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IGT CONF CALL NOTES - CEO'S DREAM STRATEGIC TRANSACTION

Our math suggests IGT should trade at a little over $17 given the high probability of closing and low probability of a competing bid

 

 

"CEO's Dream Strategic Transaction" and joining forces with "a tough competitor" - Patti Hart


IGT and it's management team catches a golden parachute while positioning the NewCo for a broader, deeper global platform

 

 

PREPARED COMMENTS

 

Overview:

• Creates world leading end-to-end gaming company across all segments

‒ #1 global gaming equipment supplier
‒ #1 global lottery business
‒ Top tier in social gaming and interactive wagering

• Enhanced global scale with diversified product portfolio and geographic mix
• Greater resources allow further strengthening of industry-leading R&D effort
• Uniquely positioned to exploit key market trends
• Industry leader with more than $6B in revenues and $2B in EBITDA

 

Transaction Details:

• $13.69 in cash plus 0.1819x GTECH shares, equivalent to $18.25 per IGT common share (75% cash and 25% stock)

• NewCo will incorporate in the UK and UK tax resident 

• NewCo will be NYSE listed, 80% owned by GTECH & 20% IGT 

• Synergies: $280 million expected over 3 years

 

New Segments:

• Lottery Operations

• iGaming

• Video Lotteries

• Content

• Casinos

• Social

 

Pro Forma Revenue Mix (based on 2013):

• 51% Gaming Equipment'

• 35% Lotteries

• 8% Interactive

• 6% Other

 

Geographic Revenue Mix:

• 46% US and Canada

• 36% Italy

• 18% International

 

 

Q&A

  • Process & Roadblocks:  goal was to create strategic value for shareholders, no other transaction more strategic!  No anti-trust issues. "CEO's Dream Strategic Transaction"
  • Cost savings of $280 million are incremental to previously announced cost savings transactions
  • Break-up fee: not disclosed today, but standard break up fee.
  • Discussion timeline: talks moved from partnering to tying the know, positive relationship....was a full process and evaluated all possibilities and outcomes, this is the highest value creation for IGT shareholders.
  • Participation business: no significant shift from historical, but opportunity to bring size, scale, and geographic diversity.
  • Industry needed consolidation to remove excess costs.
  • Believe industry can be stronger and IGT (NewCo) can be stronger with fewer suppliers.
  • EGM not expect unusual rescission elections.
  • Regulatory concerns: looking at 9-12 months, shooting for front-end, earlier - need to license in a few additional jurisdictions, go thru anti-trust, two Board and shareholder meetings.
  • UK domicile: GTECH had requirement to be in the EU, also believe UK is a "fantastic" market to facilitate US-listing, English speaking, slight tax advantages.
  • UK tax advantage: 100-300 bps advantage, but not the driving decision rather strategic advantages drove decision
  • Game Ops - industry needs to innovate; size and scale will afford this innovation advancement
  • GTECH licensing: a small number, no jurisdiction would appear to pose a risk to the transaction
  • Additional industry consolidation required?  No such thing as a pure gaming, slot machine supplier anymore.  More of a "distributed gaming" world.
  • Merger rationale: Reduce vulnerability and add strengths

RISK INCREASING?

Client Talking Points

JANET YELLEN

Yellen’s comments to Congress on Tuesday were deemed as more Hawkish, she defended keeping interest rates low but opened the door to quicker rate hikes if the labor market strength continues. We remain on the other side of that as we see economic growth continuing to slow into Q3.

PORTUGAL

Has Portugal reached a bottom? The country is now leading Europe on the upside. Now Riforte Investments SA, a holding company in the Espiritu Santo family, missed a $1.2B payment of commercial paper yesterday. Central Bank Governor, Carlos Costa, made a statement saying shareholders of the parent company were standing ready to inject capital into the bank if need be. Without being on the ground, it seems surprising Banco Espiritu Santo’s bonds and stocks have recovered a portion of the losses today with the news of another missed payment unless a big buyer came in to support the market. The 7.125s of 2023 jumped 8.8 points to 79% of par (10.6% yield) and the shares rallied 18%. Portuguese ten-year sovereign yields are down -8 bps currently.

VOLATILITY

The VIX closed at 11.96 1 day percent change of 1.18%, our immediate term risk range is now 10.32-12.94. Volatility has been at generational lows across asset allocations and continues to tick lower, we see the risk increasing the more you push the ball under water.

Asset Allocation

CASH 14% US EQUITIES 8%
INTL EQUITIES 10% COMMODITIES 22%
FIXED INCOME 24% INTL CURRENCIES 22%

Top Long Ideas

Company Ticker Sector Duration
HOLX

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.

OC

Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.

LM

Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.

Three for the Road

TWEET OF THE DAY

$INTC does the right thing, moves biz to net cash neutral reqmt. To repurchase $7B of stock in 2H14 & $10B more in 2015. Wow.

@HedgeyeBerger

QUOTE OF THE DAY

Hard work spotlights the character of people: some turn up their sleeves, some turn up their noses, and some don't turn up at all.

