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Signs point to more Interaction.  iGT?

Very few new casinos to sell to, stagnating replacement demand, pressure on gaming ops yields – what’s a slot company to do?  We may start referring to IGT as iGT.  While it’s clear that more company focus will be on Interactive, our suspicion is that IGT could be looking at a significant ramp in investment.  That could have mixed reviews from investors depending on the path management chooses. 

Significant additional capital investment into Interactive could be seen as desperate, probably wouldn’t be accretive for awhile, and could signal to investors more trouble ahead for the core business.  However, an Interactive spin-off even if combined with an acquisition would probably be received favorably by investors.

“I saw the sign” – Ace of Base

So why do we believe something may be in the works?  Mostly, it comes from IGT’s own words:

  • CEO Patti Hart’s background and early comments suggest brick and mortar casinos won’t be IGT’s focus going forward
  • Company guidance for 2014 was sketchy and vague:  “GAAP earnings per share from continuing operations for fiscal year 2014 will include acquisition-related expenses, primarily related to DoubleDown, the amount of which is not determinable at this time.  The company may also recognize other items that are not currently determinable, but may be significant. For this reason, the company is unable to provide estimates for full-year GAAP earnings per share from continuing operations at this time.”
  • Expanding the role of the CFO to run the Interactive business indicates it is very important to IGT:  “Robert Melendres has been running that business for us on a global basis. He's done a great job of integrating IGT content into the DoubleDown environment. But we're entering a new chapter of taking this business from the run rate it is to a significantly greater run rate. And we're moving…from exercising the assets we acquired and the assets we already owned, which was our game content library, and into more of a strategic phase and a phase where we'll be redirecting investments from other part of our business into DoubleDown to continue to accelerate the growth.” – Patti Hart, CEO
  • “My view was that John [CFO] has earned the right to do that, and that financial oversight is something that I think is going to be critical in the coming years.  John today also manages our strategic planning and corporate development, and I wanted to have that more closely aligned.” - Hart

On the math, the investment and focus shift makes sense.  As can be seen in the next two charts, IGT’s core business is under pressure and should be through 2015.  Slot sales are likely to be down in 2014 and then again in 2015 while ASPs are now declining.  The 2nd chart details the important metrics driving the gaming ops business.  Yields continued to fall while IGT also lost unit share.  There aren’t many positive trends in IGT’s core business.

IGT: FLYING AWAY FROM CORE BUSINESS HEADWINDS? - igt1

IGT: FLYING AWAY FROM CORE BUSINESS HEADWINDS? - igt2

While it is certainly arguable whether IGT overpaid for DoubleDown, there is little doubt that Interactive has and should outperform the core business.  

IGT: FLYING AWAY FROM CORE BUSINESS HEADWINDS? - igt3

What are IGT’s options with Interactive:

  • Materially increase the level of investment into Interactive – Patti already said on the earnings call that they will be redirecting capital spend from other parts of their business, presumably gaming operations. There was a taste of that in F4Q with elevated SG&A, partly driven by higher advertising expenditures.
  • Acquisition of a social gaming company.  Who’s out there:
    • Zynga (ZNGA) - $3b market cap
    • GLU Mobile (GLUU) $225m cap
    • MeetMe Inc (MEET) - $71m cap
    • CZR Interactive
    • Private companies:  Rovio, Wooga, King, Tetris Online, Halfquest, GSN, Happy Elements
  • Spin off to unlock value - IGT could spin off the Interactive and establish an agreement around content – give the new company an exclusive deal on their content library in exchange for a fee to IGT.  We’ve seen quite a few splits in gaming/lodging:  spin-off of CZR Interactive, the PENN transaction, the MAR timeshare spinoff, and lodging mgmt and real estate splits. 
  • IGT could also combine two of the above approaches such as buying Zynga and spinning its own interactive assets into an existing trading company