Digging deeper into the incremental R&D
The vagaries of GAAP accounting force companies to expense Research and Development expenses as incurred. In the slot industry, some R&D is indeed maintenance but much of it benefits future periods and could be considered investment spend. WMS fell 3% yesterday – it was actually down more than 6% at one point – due in part to guidance for higher R&D reducing EPS by $0.10-0.12 in FY2011.
Would anyone care if R&D expenses were capitalized and WMS jacked them up by $10m? Think about it. Applying a 20x multiple on the $0.10 FY2011 hit yields $2 in value loss versus $0.17 ($10m divided by 58m shares) in stock value if R&D was accounted for as investment spend – and that would assume zero ROI. So the real question is whether the incremental R&D is recurring, i.e. maintenance, or is it true investment?. We think the latter.
While management was a little stingy with details of the incremental R&D spend, we’ve got some juice:
- $10m step up has to do with networked gaming – WageNET
- WMS has gotten a very favorable response to the WageNET products that are a few years out. Customers want the products sooner rather than later.
- Essentially accelerating the commercialization of WageNET
- Being opaque for competitive reasons (but some of it is what they’ve talked about like cashless account-based wagering)
- Opening India too, so they can work around the clock
- Won’t see a revenue benefit for 12-15 months
WMS has no debt and operating cash flow is finally ramping. The beauty of the model is that they can grow and still generate positive cash flow. The high class problem is where to spend it. Share buyback? Yes - $300 million worth. Invest in the business? Yes - $10m incremental in R&D and $40m in incremental Capex for Italy, leased games, and growing/refreshing the participation base. Rather than detracting from value, these expenditures will generate future ROI and should be accounted for as such.