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Merger Magic

How the M&A activity in the gaming industry has changed

Merger Magic

The pace of mergers and acquisitions in the gaming industry has accelerated over the past two years to the point that any day can see another deal announced.

Unlike past cycles, there is no single predominant theme. Deals are happening for every reason: buying growth, consolidating fiercely competitive markets, achieving strategic objectives, taking advantage of low valuations, monetizing assets, technology convergence, and its related phenomenon, business model convergence.

As might be expected by such diverse motivations, the companies involved run the gamut—casino companies like Boyd Gaming, suppliers like IGT, traditional horse-racing companies like Churchill Downs, upstarts like Amaya Gaming, real estate investment trusts, and even non-gambling companies like GSN Games.

The backdrop for all of this activity is a contrasting—if not ironic—one: a maturing brick-and-mortar gaming industry in the United States forcing down casino valuations, while rapidly evolving technology and business models prompt companies to jockey for position in a new world taking form.

Releasing Value, Monetizing Assets

U.S. regional casino companies have never been highly valued. Born of junk bond debt and always susceptible to legislative whims that undercut their business plans, regional companies historically have sold at six, seven or eight times EBITDA. Comparable companies in lodging sell at 10 and 12 times. Entertainment companies fetch even higher valuations.

Penn National addressed that gap by creating a separate publicly traded company, Gaming and Leisure Properties, as a real estate investment trust, or REIT.

The REIT will own most of the properties where PENN operates and become PENN’s landlord.

But the big potential for GLPI is to take advantage of low equity prices by acquiring other casinos and leasing them back to their former owners to operate.

Several analysts estimate that there is as much as $10 billion worth of casinos that can be bought.

Renting out properties gives GLPI a predictable revenue stream and allows owners to monetize their assets in a low-valuation environment, while still operating their casinos.

That, at least, is the theory. If it proves out, many privately owned casinos will be sold, other gaming companies will consider spinning off REITs or property-owning entities, and non-gaming REITS will move into the space.

Strategic Opportunities

The blockbuster deals of the past two years were Scientific Games (SGMS) buying WMS for $1.5 billion and Bally Technologies (BYI) buying SHFL entertainment for $1.3 billion.

In both cases, the acquiring companies greatly expanded their businesses into new sectors, in effect remaking themselves into broader competitors.

SGMS, a lottery company with a growing slot-like machine business in the United Kingdom and elsewhere, acquired a proven slot machine company with an ambitious interactive gaming business.

BYI, a legendary slot machine company with a very strong systems business, instantly became the world’s biggest table game and automated card shuffler company.

Further, BYI bought a company that leases most of its products, thus injecting a strong dose of recurring revenue. And it acquired a company with a much stronger international presence, giving BYI a global sales platform and an unparalleled cross-marketing opportunity.

One of the big words used in an acquisition is synergy. Usually, synergy is a euphemism for cost-cutting as companies consolidate operations and eliminate redundant operations.

In the case of Bally-SHFL, those synergies were put at a minimum of $30 million a year. SGMS expects $120 million.

However, both Bally and Scientific Games expect to grow sales through their purchases, which is partly what makes them strategic.

Way Too Crowded In Here

It is no surprise that the biggest deals have involved gaming suppliers. The space has become very crowded, and is becoming more so every day.

Not long ago, the industry had a Big Three in North America—IGT, Bally, WMS. Then Aristocrat expanded and it became a Big Four. More recently, Konami Gaming, a division of deep-pocketed Konami Corp., has grown into what some now call a Big Five.

Aruze, another division of a deep-pocketed Japanese company, wants to be among the top three. European giant Novomatic is moving ambitiously into the U.S.

Australia’s Ainsworth is displaying its American ambitions with a giant new facility in Las Vegas.

Ortiz has moved in from Latin America.

Class II suppliers moving aggressively into the larger Class III world of commercial casinos include Multimedia Games and American Gaming Systems.

Incredible Technologies is transitioning from the declining world of arcade and coin-in industry to the more viable gambling industry.

