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Little Giants

Several small-cap companies offer value in a bear market

Little Giants

Discussion on investing in gaming stocks is dominated by the names of the largest companies such as MGM, Caesars, Wynn, Las Vegas Sands, Aristocrat, Light & Wonder, and in emerging digital gaming, the likes of DraftKings and Evolution.

That is understandable. They have tons of information available, in news and from analysts. There is a lot of stock to be purchased—an essential for institutional investors, who, after all, drive stock prices. The focus also is totally appropriate given the security provided by long histories of proven performance and the fact that the best long-term returns in nearly all industries come from the biggest and the best companies.

But in what has been a small-cap bear market, there are some stocks that can potentially provide double-barreled returns of both earnings growth and higher valuations. Of course, small stocks generally are riskier than big ones, but for those looking for outsized gains, here are three interesting names:

  • AGS CEO David Lopez probably said it best: His company’s success will be built upon products, people and process.

AGS has long had a strong people-oriented culture. Its product line is growing, but products have not been its problem. The issue has been managing the company to improve the bottom line. Now, that process part is performing admirably. In the last quarter, AGS not only grew revenues around 15 percent, it grew EBITDA at that rate, too. Further, its debt burden is fast becoming a non-issue as AGS has brought its leverage ratio down to 3.2 times on its way to below three times by year-end. All the while, it is maintaining its R&D budget to assure a flow of new products.

The potential for the $350 million market cap company is obvious. Slots, which still provide 90 percent of revenues, are growing around 15 percent at EBITDA margins of around 45 percent. Table game and interactive divisions are growing even faster. Indeed, little AGS is fast becoming not-so-little given its product and jurisdictional expansions.

The growing popularity of its products has been documented, as in the Eilers-Fantini surveys that show AGS gaining ground throughout its business. In fact, AGS was cited by Eilers & Krejick Gaming at the firm’s annual awards program as the industry’s most improved supplier in core products.

Yet, for all of these strengths, AGS stock sells for only five times next year’s estimated enterprise value-to-EBITDA. Imagine what happens to the stock price when it reflects growing profits with commensurate valuation.

  • Full House Resorts historically is a footnote of a company with EBITDA around $40 million a year and properties that would make a yawn exciting.

That is changing. The company has opened two unique properties that promise to be transformational. In Cripple Creek, Colorado, the $300 million Chamonix casino is the first resort-quality property in the market. In Waukegan, Illinois, FLL has opened a temporary American Place casino that, when the permanent property is developed, will be a $500 million, upscale operation with all of Chicagoland to draw from and a lock on a neighboring affluent locals market of 1 million people.

CEO Dan Lee says the two properties should combine for $100 million in EBITDA and the company as a whole $130 million. That’s triple FLL’s norm. But performance likely will be better. Fifteen percent returns on investment would yield $120 million from those two properties alone; 20 percent would generate $160 million. And there is growth potential in the company’s other properties. In other words, a tripling, quadrupling or even more of EBITDA over time is not out of the question.

FLL has been penalized because Chamonix and American Place have gotten off to slow starts. Chamonix especially has been marred by property opening glitches. An investment in Full House is a vote that those properties will provide significant returns, even if just extra-base hits and not home runs.

Investors also have been wary of debt, noting the company still has to finance the permanent American Place. However, Lee and CFO Lewis Fanger described in detail during the fourth-quarter investor call how American Place debt should be under $200 million and will not be needed for a couple of years, by which time growing cash flows with further strengthen the balance sheet.

  • Inspired Entertainment may be the least known company with a lead position in potentially a huge product line—virtual sports wagering.

If the global sports betting market reaches $80 billion, as many expect, and virtual sports betting maintains its historical position of 10 percent of that, the size of the market is clear for a company with a market cap around $250 million. And margins are ridiculous. In the third quarter, Inspired generated $11.7 million in EBITDA on $13.4 million of virtual sports revenue.

Inspired has other potentially huge growth markets—VLTs in the U.S., the success of its Vantage cabinet that is growing revenues double digits from earlier-generation cabinets it replaces, iLottery, and international expansion, such as Brazil.

In other words, Inspired has a lot of potential.

The story of all three of these companies is the same as for any so-called story stock. They have to produce. Or, as Inspired CEO Brooks Pierce said on his recent investor call in regards to virtual sports, the coming year will be one to put up or shut up.

The good news is that even if they fall short, they could find a market of buyers ready to scarf them up. What would a larger company pay for Inspired and its virtual sports and iLottery products? Or a casino operator to own Chamonix and American Place? Or for AGS and its ever-growing product line?

Well above their current prices, I should guess.

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