Bally Tech. Will Be Best Short-Term Performer in Gaming

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Antoine Taveneaux

Bally Gaming(BYI) sells slot machines (34% of sales), networks them and earns a recurring fee of betting pools (43% of sales), and provides player tracking, bonus-ing and slot marketing systems to casinos (23% of sales).

BYI will be the largest share gainer in the next 1-2 years, primarily from Konami and Aristocrat. BYI has high teens/low 20's share currently, but can grow to 25% in the next 1-2 years. One big driver (not yet in the numbers) is IGT's loss of an exclusive relationship with game designer, High 5 Studios. Now BYI can access these games and win share vs. IGT as well.

Pricing Power
The company has pricing power of 1-3% annually. Mix hurts a little lately as some new jurisdictions put in low priced VLTs, but the core business is not being hurt by mix.

Industry Trends
1) Machine sales: replacement cycles for casinos refreshing their slot floors were 10% (or every 10 years the whole floor was turned over) before 2008. Since then, capital spending by casinos has plummeted, pushing the cycle to 18-20 years for the last 5 years. This begins to pick up. The new jurisdictions are adding another 20-25K units for the next few years from a trough of 10k per year in 2011. BYI has the Curve and Alpha Pro 2, which are both getting great reviews.

2) Networks of high payout slots, or Progressives (there are both local area and wide area- I don't cut it that finely however). BYI has traditionally lagged here but my checks with 10 slot managers indicate this is changing from games such as Pawn Stars and Michael Jackson. A great business of recurring revenue from placed slot machines across the country.

Similar to a casino's "table hold", there is some near-term unpredictability to when and how often jackpots pay out referred to as the "jackpot expense". this has come under expectations recently and a reversion to a mean is a reasonable assumption (recent quarter GM was 70% vs 72% LY due to essentially bad luck). Notably total company Gross Margins came in at 66% vs LY 63% and expected 64%. So still a nice beat even with some bad luck.

3) Player tracking systems: IGT and BYI dominate here. High switching costs once casino already puts in place. This feature helps BYI to bundle and gain share better than most other competitors in new jurisdictions. Visibility here is strong and company noted this when raising eps guidance last call.

4) Recent activity in the industry: WMS was bought Jan 31 for a 50% premium. Activists are agitating at IGT. The whole sector is cheap and is at trough replacement cycles. New BYI CEO bought 25,000 shares post earnings call, which looks like a real buy given the size relative to his holdings.

Summary
F2013 EPS of $3.58 and 2014 of $4.23. With the bottoming replacement cycle, improving new jurisdictions, pricing power share gains, M&A activity, and renewed investor interest in a significant % of recurring revenue in the model, I believe company should trade at 18-20X PE. Notably, IGT used to get mid-high 20's multiples partly due to a bubble in gaming but somewhat to the steady income provided from slot businesses.

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