If it was true, as often stated in the past, that consolidation must come because the costs of running a broad gaming supplier company were too great to be supported by small market share, then that truth is even more acute today.

Something will have to give, which suggests some big fish will be dining on small fish in the not-to-distant future.

Interactive Gaming And Convergence

Interactive gaming is changing everything.

Formerly unexciting bookmakers like William Hill are now trendy online operators gone global—in part because of acquisitions of Australian online companies and U.S. sports books.

Other companies, like young Amaya Gaming, are offering their own online platforms, as in its $33 million acquisition of OnGame poker network.

And the social gaming space is just plain alive.

For the gaming industry, the deal that caught everyone’s attention was IGT buying social gamer DoubleDown for $500 million two years ago.

At the time, IGT was criticized for paying a steep price for the most popular social gamer on Facebook.

IGT overpaid. There is no barrier to entry. Prices for competitors such as Zynga were collapsing, the critics said.

Since then, DoubleDown has grown rapidly in both number of users and revenues, reaching profitability.

Today, analyst Dave Bain of Stern Agee says, DoubleDown might be worth $1.1 billion. Even at a value of $800 million others consider more likely, IGT’s return is 60 percent in two years.

More recently, casual gamer GSN Games bought Bash Gaming up to $170 million, or an estimated three to four times sales.

Bash operates social Bingo Bash and reportedly was being sought by gambling suppliers, as well.

All of which leads to the issue of technology convergence and the situation in which all companies—casinos, suppliers, online platform and software providers, online betting shops and casino companies, lotteries—try to position themselves in a world so fluid where none can plant their feet firmly.

This convergence and fluidity mean that companies will grow into a little bit of everything, just like William Hill transformed from an operator of betting shops in Britain into an international company with online sports books, casinos and mobile apps.

Buying Growth

Not all M&A will be driven by sexy new technologies or transformational business models.

Sometimes, just buying a business with growth potential will work.

Two successful practitioners of this tried-and-true approach are Boyd Gaming and Churchill Downs (CHDN).

BYD’s most recent purchase was the $1.3 billion acquisition of privately held Peninsula Gaming, which owns casinos in Iowa, Kansas and Louisiana.

Churchill Downs came to be a buyer from a different perspective. It wanted to diversify away from being a pure horse-racing company into being a growth company in the broader gaming industry.

BYD CEO Keith Smith recently made clear that the company continues to keep an eye open for acquisitions that, as he said, are a good fit, reasonably priced, and can be integrated into BYD’s national network.

However, BYD has reached a size that makes it more difficult to find available properties of the quality and scale it now requires, he added.

CHDN, on the other hand, has smaller targets, like recently acquired Oxford Casino in Maine. Thus, CHDN has a target-rich environment.

Other seekers of small properties that proliferate in regional markets are Full House Resorts and Monarch Casino. And, of course, there is Gaming and Leisure Properties.

They Gotta Sell

Sometimes, casinos have no choice but to sell thanks to their financial condition.

The most famous current such case is Revel Casino in Atlantic City.

Built at a cost of $2.4 billion, Revel has had co-founder Morgan Stanley walk away from its investment, debt restructured down through a bankruptcy reorganization, and now is on the sales block again.

Speculation is that Hard Rock International and Caesars might be interested in purchasing Revel, though, one can expect, at a fraction of $2.4 billion.

A couple of leftovers from the Great Recession present similar possibilities.

At some point, Deutsche Bank will want to get out of the casino business and sell Cosmopolitan Las Vegas, and for what surely will be less than the $3.9 billion project cost.

Likewise, Carl Icahn bought the $2.9 billion Fontainebleau Las Vegas for $156 million with the idea that someone would eventually be willing to pay more to buy the project and complete it.

Such a deal already has happened with Genting buying Boyd’s multibillion-dollar Echelon project for $340 million. Genting got $900 million in infrastructure already built by Boyd and will invest $2 billion-plus building a mega-resort themed on ancient China.

With Las Vegas rebounding, Fontainebleau’s day might be nearing for a similar purchase.

Put all together, there are lots of reasons for M&A to be a major theme in the gaming industry for at least the next several years.

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