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Tuesday, March 23, 1999

International Game Technology
Phone: 775-448-0110
Website: http://www.igtgame.com
Price (3/23/99): $14 5/8


Sometimes even the gorillas have a hard time collecting food when drought hits the jungle. With the number of new casinos opening across the country significantly slowing in number, investors in the nation's largest slot machine manufacturer have had an acute case of nervousness. International Game Technology, known in the industry as simply IGT, saw domestic shipments of slot machines slip 30% in fiscal 1998, which has caused many investors to look for the exit.

Also hurting the company over the past several quarters are low interest rates. Since IGT is a major buyer of annuities to fund jackpot liabilities from its machines, the lower rates raise the initial cost of buying the financial instruments. Similar to the payment system for many lotteries, the company pays its winners a set amount annually over a given time, normally 20 years, instead of giving those lucky enough to hit a jackpot a single lump sum. IGT is one of the few companies in the market that has actually been hurt by lower interest rates.

In addition, there are several competitors nibbling at the company's impressive market share. The most salient example comes in the form of the rejuvenated WMS Industries (NYSE: WMS). WMS managed to capture the attention of Wall Street when the company's line of slot machines based on the Monopoly board game became one of the hottest slots available in Nevada. While IGT may continue to dominate its competitors in size, the technical innovation and inroads those competitors have made has clearly dampened the enthusiasm of IGT's investors over the past year.

This year, after major lobbying efforts by several major casinos, the Nevada State Legislature is rumored to be considering legislation that will prohibit slot manufacturers from receiving a portion of the profit or revenue from machines placed on casino floors. With this type of arrangement behind a major chunk of IGT's profits, another major dose of uncertainty has been injected into the company's future.

The final blow came to the drifting stock on March 4 when the company announced that it may not meet the earnings estimates analysts had expected from the company. The earnings warning and the continued threat of negative legislative action caused the stock to trade as low as $14 1/8, half its yearly high and a level investors haven't seen in nearly two years. Bar -- Cherry -- Trouble.


Based in Reno, Nevada, International Game Technology is the nation's largest manufacturer of slot machines and related equipment. Slightly more than 75% of all the slot machines operating in the nation were manufactured by the company and bear the IGT logo. The company sells machines around the globe but has a significantly smaller market share abroad. The company's products include the full array of machines from the traditional reeled slots to advanced video gambling devices.

A significant chunk of the company's revenue, 42% in fiscal 1998, is derived from its proprietary games division. This division is responsible for running the country's largest portfolio of wide-area progressive jackpot systems. Machines running under these systems are linked together and have an extremely large top prize that progressively increases in value with every coin inserted into a machine on the network. IGT places these machines with essentially zero up-front cost and assumes the liabilities from the jackpots. The company then collects a percentage of the daily revenue or profit the machines generate. Megabucks and Nicklemania are two examples of these systems that IGT manages.

The company is a member of the S&P 400 MidCap index.


Income Statement
12-month sales: $880.8 million
12-month income: $157.2 million
12-month EPS: $1.39
Profit Margin: 17.8%
Market Cap: $1,596.6 million

Balance Sheet

Cash: $182.4 million
Current Assets: $672.6 million
Total Assets: $1564.1 million
Current Liabilities: $224.5 million
Long-term Debt: $792.2 million
Total Liabilities: $1016.8 million

Price-to-earnings: 10.5
Price-to-sales: 1.8


While accurately predicting lower interest rates would have been extremely difficult and the Nevada legislation came largely out of the blue, there were nevertheless signs that IGT had some difficult sailing ahead. With new casino openings slowing, especially in the Midwest, to a fraction of their former rate, it is little surprise that the company's total machine sales slowed in 1998.

Furthermore, those watching WMS and some of IGT's other competitors such as Alliance Gaming (Nasdaq: ALLY) would have seen that the other companies in the industry were gathering the most attention with their new machines. Companies must continually develop new and exciting games to stoke demand for replacements and upgrades, and IGT's recent lack of blockbuster machines has hurt the company's cause.


Even though the company may be scarred from recent tussles with its competitors and the disgruntled casino operators behind the prospective Nevada legislation, IGT remains the slot machine gorilla and has plenty going for it. As the slot machine industry goes through the later stages of a cyclical downturn, some of the company's competitors may not be around when (and if) the situation turns more positive. Many of the smaller companies in the industry, including former high-flyer Silicon Gaming (Nasdaq: SGIC), are in dire financial straits and may not be around to compete with IGT down the road.

It would also not be surprising to see the company continue to acquire companies like it has in the recent past. In 1998 the company bought Barcrest, a British firm, as well as the Australian-based Olympic Amusements in order to get its foot in the door of the booming gaming market Down Under. In March IGT also announced its intention to purchase its exclusive distributor to the Native American casino market, Sodak Gaming (Nasdaq: SODK).

IGT has recently stated that it expects total machine shipments to remain stable for the balance of 1999. While it's good to see the number of machines shipped firm a bit, it does not inspire hope for a killer year. But should California, Maryland, or Pennsylvania approve slot machines (all of which are in various stages of considering the option), IGT's total market will increase. Likewise, the massive group of machines shipped in the early '90s when casinos were popping up across the country are not getting any younger, and there is the potential for the replacement business to see a spurt in activity down the road.

The largest concern of IGT shareholders today has to be the rumblings coming from the Nevada State capitol. While it is doubtful the state representatives will ultimately pass such a measure that has virtually no benefit to the voters in the state, the power exerted by the casino operators will definitely be felt in future negotiations concerning the contract terms for the company's progressive slot systems. The writing is on the wall for increasingly difficult times from the proprietary games end of the spectrum.

At roughly 10x trailing and forward profit estimates, the stock is clearly trading at a significant discount to the rest of the market. The company has also managed to take advantage of the depressed value seen in its stock by buying back shares over the past several years. In 1998 alone the company bought back roughly 5% of its shares without materially changing its balance sheet, and continued share repurchases have been approved by the company. Even with all of its problems and shortcomings, IGT is still worth consideration from value-oriented investors looking for a leader that is currently down on its luck.

Related articles:
-- Silicon Gaming, Daily Trouble (9/29/98)
-- WMS Daily Double (10/1/98)

Paul Larson

Call Your Boss a Fool.

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