CAPScall of the Week: Multimedia Games

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For years, satirical late-night-TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database and make a CAPScall of outperform or underperform on that company.

For this week's round of "Better Know a Stock," I'd like to take a closer look at Multimedia Games (Nasdaq: MGAM  ) .

What Multimedia Games does
Multimedia Games develops and distributes electronic gaming units for Native American gaming markets, as well as commercial casinos. It also supplies the central determinant system for the video lottery terminals installed at horse racetracks in the state of New York.

As of Multimedia Games' recently ended quarter, the company had 10,149 installed units within the U.S. and 985 installed internationally. In the third quarter, the company reported net income growth of 162% on a 21% rise in revenue as units sold rose to a quarterly record: 543. Multimedia Games also boosted sales and EPS beyond its previous forecast. 

Whom it competes against
The most direct competitors to Multimedia Games are International Game Technology (NYSE: IGT  ) and Bally's Technologies (NYSE: BYI  ) , which, you may recall, were awarded the first U.S. online gaming licenses earlier this year. Although that doesn't allow these two companies to begin selling their software to casinos, it's the first step toward the potential legalization of online gambling in the U.S. and could put Multimedia Games at a disadvantage to these larger peers .

It's also worth mentioning that Zynga (Nasdaq: ZNGA  ) could also present future competition for Multimedia Games if online gambling is legalized. Zynga Poker is already a well-established platform on Facebook and likely wouldn't have any trouble garnering customers from the get-go.

The American consumer is actually the hidden competitor for the entire casino sector. You might assume that the urge to gamble will transcend recessions or even weaker growth periods in the U.S. economy, but that has proven historically not to be the case. Consumer spending has already dipped to its lowest levels in more than a year , and unsurprisingly, Wynn Resorts' (Nasdaq: WYNN  ) second-quarter results reported in July fell short of Wall Street's estimates by $0.11. The biggest revenue drag was witnessed in Las Vegas where sales dipped 12%.

The call
After carefully reviewing the merits of Multimedia Games, I've decided to go against the optimistic CAPS consensus and make a CAPScall of underperform on the stock.

One of the primary reasons I remain pessimistic on the gaming sector as a whole, despite the strong sales figures exhibited by Multimedia Games, is weakening consumer spending. If consumers are holding onto their cash, growth in slot sales is only bound to be temporary.

That leads me to my next point – a lack of international diversification. I can understand that the company wants to dominate the domestic market, but by a margin of greater than 10 to one, Multimedia Games is wholly reliant on the U.S. consumer. With basically no exposure to Asia, I'd consider its long-term slot growth potential to actually be quite minimal.

Valuation is also a concern. Wall Street's current estimates place the company at 25 times forward earnings -- far too rich a price to pay with the potential for online and mobile gaming, as well as weakening consumer spending, just waiting in the wings to steal the company's revenue stream.

Will Zynga's close relationship with Facebook prove to be a long-term boon or a short-term bust? Find out the answer to this question and much more in our latest premium research report on Zynga. Packed with in-depth and unbiased analysis on the opportunities and threats facing Zynga -- and complete with a year of regular updates - this report will give you the tools necessary to make smart long-term investing decisions. Click here to get your copy.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of Facebook. Motley Fool newsletter services have recommended buying shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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