Today's Short Opportunity: Bally Technologies

Today, we're going short on "11 O'Clock Stock." Also, take a shot at winning a free copy of our market-crushing newsletter Stock Advisor! Leave a comment below, with either a question about Bally Technologies or your own analysis of the company. The best comment each day wins a free subscription! To hear more about the series, click here to see a video from Motley Fool co-founder Tom Gardner. Can't make it at 11 a.m. ET? Come back to Fool.com, and we'll have the article in our Top Stories section 24 hours a day.

You know that pair of rose-tinted glasses you own? That glass of water that always seems to look half-full? Chuck 'em. Roll up your sleeves and grab yourself a magnifying glass, because we're bringing you our first 11 o'clock short recommendation.

Finding the market's best short opportunities requires you to look at the world a bit differently. It doesn't mean you have to have a pessimistic or even a cynical perspective on things -- just a critical one. That's something I've learned so far working with John Del Vecchio, who's heading up our new Big Short service launching in September.

John is full of great lessons, and great short ideas -- which brings me to my pick today. There are plenty of reasons to short a stock, but seldom do you come across a business that operates in a struggling industry, is flashing some serious financial red flags, yet remains priced as if times were still golden. I see all these things right now in Bally Technologies (NYSE: BYI  ) .

Bally Technologies fast facts

Market Capitalization    

$1.7 billion

Industry

Casinos and gaming

Revenue (TTM)

$778 million

Earnings (TTM)

$138 million

Cash/Debt

$145 million/$174 million

Key Competitors

International Game Technology (NYSE: IGT  ) , Scientific Games (Nasdaq: SGMS  ) , WMS Industries (NYSE: WMS  )

Source: Capital IQ, a division of Standard & Poor's.

An industry that's crapping out
Bally's builds and sells slot machines, video machines, lottery systems, and casino management systems, mostly to casinos in the United States. It has been in business for more than 40 years -- a good time to be in the gambling business, considering the tremendous expansion of state-run and Native American-owned casinos across the U.S. over that period.

But business couldn't be worse for the gambling industry right now. After hitting a peak of $34.1 billion in 2007, just before the onset of the financial crisis, gross gambling revenue for U.S. casinos -- the amount wagered minus winnings returned to customers -- has steadily declined.

Year

Gross gambling revenue (in billions)

2000

$24.5

2001

$25.7

2002

$26.5

2003

$27.0

2004

$29.0

2005

$30.4

2006

$32.4

2007

$34.1

2008

$32.5

2009

$30.7

Source: American Gaming Association.

No surprise, right? After all, we're in the middle of a terrible recession. The economy stinks. Unemployment is high. But it will bounce back. People love to gamble.

Ask yourself this: How much of the secular growth in the gaming business over the past several decades was fueled in part by the enormous expansion in consumer credit and housing prices? Las Vegas is sometimes referred to as the City of Lost Wages, but it wasn't just household income that kept the betting tables flush in recent years. Home equity loans and credit cards financed their fair share of trips to Vegas and other gambling hotspots.

A protracted period of tighter credit, lower home prices, and dare I say, higher consumer savings rates, could delay gambling's revival for years, if not decades.

That doesn't bode well for slot makers such as Bally. Hotel and casino developers will be hesitant to invest in new projects, and you can bet they'll try and squeeze every last nickel out of each gaming machine at their existing casinos before they have to junk them and replace them with newer models.

We're already seeing this trend play out for many of the industry's biggest casino operators:

Company

2007 capex

TTM capex

Change

Las Vegas Sands (NYSE: LVS  )

$3.8 billion

$2.1 billion

(44.7%)

Wynn Resorts (Nasdaq: WYNN  )

$1.0 billion

$422 million

(57.8%)

Boyd Gaming (NYSE: BYD  )

$297 million

$76 million

(74.4%)

Rolling snake eyes
If these secular headwinds weren't enough, Bally's latest results suggest that it's facing a potentially serious near-term slowdown in its revenue -- something that I don't think has been adequately reflected in the stock, or in the company's full-year earnings guidance.

Let's start with Bally's inventories.

Metric

June 2009

Sept. 2009

Dec. 2009

March 2010

June 2010

Revenue

$196.0

$187.3

$205.0

$190.6

$195.2

Inventories

$52.9

$52.9

$43.7

$42.9

$42.8

Source: Capital IQ, a division of Standard & Poor's, and company filings. Revenue from the discontinued casino operations segment has been excluded. Numbers in millions.

Normally, this would appear to be a positive trend. Inventory is declining faster than revenue, suggesting a positive sell-through for Bally's products. That generates cash and helps avoid potentially expensive inventory write-downs.

