Bally Technologies (BYI), the producer of electronic gaming machines, has announced a transformational deal. Bally announced the $1.3 billion strategic acquisition of SHFL Entertainment, the company better known as Shuffle Master.
The deal is executed at premium valuation multiples and results in a quite aggressive build up in leverage, making me hesitant to invest in Bally. With shares and leverage at very high levels, shares have room towards the downside if the economy were to slow down.
Bally Technologies announced that it has reached a definitive agreement to acquire SHFL Entertainment (SHFL). Bally will pay $23.25 per share in cash for the company, for a total consideration of roughly $1.3 billion. The price tag takes into account SHFL's debt position of $8 million and current cash balances of $41 million.
Shareholders in SHFL stand to receive a 24% premium compared to Monday's closing price. With the deal, Bally is combining highly complementary technological gaming assets, offering a wide range of products. Bally gets access to the growing e-Tables market while increasing its access to key regions including Asia and Australia.
For the calendar year ending on October 2012, SHFL generated annual revenues of $259.0 million. Net income came in at $38.6 million. Based on the $1.3 billion price tag, the deal values SHFL at 5.0 times annual revenues and 33-34 times annual earnings.
The deal has already been approved by the board of directors of both companies. The deal is still subject to shareholder approval, regulatory approval and normal closing conditions. The deal is expected to close in the second quarter of the calendar year of 2014.
Bally Technologies ended the third quarter of its fiscal 2013 with $63.8 million in cash, restricted cash and equivalents. The company operates with $490.2 million in total debt, for a net debt position of around $426 million. Bally already has committed financing in place to finance the deal.
Total revenues for the first nine months of the year came in at $732.6 million, up 15.5% on the year before. Net income rose by 39.5% to $104.1 million. As such annual revenues could come in around $1 billion, while the company could earn around $140 million, as it guides for annual earnings between $3.35 and $3.45 per share.
Trading around $66 per share, the market values Bally at $2.7 billion. This values the company around 2.7 times annual revenues and 19 times annual earnings.
Bally Technologies does not pay a dividend at the moment.
Some Historical Perspective
Shareholders in Bally have seen reasonable returns over the past decade, a period within which shares have tripled. Shares were trading as low as $10 in 2005 to peak at $50 towards the end of 2007. The financial crisis sent shares back towards $15 in 2009.
From then onwards, shares have steadily regained lost ground. With year-to-date returns approaching 50%, shares are trading at all-time highs around $66 at the moment.
Between 2009 and 2012, Bally has increased its cumulative revenues by merely 4% to roughly $880 million. The company experienced a few difficult years in between. Net income has fallen from $126.3 million to $101.1 million in the meantime, but is expected to recover strongly in the fiscal year of 2013.
The deal does not come cheap. SHFL's revenues for 2013 could come in around $280 million on which the company could report net earnings of $40 million. This values the company at 4.6 times annual revenues and 32-33 times annual earnings.
This compares to Bally's operations which are valued at just 2.7 times annual revenues and 19 times annual earnings. On both revenue and earnings metrics, Bally is willing to pay a 70% premium compared to its own valuation.
The reason why shareholders are still pleased with the deal is the synergy estimates of at least $30 million. Based on statutory tax rates, incremental earnings from SHFL could amount to $60 million, bringing the valuation multiples down to 21-22 times annual earnings.
The pro-forma combination generated annual revenues of $1.3 billion over the trailing twelve month period. Of these, $644 million in revenues are expected to be recurring. Bally expects to report adjusted EBITDA of $415 million.
Net earnings could come in around $200 million before financing costs, or around $170 million after taking these costs into account. While Bally's net debt position will increase significantly following the deal, the equity valuation will come down towards 2.1 times annual revenues and 16 times annual earnings.
The market thinks the deal is quite attractive. Shares of SHFL rose towards $23 per share on the back of the news, increasing the value of the business by some $225 million. Bally's shares rose some 7% as well, increasing its market capitalization by almost $290 million. As such, the combined entity has seen its market valuation increase by roughly half a billion following the announcement of the deal.
Therefore I think the market is overreacting a bit. The combined market valuation of the firm is increasing on the back of the usage of leverage and $30 million in estimated synergies.
Half a billion seems a bit much, despite the strategic rationale behind the deal and increased diversification of operations, as Shuffle Master generated roughly half of its revenues broad. In all fairness, Bally stated that a major reason behind the deal was the IP portfolio of SHFL as well. Its strong innovation team made it the first company to introduce the card shuffler in casinos.
While the earnings metrics have come down overall, it is entirely attributable to a massive jump in leverage. The move is quite aggressive and could result in severe problems if an economic slump would come up in the coming times. The deal is a tiny bit too rich and too aggressive to my taste, making me stand on the sidelines.