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    MARKET EDGES

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A hedge to interest rates, a strong BS and FCF, margin levers, and a countercyclical element to its growth profile should make IGT a much more defensive stock than its trading would indicate.

It’s no secret we like this sector long-term.  We like it near-term too when sentiment gets overly focused on the timing of replacement demand; like now.  Twenty years is not the new replacement cycle paradigm.

How can the new slot replacement cycle be 20 years?  Video poker has averaged a 13 year cycle historically and they only get replaced upon disintegration.  Even if we assume a 13 year cycle for all slots, that is a level 45% higher than the current 45k replacements.  Hence, our belief is that currentl replacement levels are simply not sustainable. 

We like the Big Three over the long-term but with all the risk out there in the world IGT might be the most defensive.  IGT and BYI should be market share gainers over the near term.  Favoring IGT is no more than a risk management move.  While BYI is probably better positioned over the long-term – not susceptible to prolonged participation market share losses - IGT has more margin levers over the near term and less risk with systems timing so it’s more defensive in an uncertain time.

Defensive

  • Great balance sheet – only 2x levered
  • Free cash flow positive – around $1.40 per share this year
  • Hedge to higher interest rates – higher game ops margins due to jackpot annuity funding at lower net present values as interest rates rise
  • Benefits from budget deficits so countercyclical to some extent – states need money!
  • Near term margins levers

Growth

  • Trough replacement demand and new market growth currently
  • 40-50% increase in replacements just to normalized levels
  • Visible new market growth already but states and international budgets are in rough shape – casinos are now a politically palatable way to increase government revenues – we’ve seen it before
  • Combined we should see 20-25% CAGR EPS growth over a 3-5 year period – and that growth will be highly cash generative