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We are initiating coverage on International Gaming Technology (IGT), the world's largest manufacturer of casino gaming machines, with a hold recommendation.

With 70% market share, IGT is the Intel of slot machines. IGT's stellar portfolio of titles gives it a competitive advantage that keeps rivals at bay, and it's reflected in the company's enormous profits. In 2005, IGT boasted over $1B in gross profits off $2.3B in sales. Return on equity (ROE) was an impressive 21%.

IGT's head and shoulders above the rest because of its heavy focus on research and development. While it spends twice as much on R&D as its rivals do, IGT also leverages its size across its fixed costs, which boosts margins above 30%. In general, IGT has chosen a good business, as barriers to entry in the slot machine space are very high: it takes IP, guts, and good technology to get in. It is essentially impossible for rivals to step in a with a lower priced machine, as casinos are not famous for price sensitivity.

Robust growth, high barriers to entry, and great gaming releases make IGT a stock to own -- at the right price. Slot machine makers undergo dizzying operating cycles -- machine replacement cycles are far from easy to predict. To combat this, IGT has been using its new cashless machines to smooth earnings. These machines are all the rage within the casino industry, even as far as Japan, where IGT has found new stomping ground. Japanese gaming facilities, say analysts, enjoy shorter replacement cycles. A ramp in Japan-driven machine implementation could hit IGT's bottom line like a ton of bricks.

We don't see IGT losing its stronghold anytime soon. One caveat, however: potential investors may want to track CEO Tom Matthews before jumping in the water. On February 15th, Matthews unloaded approximately $15M worth of stock; additionally, execs own less than 2% of the shares outstanding. We typically look for 5-10% insider ownership, as it provides a margin of safety. That said, with leading market share, industry-high margins, and $400M in 2005 free cash flow, IGT strikes us as a reasonable pure play on the slot machine boom.


IGT 1-yr Chart

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Source: International Gaming Technology Is A Serious Player (IGT)