Multimedia Games Is Return-Free Risk

| About: Multimedia Games, (MGAM)
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Summary

Multimedia Games agreed to be acquired for $36.5 per share, which was a huge premium to the price at the time.

The only justification for $36.5 is that another company has already agreed to pay it.

The current price of $35.94 represents a discount of only $.54 to the acquisition price.

If the deal fell through, the stock would have due cause to plummet.

The acquiring company, Global Cash Access Holdings, has seen their stock drop since the deal was announced.

Multimedia Games Holding Company, Inc. (NASDAQ:MGAM) is a designer, supplier, and manufacturer of gaming machines. The company primarily sells their products to casino operators in North America, international lottery operators, and commercial bingo gaming facilities. The majority of gaming revenues come from participation arrangements or development and placement fee arrangements. When I originally started on this article, the discount was only $.14. I'm bearish on holding the stock any time the discount to acquisition value goes under $.30. I would become bullish at a discount of $1.00 to $1.20.

The acquiring company

Global Cash Access Holdings (GCA) is expected to offer $700 million in senior secured notes to finance their acquisition of MGAM. Shareholders of MGAM have no problem with the deal and voted in favor of the merger. 87% of eligible shares were voted in favor of the acquisition.

The price movements

When the deal was announced, it signaled positive things for MGAM and negative things for GCA. Look at the stock price chart below and see if you can tell when the deal was announced:

If you guessed early September, you were right. The deal was announced with an expected price of $36.50 and the shares immediately jumped. However, you'll also notice that in October there was a dip in the share price. That dip represents the risk inherent in a position in MGAM. The company is being acquired at a substantial premium to the fair market value it held prior to the deal. If the deal fell through for any reason, there would be nothing to support the current price. The market had already evaluated the company and determined what it was worth. I think it is unlikely that the deal will fall through, but 14 cents isn't near enough compensation for that risk. The deal is expected to close in early 2015. Since the compensation for holding the shares is now $.56, it is within the reasonable range. I still feel the risk is too high for anything other than a very small share of the portfolio (less than 1%) unless the expected return increased.

If I was already holding shares of MGAM in a tax advantaged account or eligible for long term gains, I would be putting in a limit sell order around $36.12 to $36.20 because I expect the occasional bumps and dips in the stock price to be enough to trigger that. If the position MGAM was more concentrated than 1% to 2%, I would be setting the limit sell order lower to increase the odds of being out of the stock by the holidays. That's a personal psychology thing with not wanting to combine the downside risk with the stress of the holidays, not because I think the holidays make bad news more likely.

That seems interesting:

It has already been reported that:

"The Nevada Gaming Control Board recommended approval of the acquisition following a hearing on Thursday. It also approved the application for deregistration of Multimedia Games as a publicly traded company."

The NGCB uploads their minutes in a PDF document, rather than an HTML page. I've included a link, but be advised it links to downloading the minutes rather than to the website. Here are the minutes from the NGCB meeting. The minutes confirm the report that the NGCB was favorable to the merger.

However, neither the investor relations page for MGAM nor for the investor relations page for GCA makes any mention of this news. Given that this news should be relevant for the company, I thought it was interesting that neither company was publishing in that regard.

GCA may have some wiggle room

If anyone knows how the Nevada Gaming Control Board operates, it would be GCA. I took a look at the profiles of the directors of the company. Mike Rumbolz "additionally served as a member and subsequently the chairman of the Nevada Gaming Control Board, and is the former chief deputy attorney general of the state of Nevada".

I expect that he will be guiding this process and the only way this merger would get derailed is if he wanted it to get derailed.

Would they want it derailed?

I doubt that GCA would have any intentions to sabotage the deal; the most likely scenario by a large margin is that it goes through. That's why the stock is trading so close to the agreed upon price. However, this represents a very negative skew to the potential returns. The upside is pretty much capped at $36.5. If the deal doesn't go through, or if there is any doubt about the deal, the stock price could fall. Investors need only look back to October 2014 to see how the share price dipped. For a while, there was significant upside in MGAM, but that has been entirely priced out of the investment.

Remember that this deal is being financed with debt that has not been issued yet and that the plans of GCA are subject to the availability of financing on the terms they are willing to offer. The notes will not be publicly traded. If the terms offered on the debt were substantially worse than what GCA was anticipating, it may give them cause to avoid the deal.

Conclusion

While it is very likely that this deal will go through, the potential return on holding the shares is not enough to compensate investors for the slight possibility of suffering a very substantial loss if anything goes wrong. When shares were priced at $36.36, the potential return of 0.39% was terrible compensation for the risk and time. At $35.94, the potential return of 0.99% is not so bad, but it is still a relatively weak return. Around $35.50 to $35.30, assuming no meaningful negative events have been released, the shares get interesting and I get bullish in the context of 1% of a portfolio with virtually no trading costs.

In early November, the shares were priced around $35.00, which does represent an acceptable level of upside relative to the risk. For investors with substantial capital and very low trading costs, it may be appealing to short the company whenever shares are trading over $36.40. The potential loss of $.10 per share would be a relatively small risk when any negative news would provide the opportunity to cover at substantially lower prices.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.