The Street should've known about the ugly slot sales and share loss. After today, we'll get more positive as the Sell Side gets more negative.
As we telegraphed in our 12/02/11 post, “Replacement Reversal” and reiterated in our IGT earnings preview, industry replacement demand was likely down in CYQ4, compounded by IGT losing share. That was certainly confirmed by IGT’s earnings release this morning.
IGT’s quarter was pretty terrible and to be honest, we thought the stock would be down in the AM consistent with the 8% pre-market drop. However, given the bright outlook for the rest of the year, investors seem to be taking the bad news as ‘old news’ and in stride. In retrospect, IGT’s stock has massively underperformed the gaming sector since we put that post out – the worst performing stock in our universe – and experienced almost a 5% reversal late in the day yesterday. Bad news leak out early.
While this quarter’s results were just plain bad, CY2012 is likely to be a strong year for the slot guys. Unit shipments were pulled forward by IGT and WMS into CYQ3 so the CYQ4 slowdown is not indicative of a trend. In fact, we think the catalysts are there for significant growth in slot trends in 2012:
- The Big Four slot operators – BYD, CZR, MGM, and STN – are in much better shape financially
- They’ve all refinanced recently
- 2012 trends on the LV Strip and LV locals are looking much better than expectations so cash flows should be better (we still like BYD and MGM on the long side)
- STN could go public
- CZR likely to up their $50MM IPO since online poker, given the recent DoJ opinion and CZR’s ownership of the World Series of Poker brand
- Remember that these are the largest slot operators and each has significantly under spent on slot CapEx for four straight years
- 17 year current replacement cycle unsustainable from a physical perspective
- Replacement demand growth has been positive for three quarters until Q4 (we’ve explained it) so the trend even outside the above factors has been positive
- Significant new openings/expansion should make 2012 the first real growth year in slot sales in a couple of years
BYI’s stock has significantly outperformed IGT recently, and WMS still has a few more ugly quarters so IGT may be the best way to play improving 2012 trends over the near and intermediate term. We’d like it cheaper – like $15, where it was trading pre-market – and maybe we’ll get a downgrade or two.
Q1 FY2012 Details:
- Product revenues and margins
- We knew that replacements were going to have a 3’ handle but we hoped for high 3’s. I guess we confirmed what we already knew – IGT lost a lot of share.
- IGT claims to have gotten 30% replacement share this quarter which would imply a replacement market of just 9.3k units and total NA shipments of 12.4k in the quarter. That would suggest huge misses for all the manufacturers. We’ll take the under on 30% and guess that IGT’s replacement share was somewhere between 20-25%. We’re fairly confident that the NA shipments will be at least 14.5k this December and probably closer to 15.5k. That said, we agree with IGT’s statement that their ship share will increase for the balance of the year…how can it get any worse?
- IGT blamed low profit margins on product mix and lower conversion/parts revenue. There is some operating leverage so fewer units do not help margins. It’s no secret that IGT had been offering their customers various discount packages that included free upgrades and conversion kits over the last year or so. While some of that shows up as lower pricing/discounts in the quarter, as one of our clients pointed out, some of it shows up as forgone conversion kits/upgrade revenues in future quarters as clients exercise their free options rather than making new purchases.
- Gaming operations revenues:
- Gaming operations revenue was a little lower than we estimated due to lower yield per day but IGT also blamed product mix. We expected a little more 'juice' from the install base growth, organic and acquired growth in interactive, and higher MegaJackpots yields. It appears that the YoY yield growth trends that we've seen over the last 3 quarters 'decelerated' this quarter.
- SG&A was a lot higher than we expected – especially given the lack of top line production. Some of that was blamed on the Entraction acquisition (which apparently didn’t bring much revenue). However, the high SG&A was offset by lower R&D and D&A. We’re not sure if that’s a good thing though.
- Since IGT likes to point out cash flow metrics, here are a few of our observations:
- On a 4% decline in revenues YoY, cash flow from operations declined 37% or $38MM\
- Inventory build only accounted for $8MM of the decline
- Cash flow before financing activities/buybacks/dividends declined 64% YoY
- ASPs were much higher both domestically and internationally. It’s possible that discounting slowed this quarter in NA. International price lift was attributed to a decrease of lower-priced shipments to Mexico.
- Gaming operations margins were better than we expected. Some of this is mix related but who really knows since the disclosure is terrible.
We won’t harp on this point too much since IGT will be providing better disclosure next quarter, however, we must point out that average revenue per unit in gaming operations is becoming an irrelevant disclosure. According to IGT, the numerator in this calculation includes a small but rapidly growing amount of revenues from the interactive division which have nothing do to with the install base. The average revenue per unit that IGT provides for product sales is also a completely worthless metric since the numerator includes systems sales, parts, used units sales (including trade-ins) and systems revenue which also have nothing to do with the number of units sold in the quarter.