What did they learn from their entry and exit into and out of UK & Japan?

  • In Japan and UK, there was very little that could be leveraged outside that markets so that's why they decided to exit those markets.  It's really about trying to leverage what they do well and bring that into those markets.
  • What are they spending on R&D efforts internationally? It's minor and included in $200MM budget.  It's more about skinning their existing content and localizing it rather then developing content from scratch. 

Timeline from market studies to localize content to put out new content

  • They are already re-skinning existing math to local tastes

How to get to $2.5BN revenue?

  • Outsized participation from the international side, which comes at a lower margin.  Interactive contribution also has a lower margin. They will need to be more aggressive internationally to gain share.  The efficiencies will come from all the back-office support functions by consolidating all the international operating systems.  Doing more market research will get them a higher success rate on the hit games, so they put out less flops by having better inputs into the product development process.  Used to have each studio have different product development tools and they are going to globalize that process.
  • ETG expertise/ lack thereof
    • Their ETGs are performing well at Acqueduct.  Their strategy is to identify good platforms and take them globally.  They had historically built games for markets - like the Australian games - and they are looking to change that and bring those low cost boxes into other markets. 
  • Investment required to grow their market share in various markets (LATAM/Asia) will not degrade their margins
  • Operating profit in Australia has significantly improved over the last 5 years.  It used to be a B/E division and is now one of the largest international contributors.
  • SAP implementation/ disruption?
    • There will be no disruption.  Berg did it at all his other companies (did it 3 times before).  Will get the implementation done in 18 months.  SAP will allow them to see how they are doing real time - and course correct - plan discounts / etc; they don't have that expertise currently.  Rolling out these systems is complex and that's why they hired Berg.


Energizing Interactive (Gideon Bierer - EVP New Media)

  • On track with plan. Few key pillars over the next 3-5 years.
    • A fews years ago, 95% of revenue in this division came from UK
    • Produced 2x as many games this year vs. last year (online casino)
    • Mobile gaming: acquired a Million to One (small tuck in) -  more then tripled their business.  Transitioned their business from feature to smartphone business.
    • Entered sports, bingo, and poker business through the Entraction acquisition.  Have a turnkey business for clients that want to get online (white label service) quickly.
  • Markets
    • Growing in UK
    • Entered into Canada in June 2011 when online was legalized; IGT should have the highest market share in online casino in Canada
    • Denmark: Legalizes Jan 1. On track to be the #1 share for online GGR casino revenue.  All the Entraction offerings have been taken up by that market.
    • Italy is in the process of legalizing online gaming.  Expect to go live March 2012
  • Customers
    • Serve 13 of the top 20 operators; landed customers in 6 markets (signed contracts), have 37 new customers.
  • Go to market strategy
    • Most of the markets that they are targeting are either in final legalization stages or just going live.  Each market is different in terms of strategy / offerings/ etc. 
    • Most of their games are made for all 3 platforms: Mobile. online, and tablets/PCs
  • Channels
    • Working on linking their land and online offerings
    • Poker and Casino are their leading offerings and that's where most of their money is going
    • Looking to strengthen the offering in sports and bingo offering
  • IGT's unique value proposition
    • Content for online games
    • Compliance position
    • Many online only guys don't have the same compliance standpoint and have no presence in casinos so they don't offer convergence products (WMS already offers this)
  • Strategic goals
    • Drive top and bottom line growth
    • Market expansion, partnerships, product investment, gain customers
    • Achieve a strong position in regulated markets
    • Leading supplier to land based casinos (very small market now)
    • Tier 1 in all verticals (this is revenue share model)


Next Generation Platforms/IGT Cloud Transformation (Chris Satchell - CTO)

  • Why does cloud matter?
    • Operators need more yield for their floor (better analytics/ROIC from floors)
    • Makes it easier for clients to access IGT content
  • What is a cloud
    • Data center (infrastructure as a service)
    • Development in the cloud (platform as a service)
    • Software as a service (ala salesforce)
  • So their strategy is developing private clouds for their clients which allows the clients to outsource their infrastructure, centralize management, and capital expense would become operating expense.  This is particularly nice for the really small European casinos (casinos that run in the cloud vs. locally at casinos) by putting the casino content in the cloud and player experiences in the cloud.
  • Reduces the acquisition cost of systems and game content for small operators (outsources a lot of the casino operation to IGT)
  • Value proposition of Cloud?
    • Reduces TCO and Capex (technology expense of operating casino systems)
    • "Deeper connection to patrons" by linking online activity of patrons and land based activity
    • Profitable access to new technology (pay as you go model/pay as you consume  - i.e. easier and more seamless upgrades)
    • For Patrons (reward experience, targeted marketing and content push)
    • Increases their global addressable market share for IGT solutions; decreases friction for IGT content and services delivery; generate new recurring revenue streams.
  • Timeline: Showed this to 35 operators in Oct11' at G2E. Launched first infrastructure test in Nevada in Dec 11. Signed 4 casino customers to trial the product; at G2E 2012, they plan to have the first commercial service available