-Sam Ewing

STAT OF THE DAY

Today in 1941, Joe DiMaggio had his 56th consecutive game with a hit - that's still a record.


LV LOCALS: THE MIRAGE OF A RECOVERY

At best, higher housing prices helped stabilize locals gaming revenue.  In the face of potentially lower prices going forward, gaming demand could dry up – not good for BYD and Station Casinos.

 

 

CALL TO ACTION:  DRY DEMAND IN THE DESERT

Las Vegas Locals gaming revenue have been stagnant for a while despite a pickup in home prices, but at least had stabilized.  It seemed attributable to a delayed wealth effect – housing prices proved to be the most statistically important driver of Locals gaming revenues during the boom.  However, falling sales volume – a demand indicator – since July may have been indicative of a weak overall housing environment despite higher prices.  Indeed, Q1 locals gaming revenues were disappointing after months of stability and the first 2 months of Q2 deteriorated further.

 

Our Hedgeye Financials Team sees downward pressure on home prices as they usually lag demand by 12-18 months.  The recent gaming revenue performance and declining prices would not be good for BYD and Station Casinos.  Historically, Vegas home prices have a 70% correlation with Locals gaming revenues.  At the very best, the upcoming housing environment should prevent any Locals casino recovery.  At worst, the already fragile Local customer will tighten her purse strings even more.

 

LV LOCALS: THE MIRAGE OF A RECOVERY - ll

 

EVIDENCE:

The Phoenix and Vegas housing markets have mirrored each other in the recent housing bubble and recovery.  While Phoenix home prices have remained relatively robust, home sales have declined since last July.  A number of comments from an ASU report on the Phoenix home market in May were quite disturbing:

  • Total single family homes sold fell 19% YoY with those under $150k plunging 37% YoY
  • The percentage of residential properties purchased by investors continued to decline from 16.3% in April to 16.1% in May.
  • Weak demand from 1st time home buyers
  • Outlook:
    • Some home sellers appear to be cancelling their listings and waiting for another time when buyers have a greater sense of urgency.
    • Many families are choosing to stay in their homes longer than they used to 10 to 15 years ago.
    • The mix of homes that are selling has changed a lot in the past 12 months. There are fewer distressed homes and far fewer homes priced under $150,000. This tends to push the averages and medians upward even if prices are stable.

Las Vegas home demand is not much better.   According to GLVAR, Southern Nevada total home sales (single family, condos, townhomes) declined double digits every month since January 2014.  Furthermore, in June, short sales – when lenders allow borrowers to sell a home for less than their mortgage obligation – spiked to 10.8% of all existing local home sales – up from 7.9% in May.  

 

LV LOCALS: THE MIRAGE OF A RECOVERY - LLL

 

CONCLUSION:

Housing is a critical component of the health of the Las Vegas Locals gaming market. With sluggish top-line gaming revenues thus far in 2014, more weakness may lie ahead for the Locals market as any support from rapidly rising home prices is taken out.  Of the publicly traded gaming operators, BYD is most sensitive to the Locals environment.


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

CHART OF THE DAY: Risk Happens Quickly (Cue Portugal)

Takeaway: Is Portugal the proverbial canary in the global market coal mine?

 

CHART OF THE DAY: Risk Happens Quickly (Cue Portugal) - 77


Sleep Training the Markets

“And a young prince must be prudent like that,

giving freely while his father lives

so that afterwards in age when fighting starts,

steadfast companions will stand by him and hold the line.”

-Beowulf

 

As many of you know, I recently joined the ranks of fatherhood after a solid run as a bachelor. Fatherhood is great on so many levels, but also very intriguing intellectually. As my daughter emerges on her 6th week, her mother and I have started talking a lot about sleep training, or lack thereof.

 

It seems there are many different (and really divergent) views on how to encourage a baby to fall asleep on a timely basis and, also, how to to ensure she gets the right amount of sleep.  On one extreme, there is the "cry-it-out method," in which the infant figures out how to sleep on their own. On the other extreme is "attachment parenting" in which the infant is basically brought into the familial bed.

 

Sleep Training the Markets - baby1

 

After doing a survey of my friends, one suggestion that was most unique was to read Beowulf just before bedtime.  I’m not sure if we will employ the so called “Beowulf Method,” but admittedly if it didn’t put our little Emmy to sleep, it would certainly work with her parents.

 

Speaking of sleep training, global asset markets continue to be in deep REM sleep.  In our Q3 themes deck, we emphasized this with our theme: Volatility Asymmetry.  A few highlights from that theme include:

 

  • U.S. equity volatility is literally at an all-time low and well below the 20-year mean of 20.05;
  • Fixed income volatility is also literally at an all-time low and the current reading is 54.03, which is in the 1.5% percentile versus the long run mean of 99.7; and
  • Finally, the JPM Global foreign exchange volatility index is at 5.45 versus the long run mean of 10.6.

Yes, it is official -- the world’s central banks have lulled the markets to sleep, for now at least.

 

Back to the Global Macro Grind...

 

The interesting thing about global markets of course is that global risk can happen all at once.  Any of you that have invested and thrived over the last decade know this fact only too well.  As of late, so do those investors that have parked capital in Portugal.

