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    MARKET EDGES

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Our FQ4 and FY2011 estimates are below consensus but above the fear line 

The long-term fundamentals for the gaming supply sector are very compelling.  We believe we are at the beginning of a five year bull run in slot demand that could drive industry EPS up 20-25% CAGR over that period.  New markets and a simple normalization of replacement demand will be the drivers.  The over/under of the start of that cycle seems to be about 18 months.  We'll take the under. 

IGT is particularly compelling because sentiment is so poor surrounding this perennial market share loser.  However, we think June and September quarter market shares are unsustainably low.  Market share should pick up.  The buy side seems to be expecting around a $0.15 quarter and guidance in the $0.75-0.80 for fiscal 2011; too low in our opinion.  We think there are interested buyers who don't want to get in front of this quarter, which sets the stage for a relief rally.

We expect IGT to report $0.18 this quarter and assuming that IL shipments gets delayed until their F4Q2011, they can still produce $0.87 cents of EPS next year.

We’re not expecting a lot of cheerful news this quarter.  We know that there aren’t a lot of new openings in NA and that the new opening and expansion picture will be even worse through June 2011.  Replacements haven’t picked up yet, and we’re only expecting a Grand Total of 13,000 total shipments into NA this quarter.  Yes, the environment is ultra competitive: Konami is firing on all cyclinders; WMS is rumored to be unveiling a new poker product at G2E which we have also suspected since their Analyst Day – and if successful, will be another hit to IGT. 

So what is there to get excited about?  Well, EPS whisper expectations are too low as is IGT's current market share.  IGTs has been underearning its fair share, in our opinion, so share should begin to improve in December.  Its content has gotten a lot better.  Also, IGT can juice its EPS by about $0.10 by taking out its Convert. 

However, the big prize will be a pick up in replacement demand and there is some visibility there.  Large customers are getting "fit"; Harrah’s just got its balance sheet in “good” shape and is doing an IPO; STN is also in the clear; gaming operators have had enormous rallies this year; and the heighted M&A environment may just mean that some of the gaming assets that have been on their deathbed get a fresh infusion of capital - all of which point to an eventual sharp pickup in replacements.  As we've written about, recently introduced favorable tax depreciation laws should help, especially considering that the 2004 peak of the Ticket In/Ticket Out replacement cycle will be rolling off the 7 year tax depreciation schedule next year.

The following is our projections for the quarter:

F4Q2010 Detail

  • Product sales of $203MM at a 50% gross margin
    • We estimate that IGT will ship 3,550 units to North America at an ASP of $14,500
      • We estimate 2,700 replacement shipments and 700 new shipments and 150 deferred
      • IGT will recognize most of their Sugarhouse shipments this quarter but Cosmo shipments won’t get recognized until F1Q2011
    • We estimate 6,225 international shipments at an ASP of $10,300
    • North American non-box sales of $55MM and international non-box sales of $32MM
  • Gaming operations revenues of $273MM at a 60% gross margin
    • We expect a flat sequential install base and average win per unit of $50.3
  • Other stuff:
    • SG&A: $81MM, including $2.5MM provision for bad debt
    • D&A: $20MM
    • R&D: $53MM
    • Net interest expense: $25.5MM
    • 38% tax rate