But Bally uses a build-to-order model approach to most of its manufacturing, meaning that it waits for a confirmed order before it makes and delivers the product. Inventory in the build-to-order business can therefore be a useful proxy for new orders.

In the most recent quarter, Bally's inventories hit their lowest level since the fourth quarter of 2003. That low inventory number in 2003 foreshadowed a sharp slowdown in Bally's sales, beginning in 2004 and running through 2005.

Another sign of a potential revenue slowdown can be seen in Bally's deferred (or unearned) revenue -- cash that has been paid to Bally before it delivers the product. Like Bally's inventory line, deferred revenue is a good indicator of new orders.

Metric

June 2009

Sept. 2009

Dec. 2009

March 2010

June 2010

Revenue

$196.0

$187.3

$205.0

$190.6

$195.2

Deferred Revenue

$49.1

$43.4

$43.1

$42.0

$33.9

Source: Capital IQ, a division of Standard & Poor's, and company filings. Revenue from the discontinued casino operations segment has been excluded. Numbers in millions.

Bally's deferred revenue has trended sharply lower in recent quarters, yet another sign that customers are slashing or delaying new orders.

Still, despite inventory down 19% and deferred revenue down a staggering 31%, Bally's revenue is virtually flat year over year. And most analysts are pegging Bally's revenue to actually climb 6% on average over the next 12 months, and nearly 12% for fiscal 2012.

I'm not much of a betting man, but given the trends I'm seeing in Bally's order volume, I'd wager some good coin on Bally's revenue falling short of those targets. It wouldn't surprise me at all to see Bally ratchet down its earnings guidance in the next quarter or so, especially if the economy remains sluggish and consumers keep spending more on food and diapers than they do on their gambling habit.

A pricey gamble
Still, Bally wouldn't make a great short candidate if I thought these problems were already sufficiently priced into its stock. Yet, as you are about to see, I don't think that's the case at all. In fact, Bally is actually more expensive than it was back during the economic go-go days of 2006 and early 2007.

Metric

FY 2006

FY 2007

FY 2008

FY 2009

Current

Price/Sales

1.6 times

2.1 times

2.1 times

1.8 times

2.3 times

Source: Capital IQ, a division of Standard & Poor's.

Now, you could argue that Bally's sales are depressed because of the recession, and that any measurable rebound (provided it doesn't also come with a higher stock price) would reduce that multiple. But Bally's stock price has more than doubled since hitting a low of around $13 in early 2009. I don't think that rise and today's price-to-sales multiple are justified, given the challenges still facing the gambling business, and the possibility of future revenue and earnings misses that Bally's order book suggests.

The bottom line
Investors betting on Bally Technologies today are gambling on a pricy stock with significant long-term and near-term challenges. In my opinion, the odds of a serious revenue miss over the next 12 months are higher than investors are currently anticipating in the stock price. That makes Bally a great short opportunity right now.

Looking for more short ideas, or ways to hedge the stocks in your portfolio against further losses in the stock market? Enter your email in the box below. You'll get our special report, "5 Red Flags -- How to Find the BIG Short," free right now, plus all of our latest research.

And don't forget to either hop in and ask a question or leave a thought on Bally Technologies in the comments box below. We're giving away a subscription to Stock Advisor for the best comment on each "11 O'Clock Stock" pick this week! To see rules for the Stock Advisor giveaway, click here.

Previous recommendations:

Come back to Fool.com tomorrow for another great stock pick. There's plenty more great stock advice, and you can find video of each day's recommendation as well! "11 O'Clock Stock" is sponsored by Motley Fool Stock Advisor.

The Motley Fool will wait at least 24 hours after this publication before shorting shares of Bally Technologies. To see an FAQ on "11 O'Clock Stock," click here.

Matthew Argersinger loves a good gamble now and then, but he doesn't own and isn't short any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (27) | Recommend This Article (48)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 27, 2010, at 11:02 AM, TMFMattyA wrote:

    If anyone has any questions about Bally Technologies or anything mentioned in the article, please post them. I'll do my best to answer them as quickly as possible. And feel free to tell my I'm crazy (as long as you say why) for recommending a short on this stock. --Matt

  • Report this Comment On August 27, 2010, at 12:11 PM, TMFmd19 wrote:

    I love the idea of shorting a sin stock! Not to mention that its a decent hedge against the consumer should the economy continue to be sluggish.

  • Report this Comment On August 27, 2010, at 1:10 PM, TMFmd19 wrote:

    I meant to ask, at what point should the short be covered? If we're shorting around $33/sh. are we looking to cover around $30 or do you see a lot of downside? Also, will there be selling/covering articles posted for the 11 o'clock stocks? Thanks.