 

No doubt most of you have been following the woes of Espirito Santo family of financial institutions in Portugal over the last month.  This morning the news actually got incrementally worse.  Specifically, Riforte Investments SA, a holding company in the Espirito Santo family, missed a $1.2Bn payment of commercial paper yesterday.

 

The Portuguese Central Bank Governor was quick to put on his super central banker cape and fly to the rescue.  In prepared comments, Carlos Costa indicated that shareholders of the parent were standing ready to inject more capital if needed.  In the short run, this has actually helped as Banco Espiritu Santo’s bonds and stocks have recovered a portion of their losses.

 

Nonetheless, as we’ve highlighted in the Chart of the Day below, Portugal has disconnected with Europe rather quickly in the last month or so.  Over the month, Portuguese equities are down more than 12% and are now down on the year just over 4.2%.  Of the major markets in Europe, only Russia is down more (for some obvious reason related to the Ukraine).

 

No surprise, Portuguese sovereign debt has seen a comparable spike in yields.  While the 10-year yield of Portugal is still at a reasonable 3.73%, the fact remains that this yield has widened dramatically versus its peripheral peers Italy and Spain.  We have also seen Portugal’s sovereign debt auctions have a much tighter bid-to-cover as of late.

 

The big question remains whether this is a canary in the proverbial global market coal mine, or, conversely, whether the bad news is priced in.  Our Financials Sector Head Josh Steiner likely put it best in his weekly Risk Monitor note when he wrote the following (emphasis mine):

 

“Portugal's Espirito Santo Group continues to dominate news flow on the banking front. Both EU and US global bank swaps are widening sharply, and TED Spread is beginning to widen as well. For now, there appears to be no reason to assume that Espirito Santo's problems are widespread, but there is a rising level of uneasiness as investors ask how could this bank, which was under so much scrutiny for the last few years, suddenly be now having such problems?”

 

His point is an astute one and time will tell whether this is the awakening of risk that seems to be broadly not priced into global asset classes.

 

Unfortunately for Europe, which remains under the strains of too much debt, the economic data coming out of Europe as of late, with the exception of the United Kingdom, has been less than robust.   Most telling this week was the reading from the German ZEW economic expectations index.

 

Expectations coming into the number were for a notable deceleration, but the actual number was much worse than expected. Specifically, July printed 27.1 versus expectations of 28.2 (29.8 prior).  In reviewing the leading indicators for May, industrial production fell for a third consecutive month, missing expectations, and factory orders also missed. The ZEW Current situation survey also fell sharply from June while consensus expected a slight deceleration. That gauge printed 61.8 versus expectations for 67.4 (67.7 prior).

 

Growth slowing and banks imploding . . . perhaps our call that the U.S. Federal Reserve will be more dovish than consensus (read Jan Hatzius) believes will happen sooner than expected.   But, hey, China just beat GDP by 0.1%, so there is that...

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.49-2.58%

SPX 1

RUT 1140-1170

BSE Sensex 249

VIX 10.32-12.94

USD 79.86-80.46

Gold 1 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

Sleep Training the Markets - 77


RH Black Book - Real Estate Deep Dive (7/17, 11am ET)

Takeaway: Join us for a call to debate the key issue today facing RH – real estate. Our deep dive will show why we think this story is far from over.

Please join us on Thursday, July 17th at 11:00 am ET for a call titled RH: Real Estate Deep Dive. We’ll be releasing our 2nd  Black Book on Restoration Hardware, specifically outlining the key issues that we think are critical to the investment thesis and the stock at this point in the company’s growth trajectory.  The reality is that some of the key factors to this story deserve greater scrutiny today than they did just $30 ago. 

 

We’ll hit on several topics, but the key focus on Thursday will be real estate. The crux of our commentary will focus on the likelihood of success in RH’s build-out of its large format Full Line Design Galleries. We’ll outline the biggest opportunities, potential risks, and whether or not the company is set up to execute on this opportunity. Ultimately, we’re going to flush out the real estate profile and potential store growth in the same way and using the same tools many retailers use to analyze their own store growth opportunity.

 

KEY TOPICS WILL INCLUDE:

1) What does RH’s addressable market look like, and how will that evolve over the next 5 years?

2) How many markets in the US can support a Full Line Design Gallery at the sales productivity standards that RH is setting for its’ new stores?

  1. We’ll drill down on specific markets that have been announced, but will also analyze in great detail other markets that we think are likely candidates that the company has not yet announced.
  2. We’ll look quantitatively at the underlying economics of each FLDG market.
  3. We’ll break out ‘fill in’ markets versus new markets.
  4. The costs of the properties is evolving. How this is impacting RH’s ROIC?

3) A look at trends we’re seeing in anchor tenant space, and why we’re seeing more premium space available than most people might think.

4) Category expansion, and which categories present the biggest opportunities (and potential risks) at retail.

5) How much of a risk is a housing downturn to the RH story?

 

Participant Dialing Instructions

Toll Free Number:

Direct Dial Number:

Conference Code: 275779#

Materials: CLICK HERE

 


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