Scientific Games Corp's High Accounting Risk

| About: Scientific Games (SGMS)

Scientific Games Corp (NASDAQ:SGMS) has been borrowing money again, although numerous warning signs suggest that the New York lottery service provider's management might not spend responsibly. The company's financial statements reflected an AGR score of 9 in June, indicating higher accounting and governance risk than 91% of comparable companies.

The subsidiary, Scientific Games International, Inc., said it is planning to raise $250 million in debt that comes due in 2020 in a private offering targeted at investors such as institutional buyers. The company wants money to buy back or pay off debt due in 2016 and for general corporate purposes such as funding acquisitions, according to a press release dated August 15. On the same day, Scientific Games filed a different press release with the Securities and Exchange Commission in which it said it had already priced $300 million of debt due 2020.

Obtaining some extra time to pay off debt can certainly be a positive move. Nonetheless, Scientific Games remains a company that depends greatly on funding from outside sources. Its total debt as of March 31 amounted to more than $1.387 billion, or nearly three times the amount it had in total equity. By contrast, the median debt burden for the industry amounted to nearly 79% of equity.

What kind of management has decided to pile up so much debt? As we pointed out in May, billionaire Ron Perelman effectively controls Scientific Games, as he owns roughly a third of it through MacAndrews & Forbes, the holding company of which he is the sole stockholder. Other board members designated by MacAndrews & Forbes include the company's executive vice chairman and chief administrative officer Barry F. Schwartz and its senior vice president of worldwide government, legal and business affairs Frances F. Townsend. Meanwhile, Scientific Games' chairman and CEO A. Lorne Weil and its Asia-Pacific CEO Michael R. Chambrello work for the company, so that most directors on the 11-person board are blatantly dependent on Perelman.

With few checks and balances in place to ensure that management acts in the best interest of investors, Scientific Games has been spending in ways that suggest possibly problematic boosting of earnings. After the company purchased the U.K.-based fixed odds betting terminal supplier Global Draw Limited in 2006, it estimated that it had paid $633.7 million more for its acquisitions than they were worth on the books, or around 36% of total assets. This proportion was the same as of March 31, 2012, although companies typically have goodwill amounting to less than 20% of their assets.

Scientific Games has had more than $600 million of goodwill on its balance sheet for around six years, raising questions as to what extent the company's assets consist of estimations that might need updating. The company said in its filing for the year ended December 31, 2011, that it evaluates its goodwill at least annually.

Other warning signs exist. For example, Scientific Games this June filed an amendment to its annual report for the year ended December 31, 2011, but its note of explanation must be read in conjunction with other documents, so it is unclear and does not add to the company's credibility.

In another red flag, Scientific Games has recently experienced turnover in senior management. On September 30, 2011 the company said its general counsel Ira H. Raphaelson would be replaced by Grier C. Raclin effective that October 1. And on March 5, 2012, J. Robert Kerrey advised Scientific Games that he resigned as a member of the board on that date "in order to focus on other professional opportunities," according to a regulatory filing. On March 20, the board elected Paul Meister director effective immediately at the designation of MacAndrews & Forbes.

Meister isn't the ideal replacement. As the chairman and CEO of the consulting services firm inVentive Health, Meister does not seem likely to have much free time to devote to his responsibilities at Scientific Games. Moreover, he did not manage to save GenTek Inc. from filing for bankruptcy in 2002 when he served on the telecommunications and other industrial product maker's board. He's not the only manager with such credentials at Scientific Games, either; the company's audit committee chair Michael J. Regan served in the same role at Citadel Broadcasting Corp. when the radio station owner filed for Chapter 11 in December 2009.

Hopefully, these managers will do better with Scientific Games.

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  • Region: North America
  • Sector: Cyclical Consumer Goods / Services
  • Industry: Casinos / Gaming
  • Market Cap: $ 646.0mm (Small Cap)
  • ESG Rating: F
  • AGR: Very Aggressive (9)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I work full-time for GMI as a corporate governance expert. I am a corporate governance specialist.

Business relationship disclosure: I receive compensation from GMI Ratings to write about corporate governance.