    Matt

  • Report this Comment On August 27, 2010, at 1:34 PM, TMFMattyA wrote:

    Hi Matt,

    I see more downside in BYI than $30, but a lot depends on how things develop with their earnings over the next few quarters. Rest assured, when we decide to cover our position, we'll publish an update.

    I think most of the long position we intend to hold for at least a year, but that just doesn't work for a short. You have to follow the story much more closely and be ready to pounce when things move meaningfully in your favor.

    Thanks for your interest in the article and shorting.

    (another) Matt

  • Report this Comment On August 27, 2010, at 1:41 PM, prime22 wrote:

    How does one short a stock? I went to Fidelity web site for information, and it was especially clear to me.

  • Report this Comment On August 27, 2010, at 1:55 PM, TMFMattyA wrote:

    @prime22, check out our Fool Wiki page on shorting. It should answer all your questions about shorting a stock.

    http://wiki.fool.com/Short

  • Report this Comment On August 27, 2010, at 1:56 PM, plange01 wrote:

    a casino related stock in a depression is a great idea! you can turn empty casinos into storage and living space for the millions who have already been forclosed on...

  • Report this Comment On August 27, 2010, at 4:13 PM, davaidesign wrote:

    Considering that Vegas as a city in general took the biggest hit in this recession, wouldn't it then make sense to assume that they will make the biggest recovery once the economy starts turning around?

    BYI is cash flow positive, has little debt, and solid ROC. Low PEG, P/FCF not out of the ordinary. Nothing fishy about their books. Shorting Bally is betting against the economy, and in that case there are WAY better stocks to short. I wouldn't buy Bally, but I would definitely not short it. It would amount to a gamble, which Bally hopes people do more of going forward.

  • Report this Comment On August 27, 2010, at 4:35 PM, tekennedy wrote:

    Although a good general thesis wouldn't one of the casino operators be a better short? I think just based off of more regular replacement revenue that earnings should have more stability within this company. Also their financial health should help them endure any nearterm downturn in demand. Although not a cheap stock I wouldn't go out of my way to call it overpriced.

  • Report this Comment On August 27, 2010, at 5:44 PM, kinosternon wrote:

    I have to agree with davaidesign. BYI has a fair bit going for it. Shorting a gaming stock sounds great but I would have chosen PENN--it has a negative profit margin, negative ROE, and over 2 billion in debt. Furthermore, PENN has no operations in Nevada or Michigan and we can't blame the recession in those states for their lousy performance. They're just a lousy company. True, Vegas has been hit hard with the recession, but I believe it's due more to people not traveling to Vegas to gamble than it is to people not gambling. We're Americans, we'll always gamble--especially those that can least afford to do so. I live in Michigan and have four casinos within a 2 hour drive. If I care to drive 3 hours I have three more to choose from, and they're building another one only 15 minutes away. Why fly to Vegas? Oh, and BTW, did everybody notice how quickly BYI dropped from 3 stars to 2 stars today.

  • Report this Comment On August 27, 2010, at 6:00 PM, brucedieter wrote:

    In very bad times women will continue to have their hair done and folks will gamble. What a way to go out!

    Is it possible that orders have slowed while gambling halls are converting to the reality that folks have less? Slots are a good place to start and finish; wheels and tables chew it up too fast.

    Also we have states looking for revenue. And guess where they are turning? It isn't pari-mutual horse tracks.

    Vice is nice and it is always IN.

  • Report this Comment On August 27, 2010, at 6:48 PM, xuincherguixe wrote:

    Tough times for individuals can be great times for Casinos, but at some point it will be like trying to draw blood from a stone.

    At some point reality will be more powerful than desperation. How is the casino going to collect a million dollars that customers don't actually have?

  • Report this Comment On August 28, 2010, at 12:07 AM, TMFFuz wrote:

    Nothing fishy about their books!? How about the fact that they've extended payment terms (e.g.

    "stuffed the channel") and adopted a revenue recongition change early that accelerated revenue recongition and overstated growth and likely profit margins?

  • Report this Comment On August 28, 2010, at 6:52 AM, Alain988 wrote:

    Hi Matt,

    Did you check Bally's Insider Ownership? Is there any? If so what about recent selling by Insiders?

    Alan

  • Report this Comment On August 29, 2010, at 11:39 AM, markgiese wrote:

    Hi Matt,

    Did you consider that online gambling is pretty popular and growing. What impact do you suppose that will have on Bally?

    thanks,

    Mark

  • Report this Comment On August 30, 2010, at 9:35 AM, TMFMattyA wrote:

    @Alan, Bally insiders own less than 1% of the stock, and they've been pretty steady sellers lately. Nothing they've done or are doing suggests any confidence in the stock.