Q&A for cloud/interactive parts

  • How are they going to make money on this?
    • Too early to talk about pricing money.  But the plan is to pay for services on a scaled basis (depending on who is hosting the data center, how many services they are delivering).  The traditional ways to pay for this is on a transactional basis - traditionally, not a revenue but an as you use it model.  Customers like it since it doesn't require upfront investment.
  • How much does IGT need to spend on this on an R&D basis?
    • It's part of their R&D budget.  They already have cloud servers that they use.
  • Regulatory reactions?
    • Nevada has deliberately changed regulations to allow for off-site hosting.  They are very forward looking.  In theory, it gives regulators more control in auditing data.  Nevada will be a good test bed for them. 
    • A lot of the places that they are looking at though are international where the regulator and the customer is the same client
  • There is a huge market for clients that can't do sbX because their capital investment is just too large (they will announce a customer that has lots of locations with 100-200 machines) so this is much more feasible


Financials (Pat Cavanaugh - CFO)

  • Eliminated about $200MM in SG&A. Only increase will be tied to uplifts in revenues.
  • Continuing to reduce their leverage by using their excess cash towards the bank leverage calculation (part of their covenant agreement in terms of calculating leverage)
  • Continue to be ROIC focused and be good stewards of capital
  • Got out of non-profitable business and restructured other business relationships that weren't favorable in past forms
  • Will invest in growth opportunities that support core and accelerated growth
  • Have been able to improve margins in a flat revenue environment.  Believe that some growth in revenues will deliver compelling bottom line growth.
  • Almost have $2/share of cash on the balance sheet.  Expect to generate significant cash over the next 3 years ($2BN in operating cash flow) : uses: ($700MM of capex; $350MM of strategic investments, $500MM of returns to shareholders; $700MM of debt reduction)


  • $500MM of growth in revenues will come from uptick in the US economy; jurisdictional expansion (50%) and 50% will come from emerging businesses and market share expansion internationally
  • Domestic market- status quo in the domestic market - tick up in the replacement market.  If things go their way, they think that hardware will be longer lived but driven by recurring revenues.
  • Continue to take share in the domestic market (and replacement cycle).  Systems growth will be in the cloud. 
  • Redirecting their efficiencies in the new technologies.
  • December is seasonally softest for them. Q4 is the strongest for them.
  • Quebec and Alberta has made their awards; others are still in the RFP process
    • Canada VLT replacement gets replaced in a wholesale fashion - so they should fair really well
  • How much of the convert is already in the share count? None of it until their share price is just under $20/share... they also have a call spread... so there is no dilution until price gets to around $30/share


Keith shorted IGT in the Hedgeye Virtual Portfolio at $17.05.  According to his model, TRADE support was broken at $17.26 and TREND support is at $15.62.



As we mentioned in "REPLACEMENT REVERSAL" (12/2/11), IGT may have pulled forward slot demand in their previous quarter and some casino capex budgets may have already been exhausted.  We believe total North American replacement sales growth in CYQ4 will be negative and IGT will lose share sequentially.  IGT's Investor Day is ongoing; we'll update on any incremental news.



Volatility: SP500 Levels, Refreshed

POSITION: Long Healthcare (XLV), Short SPY


Since the SP500 is Bullish TRADE; Bearish TAIL, I like my setup. Healthcare has been one of our favorite Sectors since the beginning of the year and continues to beat beta.


We want to be proactively fading beta here on both sides of the market. 

  1. On up days towards long-term TAIL resistance (1270) = sell/short
  2. On down days towards immediate-term TRADE support (1231) = buy/cover 

Where this strategy goes a little haywire is when TRADE support (1231) becomes resistance. But rather than fighting that, embrace the uncertainty associated with it and manage your hedges (gross and/or net exposures) dynamically.


