IGT should be releasing a (punchy?) response to the Ader Group soon. Here we take a stab at what that response could include.
We have no idea whether shareholders will vote in favor of the Ader Group proposal but we are pretty sure of two things: the process will be entertaining and should be good for the stock. The presence of agitating shareholders is typically good for stocks, especially cheap stocks.
As we’ve discussed numerous times, IGT has made some questionable acquisitions but management appears to be on the right path. We actually think the buyback was quite cleverly executed. However, we like the idea of an agitator on the Board and we also think some capital markets experience and pure gaming experience could only help the Board focus management on creating shareholder value. The stock is unnecessarily cheap and management deserves some blame for that.
Hedgeye is obviously not privy to the contents of IGT management’s response but that doesn’t mean we don’t have an educated guess. The following is a point by point response that we think IGT could issue as soon as tonight:
- ADER GROUP: IGT has failed to focus on the core business
- IGT: Our share in North America been increasing for the last two years and our product pipeline is in great shape. That’s more than we can say about the former management team which overspent on Server Based Gaming and contributed to a plummeting stock price. Comparisons to 2004, when our market share exceeded 60%, is irrelevant since the competitive landscape is completely different.
- ADER GROUP: Our proposed Board members have the gaming experience that IGT’s current Board lacks
- IGT: The one person in Ader’s Group with great gaming experience is very old and was directly involved in the gaming industry at a very different time.
- ADER GROUP: IGT missed out on significant opportunities in the Asian EGT space
- IGT: The entire EGT market generates revenues in the ballpark of $200MM and has lower margins than our existing product sales business. Even if IGT was able to garner 30-40% market share, this business would contribute a lot less than what Double Down is also doing. Prior management made a strategic investment in DigiDeal, an electronic table game platform, back in April 2007. Three years later, in May 2010, IGT ended our relationship with DigiDeal to focus on “core” products. Reasons for terminating the partnership were part of a broader strategy of IGT exiting low ROI markets and products including Barcrest and Japan. IGT still has a small domestic electronic table games business we were not interested in investments in low ROI product lines
- ADER GROUP: IGT overpaid for DoubleDown and could have created the same business for a fraction of the price.
- IGT: We paid $250MM to date for the acquisition of Double with an additional $250MM to be paid out in retention and bonus payments over the next few years. DD’s revenues are already doing over $165MM/ year on an annualized basis and the business should produce around $200MM by FY14. Gross margins are 60% with room for upside. Operating margins should be north of 25% when the business is mature and by 2014 the deal will be accretive. Unlike Zynga, our business is growing and did 31 cents of booking per average daily user compared to Zynga’s 6 cents. This business will prove to be a high ROI acquisition for us.
- ADER GROUP: Key personnel departures and brain drain at the company - Joe Kaminkow specifically, the former head of one of IGT’s 5 internal game development labs.
- IGT: Kaminkow wanted to be the head of social gaming and wanted to do it himself. He formed a company called “Spooky Cool Labs” (http://spookycool.com/index.html ) which is focused “on creating cutting-edge social games built on great brands and industry-leading design for social networking services and mobile devices.”
- ADER GROUP: Entraction shut down just 18 months after purchase is a perfect example of IGT’s misallocation of capital
- IGT: Ok, Entraction wasn’t the greatest acquisition of all-time, but it’s not the only business that suffered after Italy and France ring-fenced online wagering. We were also able to recognize a $40MM tax benefit in 2012 from the write-down of Entraction and still own the technology and know-how so it’s not a complete failure.
- ADER GROUP: Our Group will own 300x more stock than the existing Board
- IGT: It’s true that the current Board doesn’t own a lot of stock. However, Ader’s group ownership is spread pretty thin. 75% of the stock they own comes from one long term investor, 9% is owned by an 84 year old former Chairman (Chuck Mathewson), 10% is owned by trusts controlled by the former Chairman, and only 6% is owned by Ader and Associates. That 6% owned by Ader represents less than 20bps of the total shares outstanding. Two of the 3 Board members that the Ader group has proposed directly own less than 0.5% of the stock.
- ADER GROUP: Accelerated buyback execution left a lot of money on the table
- IGT: We bought back the stock at an average price of $13.22, which is 16% below the current price.