“Life is simple, but we insist on making it complicated…”
Last February we published watch list guidance on this company in an exclusive article to our House Edge marketplace site members. That day the stock traded at just under $24. Since then it has dipped slightly to $21.47 largely due to the general sluggishness of the entire gaming sector. Days ago, on May 9, the company reported its impressive 1Q19 results, the headline of which was that it had achieved a 99% reduction in its operating loss and was now sitting at the cusp of profitability for Q2 and beyond.
While high tech/internet stocks that continue to lose money usually get a free pass from Mr. Market and resume upward climbs even after reporting mounting losses, stocks like PlayAGS (NYSE:AGS) do not. And therein lies the opportunity for investors in this small, but robustly growing slot maker.
PlayAGS is a manufacturer of electronic gaming machines that also has modest segments in real money wagering and card shuffling machines. Its core business is the installation of its machines in tribal casinos and cruise lines against long-term revenue share contracts with those entities. It is also moving aggressively to build its installed base of bingo machines in Mexico, which has a total installed base of 20,000 machines. So PlayAGS has run room in that market as well as Canada.
The company is essentially a creature of private equity giant Apollo Global Management which now sits on 33% of its entire outstanding. Among the top five holders also are Caledonia, FMR, BlackRock (NYSE:BLK), Park West. Last January, the company debuted with an IPO priced at $16 raising $164m. So in less than a year of posting losses, it has essentially reached breakeven. It is thinly traded, but followed by a handful of large bank analysts. It’s a story stock for reasons entirely out of the realm of today’s romantic pursuit by Mr. Market for the next unicorn hiding in the forest.
Not a unicorn but a pure play where few exist
A quick review of the slot machine business.
In the early 1980s, when legal casino gaming really began to burst the bonds of illegality and start its inevitable creep across the US, the slot manufacturing business was dominated by a single giant, Bally Manufacturing of Chicago. Expansion soon gave birth to another big competitor who made tech forward video slots in poker and blackjack: International Game Technology (NYSE:IGT). And they were joined by a floodtide of competitors from the amusement gaming space as well as entries from Japan like Konami. Since then via mergers or buyouts, all the big time slot makers are now part of giant, diverse gaming tech companies like the aforementioned IGT, Scientific Games (NASDAQ:SGMS) or Aristocrat Leisure (OTCPK:ARLUF).
As a result, the global majors' shares the past year have been subject to macro headwinds blowing out of the China economic and trade issues, ferocious competition ignited by the race to close deals on sports betting as that sector explodes, the social gaming space. Depending on the market perception of which of its verticals will be impacted by macro events, the big guys' shares will either spike or take big hits. Their slot business often looks like corporate orphans to the market.
Meanwhile, this compact, tightly-focused company that makes, sells and leases its highly diverse set of slot machine titles has performed well in its space and is slowly gaining market share. For context, the total installed base of slot machines in the US and Canada is edging close to 1.3m machines. Of these, 365,700 are in tribal casinos, the company’s prime target.
According to a 2018 study by Technovio Research, it expects CAGR from now through 2022 to reach 16%. This growth will be driven by the adoption of slot machine products to online systems. In the past, if a player sitting at a machine playing say Lucky Sevens got bored, would need to get up, walk over to another machine and select from many options the game he or she wished to play. Now, one click and the same machine’s video screen displays a choice of new games. This is what is driving growth in the sector in general and where PlayAGS with 25 titles and more coming from its new Reno studio will gain share. (Below: Global slot growth: Source: Technovio Research)
We broke down the trend of total machines installed or removed in the US and Canada and found that the tribal sector had a significantly lower number of removals and higher percentage of additions than did the commercial sector. Tribal gaming is healthy because it is more geographically diverse and operates in some states where commercial gaming is not legal. So there lies what we see as a very, long healthy runway for PlayAGS that we do not believe is yet reflected in the stock.
The company has a business model which ironically, in our view, is too simple and straightforward for today’s market to understand below the surface. All it sees is a small slot machine manufacturer focused on tribal casino business. What it does not see is how tight concentration, freedom from global headwinds and growing popularity of its diverse games can build a small company into a much bigger one in a short time. The market is there. The company business model is sound.
And its performance in 1Q19, just a year from its IPO, is encouraging. I believe that’s what Apollo Global saw when it did its deal that helped bring them public. (Company headquarters in Las Vegas: Source PlayAGS)
A capsule glance at 1Q19 results PlayAGS(NYSE)
Price at writing: $21.47
52-week range: $18.62-32.80
Volume: 446,077. Thinly traded status, which we attribute to Mr. Market not really understanding the stock because of its direct, pure play business model dwarfed from visibility in a huge diverse sector dominated by giants.
Market cap: $760,272,000
Revenue (ttm) $298m.
1Q19: Revenues $73m, up 13% y/y. Recurring revenue up $52.9m y/y, up 7%.
1-year target analyst consensus: $32.90. Our target based on our internal metrics measuring RPD from our own archives(Revenue per day) yields a sales, margin and EBITDA goal that gets us to $36.00 much closer to consensus than our usual forecasts tend to be. In any event, this we believe makes this stock worth continuing watch list status if not an entry point now in the low $20s.
The key risk we see is the high concentration of ownership among the top five institutions. If they get antsy about the economy in general or the specific pace of earnings growth of the company going forward and start to sell off large chunks of the stock in a thin market, it could take a hit.
A slowdown in the US economy could impact RPD as customers curtail trips or shave their normal gaming budgets.
The road ahead looks smooth on fundamentals
Good management focus, rifle shot rather than blunderbuss on a growing market, goal to reduce leverage, opportunistic acquisitions (Integrity Gaming of Canada last February) that are accretive and growing presence in online slot space.
Net loss: Improved by 100% y/y from $9.5m to $100,000, essentially even. We anticipate that by Q3, the company will be firmly in the black. Much of 1Q19 revenue increase was driven by the increase from its purchase of the Integrity installed slot business in Canada and a 25% increase in its installed base of table games.
1Q19 posted the sale of 1,024 slots placed in 80 casinos in 23 states - a good geographic spread.
At its current trade, this stock could have a nice surprise ahead FOR Q2, 3 and 4
During 1Q19, the company’s business was bruised by weather-related shutdowns in casinos with unusual winter storms that closed them for days at a time.
Debt to equity ratio: 3.84 or $53m at end of 1Q19. Management has targeted to go to 3.00 or just below over the next year and a half or less and has a $50m revolver untapped to assure it will meet all obligations out of cash flow going forward.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.