Will MGTs '088 Patent' Lawsuit Hurt These 4 Gaming Giants?

by: Dividend Kings

The gaming industry, at least as that phrase applies to gambling, was especially hard hit in the financial collapse of the last decade, and many of the players have not recovered. Adding to the general malaise is that some of the companies within gaming industry have become among the chief players in the country's "patent wars", the cottage industry of acquiring patents for little more reason than looking for cases where those patents are being violated, and instituting litigation.

One such recent lawsuit has captured public attention, and a fair amount of confusion surrounding this lawsuit involves MGT Gaming's United States Patent No. 7,892,088 ("the '088 Patent") entitled "Gaming Device Having a Second Separate Bonusing Event." The patent application was filed in October 2001, and granted in February 22nd, 2011. MGT Gaming is majority-owned by MGT Capital Investments (NYSEMKT:MGT), a tiny (market cap of about $14.5 million) company with ongoing business in medical imaging hardware and software applications. In May of this year, MTG, with ample cash and no debt on its books, announced a plan to acquire what it believed might be valuable patents, the first of which was the '088 patent.

The '088 patent specifically refers to two or more linked games, that if a predetermined, specific criteria that was agreed upon were met, it would qualify the players of those games to a second, separate competitive "bonus round." These sorts of games are commonplace at most casinos. They are a far cry from traditional slots, and a trip to your nearest casino will show you just how popular these "competitive" games are. Note that traditional "progressive" games are not an issue of '088. The focus is solely upon linked units, which from time to time, when triggered, lead to a second, separate competitive game. Brand games at issue include Pirate Battle, Reel 'Em In, Great and Powerful Oz, Battleship, and Clue.

The defendants in the patent suit are Caesars Entertainment (NASDAQ:CZR), MGM Resorts (NYSE:MGM), WMS Gaming, a subsidiary of WMS Industries (NYSE:WMS-OLD), Penn National Gaming (NASDAQ:PENN), and privately-owned Azuze Gaming.

Caesars has been a disaster, with many of its 52 owned or managed casinos located in struggling Las Vegas and Atlantic City, and none of its 13 foreign locations in Asia. Since 2009, it lost $2.4 billion, $947 million, $732 million, respectively and this year is on track to lose at least another $1 billion. It suffers a crushing, long-term debt burden of nearly $20 billion, and its losses have led to negative shareholders' equity that will likely be about $90 million, and growing, by the end of this year. Caesars sold its Harrah's St. Louis casino to Penn National for $610 million in early November, but will likely be unable to sell additional casinos due to debt restrictions. If MGT wins the lawsuit, investors of Caesars Entertainment will take a big hit.

I don't see Caesars really having a lot of options. It will owe some $8 billion on its debt in 2014, and rolling over that debt will not come easily in this day and age. An equity offering is most unattractive at this time as the company's stock is selling at such a low price today, about one third of its 52 week high, that Caesars market capitalization is just $700 million. This is a recipe for bankruptcy, and I urge investors to avoid Caesars.

MGM is in much the same condition, unfortunately. It has not turned a profit since 2008. Its debt load is heavy, but at 68% of capitalization, is far less than Caesars 95% of capitalization. MGM is trying to grow its way out its losses, and its 51% owned MGM China is moving ahead on a $2.6 billion mega project in Macau. Less far along but still on MGM's radar is an $800 million project in Springfield, Massachusetts. I see little to like about this equity at this time. The big Macao project is still at least three years away, and by that time I suspect the domestic economy will recover enough for MGM's far ranging casinos to improve. I anticipate MGM stock will fall on any positive developments for MGT in the lawsuit.

Penn National, on the other hand, is bucking the trend of its larger siblings and is steadily profitable. It owns or manages 25 properties in the United States and Canada. It is on track to earn about $245 million this year, or $2.30 per share. This would be an all-time record year for the company. Penn National primarily operates outside the gambling meccas in Las Vegas and Atlantic City. In addition to the large St. Louis casino purchase referenced above, Penn National recently opened a casino in Columbus, Ohio, and announced a plan to split into two independent companies in a tax-free spin off. It will put its real estate holdings (which it believes the market chronically undervalues) into a real estate investment trust, while the remaining, gambling and gaming activities will be in the other company. Penn National's stock price spiked on the announcement by more than 30% on an intraday basis. Penn investors should watch the 088 patent lawsuit closely for any new developments favoring MGT to avoid losses.

WMS is in the business of manufacturing the games that are the subject of the '088 lawsuit. It sounded an alarm that it intended to ramp up its research and capital spending budgets to attempt to bring new games to market. Earnings in its first fiscal quarter of 2013 came to $9.3 million or $0.17 per share, down from an adjusted $0.24 per share a year earlier. I look for earnings to be similarly suppressed for the balance of the year. While investing in research projects is often a long-term positive for any company, in WMS' case the payback will likely not be for two years or more. In the interim, I look for WMS' stock price to trail the market. I would avoid the company for these reasons. But the '088 lawsuit makes WMS even more unattractive, as a win for MGT could send this stock tumbling.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.