  • Report this Comment On August 30, 2010, at 9:37 AM, TMFMattyA wrote:

    @Mark, certainly the expansion of online gambling threatens outfits like Bally who serve the brick & mortar casino industry. And proposed legislation that could reverse some of the financial transaction restrictions on online gambling could see more gambling money move to the online space. It's just cheaper and more convenient for a lot of people.

  • Report this Comment On August 30, 2010, at 11:13 AM, arizonadon wrote:

    Ive seen a big change in the production of high tech machines. I would be real careful on shorting a company supply this tech upgrade. Also the need for casinos to stay high tech. I talked to a a machine installer and he said the casinos are moving machines that can be controlled upstairs, without opening the machine.

  • Report this Comment On August 30, 2010, at 8:46 PM, istoppucks wrote:

    The wiki article on shorting stocks was not much help.

  • Report this Comment On September 05, 2010, at 10:45 AM, blesto wrote:

    At first I was gonna make a contrarian ouperform pick to your short, for the heck of it.

    But even when BYI, " uses a build-to-order model approach to most of its manufacturing", suggested to me that maybe their CCC (Cash Conversion Cycle) might be a saving grace;

    it's not.

    Their CCC for '08-'09 is 131.8 days!

    This along with your other reasonings make BYI a decent canidate for shorting. But market sentiment could kill you.

    Anyways, I was only making outperform picks on CAPS so I would qualify for the "yesman" charm, but I'm gonna make an underperform pick on BYI, for the heck of it.

  • Report this Comment On September 05, 2010, at 11:24 AM, blesto wrote:

    P.S. Matthew,

    If you have some spare time maybe you could create a wiki for " deferred revenue "

    http://wiki.fool.com/Special:Search?search=+deferred+revenue...

    If I was knowledgable enough I'd do it my self. :(

    And I would challenge any other of you extremely experienced Fools to take a crack at it too!

  • Report this Comment On September 09, 2010, at 12:34 PM, wahabid wrote:

    Composite average of historical data shows BYI fell in 6 out of past 10 years during 9/10 to 9/26 . In 2009 it fell $5.19. Its price charts shows it form a W (for WIN). Its general trend since its close @ 34.47 on 6/28/10 is, trading in range between its resistance at the double-top on 7/26 and 7/27 at 35.77 & 35.74 and support at 30. So is Jan11 30- puts strike better to short than Oct10 30-puts?

    Knowledge-seeker

  • Report this Comment On September 23, 2010, at 5:44 PM, lakecat wrote:

    The paper tickets use in slot machines usage is up like 10% year over year. The machines are wearing out. Just because the casinos are not doing so well financially does not mean that people are not flooding into gaming venues, they are but with less money in their pockets to lose, and don't think the gaming world spins around Las Vegas these days.

  • Report this Comment On October 01, 2010, at 12:57 PM, earl92122 wrote:

    Bally is 97% owned by institutions, short interest is 11% as of 9/15. Doesn't such large institution ownership make it harder to affect stock price ? Or will they see the light & just sell ?

  • Report this Comment On October 01, 2010, at 3:42 PM, Desjani wrote:

    Is there an alternate trade to do besides short?

    something with options so it costs less or something>? thanks

  • Report this Comment On October 02, 2010, at 5:36 PM, msbjzz wrote:

    Based on financial info from Yahoo Finance, Bally management sold the majority of the

    bulding, fixtures and equipment in 2008, meaning sales must be drastically down since they have little equipment to work with.

    This sale clouded the financial statement, because they showed the payment as a current asset in the 2009 financial statement. In the 2010 financial statement, the building and equipment note was paid to Bally and the proceeds were included in total sales, distorting their total sales figure substancially.

    In addition, financial info from the same source and Thompson Financial showed that the insiders exercised stock options, purchasing almost a million shares and immediately sold them for in excess of $37,000,000 between October 17, 2008 and September 1, 2010. Yes, that is 37 million.

    What the above items suggest is open to your your intrepretation, as stating my opinions could leave me open to a lawsuit. However, this is a serious condition, masively deserving of a short sale.

  • Report this Comment On November 18, 2013, at 1:04 PM, WortCraft wrote:

    I was just cleaning out old email and saw the recommendation to short BYI. How'd that work out for you? There was an 18% dip after about 15 months, then steady rises in the price.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1283184, ~/Articles/ArticleHandler.aspx, 10/23/2014 6:17:59 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement