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Supply-Side Economics

Why investing in the slot manufacturers may make some sense, but regional operators are risky

Supply-Side Economics

Never look behind you; somebody may be gaining.
-Satchel Paige, Hall of Fame baseball pitcher

A few months ago, Bally CEO Dick Haddrill described a perfect storm of good news for gaming suppliers-states and countries legalizing slot machines, the long-awaited revival of the North American replacement cycle about to kick in, technology driving casinos to order new games to stay competitive.

From all indications, Haddrill appears to have been right, though that darn replacement cycle still remains on the horizon.

Certainly, investors and sell-side analysts believe him. They’ve made suppliers the most popular segment of the gaming industry.

In fact, the stocks have become so hot, and expectations so high, that Bally, WMS and IGT sold off after announcing their earnings.

And we’ve helped by repeating the manta of gaming expansion-Ohio, Illinois, Kansas, Maryland and maybe giant opportunities like Massachusetts and commercial Florida casinos to come.

And then there are the burgeoning international markets: Mexico coming out of nowhere to be a Class III giant; Brazil maybe a 100,000-machine market; Italy, 57,000 VLTs; etc.

But before we get too giddy over the prospects of the Big Three plus Aristocrat, it may be wise to remember an axiom of capitalism-success attracts competition.

And that is already happening. Consider:

  • Konami Gaming, the subsidiary of the huge consumer products company, is making steady progress and has become a major North American player.
  • Ainsworth, headed by Aristocrat founder Leonard Ainsworth, is expanding in the U.S., most recently being licensed in Nevada.
  • Multimedia Games is moving rapidly into Class III slots and getting licensed in new jurisdictions.
  • Aruze, a tiny presence today, has the resources of its Japanese parent company and driving CEO Kazuo Okada behind it. And the likeable Kent Young, its North American chief, is getting an audience from casino operators.
  • Lottomatica is putting its considerable resources into slot machines combining its Spielo and Atronic operations in the U.S.
  • Shuffle Master, which re-entered the slot business in Australasia several years ago, is now looking at Mexico, and may make cautious steps back into the U.S.

 

And then there are a passel of small companies like GameTech and private ones from VLC to Cadillac Jack trying to expand beyond their Class II niches into Class III.

And the current oligarchy is not guaranteed to maintain its status quo.

Look at these anticipated March quarter ship-share calculations by Todd Eilers of Roth Capital:
    

IGT             44 percent
WMS           21
Bally           18
Konami       7
Aristocrat   7

 

Already, Konami has broken into the oligarchy. And IGT is no longer an automatic 60 percent-plus.

Indeed, change has been the history of the slot machine business. Bally once all but owned it. Then Universal took the title. Then it was IGT’s turn.

This doesn’t mean that IGT, WMS and Bally won’t stay on top, or that they won’t be highly profitable and good investments.

But an investor in any industry would be wise to heed the words of Satchel Paige.

Meanwhile, regional casino stocks have been beaten down again.

The reasons for investor dismay are the lousy business fundamentals that keep deteriorating.

On his company’s fourth-quarter conference call, Penn National Gaming CEO Peter Carlino put it bluntly.

“You can take the view the deterioration is slowing, but we really don’t have a clue where this year is going to go. Having been chastened in 2009, we don’t have a lot of enthusiasm for 2010,” he said. “I’m just trying to be realistic.”

Those comments came following new company guidance that financial performance this year would fall below last year’s disappointment, though Carlino also was quick to point to the great number of growth projects that should lift Penn National after the recession.

The picture for regional casino operators is always clearer than for any other segment of the gaming industry. That clarity comes from monthly revenue reports published by gaming states throughout the country.

Except for Nevada, Mississippi and Colorado, they provide a casino-by-casino listing, in some cases breaking revenue down to individual types of table games and each denomination of slot machines.

Regional operators are easier to track than Las Vegas operators or suppliers, where investors have to sift through bewildering methods to count slot machines to infer market share and revenue trends.

And in recent months, revenues have been dismal. Add to that the continuing drag of unemployment, the statistical downs that come with the ups early in an economic recovery, and the fears that we are on the cusp of that double-dip back into recession and that investors will lose hope for consumer-dependent stocks.

Regional casino operators have another albatross-proliferation of gaming that today more often brings cannibalization than a growing of the pie.

But before we throw in the towel, let’s consider a few points:

  • Regional casino operators have dramatically cut costs, putting them in position to bring considerable new revenue to the bottom line. And recessions do end, as appears to be happening now.
  • Improved balance sheets and operations can begin generating increasing free cash flow, as construction projects are behind. That is especially true of Ameristar and Isle of Capri. And Penn National, as everyone knows, has cash to invest.
  • Low valuations. Stock prices have returned to reasonable multiples of cash flow, making them buyable again, especially in anticipation of better times.
  • Despairing investor sentiment. We aren’t quite at the blood-in-the-streets panic of last March, but investors and analysts are almost universal in their pessimism for the business fundamentals of regional casinos.


If there’s a time to be a contrarian, this could be it.

Frank Fantini is the editor and publisher of Fantini’s Gaming Report. A free 30-day trial subscription  is available by calling toll free: 1-866-683-4357 or online at www.gaminginvestments.com.

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