MGT's Hand Just Got Stronger
In December 2012, we wrote that MGT Capital Investments (MGT) holds an interesting hand. That hand just became even more attractive, in our view, following two unrelated events last week. WMS Industries (WMS-OLD), a key defendant in MGT's recently filed lawsuit, agreed to be acquired by Scientific Games (SGMS). Separately, MGT announced that it had retained Munich Innovation Group to help monetize its medical imaging patents. Neither event is reflected in MGT's share price, in our view, implying significant upside for investors.
WMS Deal Has Big Implications for MGT
In November 2012, MGT filed a Gaming Suit against WMS Gaming, as well as Caesars Entertainment (CZR), MGM Resorts (MGM), Penn National Gaming (PENN) and Aruze Gaming America for patent infringement. WMS and Aruze manufacture gaming machines that MGT believes infringe its patents. The casino operators (Caesars, MGM and Penn National) enable the infringement by having the WMS and Aruze machines on their casino floors. We would characterize the manufacturers as primary defendants. WMS, as one of the industry's leading manufacturers - according to Scientific Games, WMS has the second largest market share - is probably the most important defendant.
Thus, WMS agreeing to a $26 per share sale to Scientific Games is big news for MGT. Because the deal is so important for both Scientific Games and WMS, we believe pressure to settle the MGT case will mount. Scientific Games views WMS as an ideal acquisition target because the two companies have such complementary revenue streams. Their combination will contribute to dramatic revenue diversification and growth, according to SGMS. For instance, Scientific Games generated LTM revenue of $930 million, of which 54% came from Instant Tickets, 28% from Systems revenue and only about 18% from Gaming (see figure below). On a pro forma basis with WMS, LTM revenue would have been $1.6 billion, some 75% higher than for SGMS alone. More than half (53%) would have come from Gaming, 31% from Instant Tickets and the remaining 16% from Systems.
Scientific Games also expects the deal to enhance organic growth, particularly as the combined entity would attain greater geographic diversification than either company enjoys on its own. The pending acquisition of WMS is so important to Scientific Games that it characterized it as "so transformational" that it represents the "opportunity … of a lifetime."
Scientific Games LTM Revenue Through Sept 2012, Actual vs. Pro Forma
Source: Scientific Games
The timeline here also works in MGT's favor, we believe. Scientific Games expects that following a regulatory and shareholder approval process lasting several months, the deal will close by year end 2013. We think the Markman hearing in MGT's lawsuit could be scheduled for sometime in 2H13, just when the proposed WMS-SGMS deal is garnering intense scrutiny. Such timing would be consistent with that of other recent patent infringement suits. For example, Vringo (VRNG) filed suit against AOL (AOL), Google (GOOG), et. al. on September 15, 2011 and the Markman hearing was June 4, 2012 - about 9 months later. Similarly, Augme Technologies filed suit against Gannett (GCI) and AOL in 2011 and reported the Markman ruling in September 4, 2012.
Overall, the importance of this deal combined with the pending timeline suggests mounting pressure on WMS / SGMS to settle the case before it goes to the next level, in our view. A WMS / SGMS settlement could also create something of a domino effect that pressures the other defendants to settle, as well.
Realizing Value From Legacy Business Next, let's look at the company's plan to retain Munich Innovation Group. Why is this good news? The relevant patents pertain to the company's legacy medical imaging business Medicsight, which is no longer core. MGT's CEO noted in the press release, "these imaging patents do not fit with MGTs current business model."
Munich Innovation Group specializes in helping companies realize value for their IP. It describes itself as "a leading service provider for intellectual property monetization" and on its website notes that it "can be your most efficient way to transform your unexploited IP into a highly valuable and strategic asset." Munich Innovation specializes in brokering deals for patents and as such, it is much more likely to find a potential buyer for the Medicsight patents than MGT could on its own.
We believe it highly likely that MGT and Munich Innovation Group can reach a deal for the Medicsight patents (according to MGT filings there are 12, with 20 pending in various geographic regions). The benefits of such a deal would be two-fold. 1) A sale would allow management to focus all its efforts on pursuing the gaming patent claim and on potentially acquiring other patents that hold similar potential. 2) It would also strengthen an already solid balance sheet.
Bolstering Cash Position Going into 2013, MGT had roughly $5.5 million of cash and no debt. We estimate that the net cash balance could rise to about $9 -$10 million if MGT garners a few million dollars for the Medicsight patents. This would give the company a strong war chest to use to acquire other patents. Importantly, we would expect MGT management to be prudent with respect to additional patents. The company spent only $200,000 upfront to acquire the gaming patent and we believe additional acquisitions would likely be at about the same level or less.
Conclusion - Story Getting Better and Better We like the MGT story for the current gaming case, which we believe just got stronger. Moreover, the acquisition of other patents with similar potential could further sweeten the story, in our view. We continue to believe the shares offer an attractive speculative opportunity for investors.