIDTA ratio is over eight times in an industry where debt historically has been low to nil.

It also has created what is called execution risk. How difficult will it be for IGT, for example, to build a coherent, unified company with an Italian CEO, corporate headquarters in London, lottery headquarters in Rhode Island, slot manufacturing in Nevada and each industry and region with its own culture?

SGMS and IGT both have strengths as they work through the early days of their integrations.

IGT has considerable cash flow.

SGMS has the most comprehensive product lines. And it has a CEO who has been CEO or COO at three of the company’s four major components.

That CEO, Gavin Isaacs, also is among the most admired in the business. One of the most frequently uttered phrases today is that “if anybody can make Scientific Games work, it is Gavin.”

One move that Isaacs has made to begin the unifying of decision-making and cultures is locating headquarters in Las Vegas.

The challenges of executing on the mergers were revealed in IGT’s and SGMS’ recently quarterly earnings results. IGT was largely in line. SGMS reported a better bottom line than expected, but some revenue segments declined.

On the other side, the simpler, more narrowly focused Aristocrat reported a rip-roaring first half of fiscal 2015 and promised more to come. EBITDA more than doubled and after-tax profit soared 68 percent.

Results were driven by the success of Aristocrat’s games, a big rebound in its home Australian market, and the addition of VGT, the U.S. Class II slot machine company.

Of course, big turnarounds at big companies can take time.

The start of Aristocrat’s success began several years ago when, under CEO Jamie Odell, the company made some key strategic decisions. One was a commitment to developing outstanding games. That led to the hiring of renowned game designers such as Joe Kaminkow.

Another was to focus on the Americas, which, after all, comprised about two-thirds of Aristocrat’s business. This commitment went hand-in-glove with game design as Aristocrat opened creative operations in the U.S.

We have tracked the results in the Eilers-Fantini Quarterly Slot Survey, the industry-leading report detailing trends among gaming suppliers.

Aristocrat’s share of new games shipped to casinos rose to 14 percent in the past survey. More interestingly, survey respondents said they intend to buy 19 percent of their games from Aristocrat this year, and 21 percent factoring out VLT replacement markets, which tend to distort the overall market.

(Note: Anyone wanting a sample of the Eilers-Fantini survey or wishing to learn more about it can contact me at ffantini@fantiniresearch.com.)

But the real proof of the pudding was in those first-half earnings.

Aristocrat also maintains a much less burdensome debt level with a leverage ratio of 3.2 times—and just 2.9 times on a net basis, subtracting cash from debt. That means Aristocrat can put more focus on building revenues rather than cutting costs, and that it even can go shopping for acquisitions.

For SGMS, reducing the debt leverage will be a key for investors to watch.

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