It's been said that getting a gambler to show up at a casino is the casino owners job, but keeping them there is the slot machine manufacturers job. With that in mind, WMS Industries (WMS) is pulling out all the stops to make sure that happens. At this year's G2E Gaming convention in Las Vegas (that's gaming as in gambling, not video games), WMS displayed an impressive array of new machines and upgraded products. For those old time players used to pulling a slot handle and watching a physical wheel spin around, those days are almost gone as the industry moves towards high definition graphic displays that simulate reel spins. But the changes don't stop there, many of the new games incorporate a user experience that is closer to a video game than a slot machine. Many of WMS's new machines even utilize touch screen capabilities. The object of course is to keep the player entertained and engaged, with the expectation that they will spend more time at the machine, which means spending more money.
WMS Industries is the 3rd largest player in the industry after International Game Technology (IGT) and Bally Technologies (BYI). WMS traces its roots back to 1943 where the founder Harry Williams was an innovator in pinball machines and invented the tilt mechanism. Today's slot machines are complex devices incorporating advanced operating systems, sophisticated technology platforms and innovative design features. Character and brand licensing also plays a big role in attracting players. WMS's portfolio of products include characters and brands such Monopoly, KISS, Wizard of Oz, The Godfather, Cheers, The Price is Right and Spiderman to name a few. The company generates revenues from selling units to casino operators and from leasing the machines to the operators, usually in exchange for a cut of the amount wagered by customers or won by the casino. The gaming operations segment (leased machines) represents about 1/3rd of total company revenues yet garners gross margins about 20 percentage points above the product sales segment. It is the company's focus to increase the level of the so-called participation games, or leased machines, yet revenues in this area are largely driven by consumer discretionary spending. High unemployment and slow economic growth is not conducive to rapid growth in this segment. However, some of this slowdown can be offset by market share gains if they develop attractive games that appeal to casino operators.
This economic scenario has also led to a slowdown in replacement capital spending and new construction projects by major casino operators around the world in recent years. Although WMS suffered a decline in revenues and earnings in its fiscal year ending June 2012, they remained solidly profitable and return on capital was well above its weighted average cost of capital.
Fiscal year 2013 ending June 2013 looks to be a period in which they can grow revenues yet increased R&D spending will likely result in roughly flat net income when compared to the prior year. Yet there is upside from that scenario. Besides the obvious benefit of a stronger global economy and increased consumer discretionary spending, WMS maintains an overcapitalized balance sheet with a net cash position as of June 30, 2012 according to the latest 10-K. Increasing leverage to buy back shares in this low interest rate environment seems to make sense at this point. Alternatively, using its free cash flow after capex of approximately $40 million to initiate a dividend would provide a current yield around 4.0% according to our estimates. Also, more activity on the M&A front might be beneficial with a lot of 3rd tier product manufacturers struggling to compete in this environment. In addition, increasing their presence in the interactive and social gaming arena continues to be a focus.
Today the company sells for around 10 times our estimated calendar year cash EPS and around 4 times 2013 EBITDA. Our discounted cash flow models projecting modest growth going forward produce values above $24 per share. The stock price was over $24.00 as recently as April of this year. Compared to its primary competitors IGT and Bally's, which sell at P/E multiples approximately in the 13-14 range, WMS would be valued in the $22-$23 range.
The combination of the catalysts mentioned above as well as some not discussed such as international growth and continued expansion in Native American gaming make that $22-$24 price range reasonably achievable over the next 12-18 months.
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