- The weakness in International Game Technology is creating a buying opportunity in shares of Bally Technologies
- The acquisition of SHFL Entertainment will create $40 million in annual cost savings
- Look for the company's leverage ratio to come down from 4x to 3x in the next two years
While there remains some concern over a slowdown in the global casino and gaming industry, Bally Technologies (BYI) appears to be one of the best positioned companies in the industry going forward. I really liked what I saw in the latest quarterly results and the fact that the acquisition of Shutterfly, or SHFL Entertainment, has been completed, with the integration ahead of schedule. The combination will lead to annual cost savings of nearly $40 million, $10 million more than originally thought. On Bally Technologies' estimated $1.21 billion revenue base this fiscal year, the savings are rather significant. Recurring revenues now account for 51% of total revenues and continued gaming innovations should drive revenue growth going forward. I also see the company reducing its leverage ratio to 3x in the next two years.
Fiscal Q2 results
EPS for fiscal Q2 came in at $1.06, which beat expectations by $0.04 and were 33% higher than last year. Revenues came in at $285.2 million, 19.7% higher year over year, but missed expectations by $15.01 million.
Both EPS and revenues were quarterly records for the company. Adjusted EBITDA for the quarter increased to $102 million compared to $81 million last year. Operating margin increased to 27% compared to 24% last year.
Strong growth remains in Electronic Gaming Machines
Revenues from the company's Electronic Gaming Machines segment rose 7% to $88.1 million. Overall, the company sold 5,152 new units. In North America, Bally sold 3,652 units, of those, 2,000 units were replacement units.
I see the replacement unit market as an enormous opportunity and something the market is missing. Gaming companies need to continually be innovating and updating their machines to capture their customers. The intense competition among the regional gaming operators benefits the equipment manufacturers like Bally no matter what.
I see the replacement unit market being a steady and growing business for the company, especially since the company's Golden Tower, 88 Fortunes, Shadow Diamond, Siren of the Sea, Cash'M If You Can and the Quick Hit title games continue to perform very well with customers.
The international market remains strong for Bally with sales gains seen in Australia, Asia and Mexico. Weakness was seen in South America and in particular, Argentina. I see weakness in Argentina persisting as that country works through its economic problems. But, the growth in Asia and Australia will more than offset any weakness seen in Argentina.
In North America, the Illinois market remains strong for Bally and that should persist going forward. Q2 was the best-ever quarter for Bally in Illinois with over 1,000 video gaming terminals sold. Since the company entered the Illinois market, it has sold over 3,400 units with nearly a third of that occurring in the latest quarter. I see the Illinois market remaining strong into 2015.
The company's operations have high gross margins across the board
I like the gross margins seen across Bally's line of businesses. Electronic Gaming Machines recorded a gross margin of 51% in Q2. Gaming operations posted a gross margin of 70%. Systems division had a gross margin of 72% and table products came in at 71%. Overall, Bally sports a gross margin of 65%, which is higher than competitor International Game Technology (IGT), which has a gross margin of 57%.
New products to drive further revenue gains
Bally has a number of new products that I like and see boosting the company going forward. In table products, Bally has the MD3 shuffler and the Chipstar roulette chipper. The MD3 shuffler just became the fastest selling model ever in terms of reaching 5,000 units placed. The Chipstar just received its first commitments in New Zealand and the U.S. In Asia, Bally should see strong sales of its new commission-free versions of Baccarat and Pai Gow Poker. These two games are two of the most popular for Chinese gamblers.
SHFL's products complement Bally's
Besides the cost synergies, I like the fact that Bally and SHFL can cross-sell products. SHFL did a great job in Asia and Bally can now sell those games in North America. You see, one of the reasons for the acquisition of SHFL by Bally was to gain SHFL expertise in Asia and combine that with strength of Bally in North America.
One gaming product in particular that Bally had its eye on is Duo Fu Duo Cai. This game is just starting to rollout in the U.S. market, where it will be on a fixed daily fee. Duo Fu Duo Cai has been one of the top-performing games in Asia for quite some time. The SHFL content and gains will strengthen Bally's product offerings and give it a competitive advantage over International Game Technology.
WAP growth seen by the middle of the year
In looking at the rest of this upcoming year, Bally has several new WAP (wide-area progressive) games that will be introduced. These include James Cameron's Titanic, The Magic of David Copperfield, and Pink Ladies, which is a follow-up to Grease. These new games will be significant since the WAP installed base grew by only 16 in Q2. These new games should boost the WAP installed base significantly as these are some of the biggest titles in the industry.
Systems division represents another growth driver
Bally remains the market leader in developing hardware and software systems for the gaming industry. In Q2, new installs were a record for the company. In terms of hardware, growth was seen in the company's iVIEW and DM hardware systems. The strong demand for these two products boosted revenues, but brought the overall gross margin down slightly as margins on the hardware side are lower than on the software side. However, the gross margins for systems are still the highest across all of the divisions at 72%.
On the software side, Bally completed a record number of Elite Bonusing Suite installations. The company also just started rolling out its new Bally Enterprise Progressive System.
The company's strategy is to invest in systems R&D and then tap into its customer base to sell new software modules. The result is that systems revenues should grow 20% this year on the back of this. I see a big reason for the growth in systems is that the gaming industry is more competitive than ever and technology is what gives an operator its competitive edge. Because technology spending in the industry will continue, Bally as the market leader in systems for the gaming industry, will see continued growth from systems sales. Furthermore, it is worth noting that majority of systems customers do not have the following products from Bally - iVIEW DM, Elite Bonusing Software modules, and the Bally Enterprise Progressive System.
Interactive division could use improvement
While Bally leads the industry in systems, it lags behind International Game Technology in interactive gaming. This is an area that has a lot of potential and one which Bally needs to direct more resources. While the company's iGaming Platform is operational in New Jersey, it currently has only one customer. This is one area where I will be watching the company's progress closely to see if they can catch up to International Game Technology. Bally should be able to leverage its strength in systems technology and marketing to capture more market share in interactive gaming. The potential is certainly there.
Reducing the debt load remains a focus
One overhang on the stock is the debt from the SHFL acquisition. The company has a total debt load of $1.94 billion and the company plans to reduce its debt load to 3x over the next two years. Currently, it's at 4x. I see this as manageable with the $40 million in annual cost savings and cash flow from operations. In Q2, Bally paid down $58 million of debt.
Don't confuse the weakness in IGT with Bally
Shares of Bally are getting hit due to the weakness reported by IGT on its most recent call. IGT reported that they were seeing weakness in the regional gaming market and they were having difficulty in locking in sales. What Mr. Market is missing is that only 44% of Bally gaming operations are variable. CEO Ramish Srinivasan addressed this issue on the company's earnings call.
"So, in terms of our business spread across the various business areas that we have, it doesn't affect us that badly as it probably affects other companies. And in terms of revenue and business visibility, we have not seen any major change in the situation. The GGR weakness has affected Gaming Operations revenue to a certain extent but not as much as it has probably affected the other vendors in the business. But leaving aside Gaming Operations, as far as EGM sales, systems visibility, the rate at which customers are planning systems implementations and purchases, we have not seen a major change in all of that as far as our business is concerned."
Bally Technologies has a much more stable and reliable business model than competitor IGT. Mr. Market is punishing Bally due the weakness of IGT. For opportune investors, this presents a great buying opportunity as Bally has several growth levers as we head into this year and will further benefit from cost savings and debt reduction.