Your execution costs might go up, but the volatility of your portfolio will come down.


Having a plan for volatility is that the plan is going to change, across durations.



Keith R. McCullough
Chief Executive Officer


Volatility: SP500 Levels, Refreshed - SPX

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Commentary by Eric Berg, President of IGT and Craig Churchill, International Senior Vice President 



Operational excellence

  • IGT has the advantage of scale in an industry where scale matters.  They believe that they have the ability to leverage their scale to deliver more operating efficiencies and better profitability.  Having this scale and cash flow generation allows them to have more capital to fuel growth opportunities and maintain their edge.
  • Goal is to be a one-stop shop for their casino operator clients and therefore, drive revenue growth
  • Want to drive operating efficiency and use some fruits of this effort to give cash back to shareholders but also invest some of the capital in new growth venues
  • Improve processes

Systems business

  • 44% share internationally for 2011 awarded business.  Roughly in 800 casinos.  Expanding presence of sbX installs.
  • Systems function as a "pull through for the games"


Game sales/operations

  • Got north of 40% ship share last quarter
  • The agreement with Sony allows them to get some themes that their competition just can't get
  • They went from 15 cabinets to just 2-3 cabinets.  Trying to improve the merchandising value of their cabinets and enhance their cabinet ROIC.
  • Top performers with > 1,000 placements: Red Hot Fusion, Hangover, Sex in the City


  • Moving to a loose federation of country subs to a tightly integrated operating model, which should get them economies of scale
  • Get rid of duplicate systems and functions

International opportunities

  • International 5-year CAGR of 15.4% (The opportunity is anywhere between 17-100k units over the next few years)
  • International GDP growth > Domestic GDP growth; Vietnam may be an opportunity

IGTs share of install base internationally

  • NA: 52%
  • Australia: 25% (dominated by Aristocrat & Ainsworth); took market share from 18% to 25% over the last few years.  This year, they actually have the #1 ship share.
  • Asia/ Pacific: 13%
  • EMEA: 15%
  • LATAM: 13%

Opportunities to improve international operations model

  • Implement best of breed practices across regionals
  • Want to become the petri dish for new technologies, internationally

Macau game plan

  • Hire and train professional account executives situated in local markets; leverage ANZ success; deliver customized games and introduce the ANZ BC2O Neo product (an EGT machine - really resonated with local market place).
  • Launched 12 new locally themed games

Latin America

  • South America casino gaming sector is forecasted to grow to $24.3BN by end of 2014
  • Potential of Brazil can be "huge" (300k units)

Localized game content: underpinning of their strategy

  • Conducting local focus groups and research to develop local content
  • Utilize global studio to develop new localized games
  • "Re-skin" game library to make it more "local"


Notes from IGT Investor Day. Nothing major yet.



2011: Deliverables

  • Growing game ops: increased domestic install base, first time since 2007; drove yields up 9% YoY
  • Improving profitability by decreasing COGS
  • Improving their competitive positioning internationally by restructuring their organization into 3 regions and introducing localized content
  • Increased their interactive presence - acquired Entraction: poker, bingo, & sports betting
  • Improved FCF: returned $120MM to shareholder; very focused on cash flow generation

Over the past 10 years...

  • Generated $2.5BN of cash flow over the decade while their competitors have generated almost none (BYI & WMS)
  • Returned $4.3BN to shareholders through buybacks and dividends compared to $250MM by WMS and ~$600MM for BYI (and that's over the last 2 years)
  • Generated $11.5BN of gaming operations revenues, which is the most valuable part of their business
  • They've nearly doubled their international revenues.  Have a +13,000 unit install base internationally.

Plan: "The World of Possible"

  • Grow revenue from $2.0BN to $2.5BN - didn't disclose over what time period so pretty useless
  • Grow international ship share from mid-teens to mid 20's
  • Gross margins from 58% to north of 60% through managing their promotions and having the best products
  • Operating margins of 27% to +30%

How will they achieve their goals?

  • Product, product, product and then focusing on process e.g. Sony
  • They need to enter new markets that they aren't participating in with more relevant products, particularly locally
  • Energize interactive division
  • Next generation platforms: leading the "cloud transformation" bringing new technologies to small facilities - first outside the US and then in the US; this will change the way content gets delivered.
  • Continue to be ROI-focused and being good stewards of capital

Merkel's Marathon

This note was originally published at 8am on December 02, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I thought about running a marathon a long time ago, but I’m just not a runner.”

