BYI reports its fiscal Q4 on Tuesday. Earnings should be fine but, honestly, we have no idea how the stock will react. We do have an idea about the long-term though.
We would like to offer some longer term thoughts on the sector and BYI, in particular, worth bearing in mind any time the stock experiences weakness. We’ll have a detailed EPS preview out a little later.
At $39, BYI is trading at 18x effectively trailing EPS, and 16x consensus forward EPS. That doesn’t sound exciting, you say. Well, we would argue that BYI and the entire sector deserves a premium multiple, given that they have managed to grow through one of the worst replacement cycles in history and are on the verge of a sizable replacement cycle. As a reminder, BYI is on track to grow EPS 19% this year, and even consensus estimates expect 8% growth for FY2010 which is another awful year, cyclically, for the space. How many companies in Gaming, Lodging or Leisure have achieved that kind – or any kind of growth this year? How many will have another down year in 2010?
While BYI should be one of the few companies in our sector to actually grow its business in FY2010, that’s not one of our key thesis points. We view FY2010 as a “bridge” year to the beginning of a huge replacement cycle and this is precisely why we like BYI and the slot space… a lot over the long term.
We entered this cyclical slowdown when gaming operators became so leveraged that every dollar went towards avoiding covenant breaches. With Harrah’s, MGM, LVS, STN, and numerous other smaller players (Tropicana, Black Gaming, Twin Rivers, TRMP, Greektown, Herbst…) all in dire financial straits, the market for replacements simply dried out. Since the big boys weren’t refreshing their floors, there was no reason for even better capitalized players to do so either. Hence the downward spiral.
Fast forward to today and we’ve got expanded gaming coming in Maryland, Kansas, Illinois and Ohio. Discussions are continuing in Iowa, Pennsylvania, Massachusetts, Arizona and other jurisdictions to expand gaming. Aqueduct looks like it may actually get slots in the next 18 months, PNK is commencing construction in Louisiana, and Sugar House and Foxwoods are finally breaking ground in Philadelphia. Our thesis is that incompetent politicians lay the groundwork for slots. Slots beget slots. States are on spending sprees, citizens are taxed almost to the max, and slots are again becoming the revenue answer.
There are over 850,000 units in North America, but room for so many more. New markets are great and provide a big boost to slot sales but they also grow and stabilize replacement demand. Once the ball gets rolling we’ll get several years of 100,000 replacement units, up from the 31,000 units we’re estimating for 2009.
The thesis applies to all the slot players but BYI looks the most attractive to us:
- It’s a lot cheaper than WMS
- BYI lacks the "hair" of IGT
- Conservative accounting and high amounts of deferred revenues provides some visibility for next year
- The systems business is a little lumpy, but is a great business that the Street under appreciates and clearly doesn’t understand. BYI should fair very well in a networked world… whenever it happens. In the meantime, products like iVIEW help deliver applications with high ROI to casinos
- Already the lowest cost provider on the “participation side”
- BYI offers many of its premium games on a fixed fee basis ($50-$60/day) vs taking a % of coin in or being on a 20/80 split. Operators really like this and its one of IGT’s biggest gripes about BYI
- Because so many of BYI games are either fixed fee or leased, they have less exposure to the economic headwinds of lower win per days
- Large base of old spinning reel games that are past their depreciable lives
- Low base internationally, making comps easier
- Hadrill has sold companies before so a buyout at a premium is always a possibility
- Litigation risk is at lowest level in years with the Wheel patent thrown out and the remaining litigation is really just a work around issue