-Shannon Miller


I’ve woken up to some pretty ambitious central plans this week, but this morning’s caught my attention most – Angela Merkel is going to become a marathon runner.


“Marathon runners often say that a marathon gets especially tough and strenuous after about 35 kilometers…”

-Angela Merkel (speech to the lower house of German parliament)


While she doesn’t appear physically prepared to reach 35k on her own, looks (when gravity is being banned) can be deceiving. Central planners can try just about anything and have people who are paid by short-term stock and commodity inflations cheer them on.


Preparing for marathon, of course, requires some form of a diet, discipline, and sacrifice.


“The lives of a lot of French people are even harder after three years. Everybody has had to make an effort; everybody has had to make a sacrifice… it’s been a genuine revolution that’s begun.”

-Nicholas Sarkozy (speech yesterday in France)


Never mind the last 3 years of French hardship. French and German bankers have been sacrificing 3 hour lunches for conference calls with La Bernank for the last 3 weeks. Convincing the Great Depressionista that we should melt The People’s Savings again must be hard a hard life.


Back to the Global Macro Grind


Life for real-time Risk Managers is hard too. God forbid none of us were born to this earth to constantly beat beta. But “god’s work” might have a different outlook than the 2 and 20 plan.


This, of course, like most things in human history, has happened before. The inability for asset managers to beat beta that is …


After Japan tried their 3rdand 4thquantitative and coordinated easing (and their stock market continued to make lower-long-term highs), beta was all that was left. What do you pay a manager to earn you beta?


Volatility kills returns, fund flows, and economic growth. Right now, all 3 of these factors are as clear as the sun rising in the East to anyone who manages money or a business.


But… we, as an industry, continue to beg for the very thing that perpetuates economic and market volatility – Big Government Interventions. Be careful what you beg for. In the long-run, we might all still have to live with its unintended consequences.


This morning, across the board in Global Macro, we’re seeing the Correlation Risk ramp as the US Dollar falls. Correlation Risk, if you are long and short, works both ways. It’s always on.


Looking across the asset classes in my model and across my core 3 durations (TRADE, TREND, and TAIL) here’s what I see:

  1. SP500 moves to bullish TRADE (1233 support); bearish TAIL (1270 resistance)
  2. US Equity Volatility (VIX) moves to bearish TRADE (31.02 resistance); bullish TAIL (23.07 support)
  3. Global Equity Volume remains in a Bearish Formation (bearish TRADE,  TREND, and TAIL)
  4. Chinese Equities remain in a Bearish Formation (closing down another -1.1% overnight and down -0.8% on the wk)
  5. Japanese Equities move to bullish TRADE (8344 support); bearish TREND (8706)
  6. Indian Equities remain in a Bearish Formation (BSE Sensex bearish on all 3 durations)
  7. Germany Equities move to bullish TRADE (5895 support); bearish TREND (6279 resistance)
  8. French Equities move to bullish TRADE (3074 support); bearish TREND (3274 resistance)
  9. Italian Equities remain in a Bearish Formation (predictable divergence versus German stocks)
  10. Brazilian Equities move to bullish TRADE and TREND after cutting interest rates
  11. Commodities (CRB Index) remains in a Bearish Formation with TREND resistance = 321
  12. Oil (Brent and WTI) are now back into a Bullish Formation (inflationary, big time)
  13. Gold scales back into a Bullish Formation with TREND line support (was resistance) = $1743/oz
  14. Copper moves to bullish TRADE ($3.47 support); bearish TREND ($3.72 resistance)
  15. US Bond Yields are testing a TRADE line breakout (2.12% is the TRADE resistance for 10-year yields); bearish TAIL

All the while, the driver of all this Correlation and Duration Risk remains the US Dollar Index. With the US Dollar being debauched by Bernanke this week (down -1.8% on the week to $78.21), that’s why you see all these immediate-term TRADE breakouts in the aforementioned market prices.


But, Cher Bernank, a TRADE does not a sustainable economic TREND or TAIL make. Neither does an overweight and overleveraged economy sprinting out of the money printing blocks for the 1st three miles of what will be a deleveraging and deflationary marathon.


My immediate-term support and resistance range for the SP500 is now 1233-1258. If this morning’s full employment report inspires you to chase beta, run like the wind.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Merkel's Marathon - Chart of the Day


Merkel's Marathon - Virtual Portfolio

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