Is It Time to Buy International Game Technology Stock?

Courtesy: IGT

International Game Technology (IGT 0.10%) is the technology design and development company responsible for much of the casino equipment used by the largest global gaming companies in Las Vegas, Macau, and other casino-friendly areas around the world. Through innovative technology and development, the company has expanded over the last 10 years to become the biggest name in the casino equipment industry by market cap, with nearly twice the annual revenue of leading competitor Bally Technologies (NYSE: BYI). However, following a double-digit year-over-year revenue decline in the last quarter and lowered guidance for the rest of 2014 from management, is IGT no longer a good play?

Not so fast. This company has some interesting highlights right now, including profit growth even in the face of reduced revenue, a growing social-gaming arm, and most important -- the anticipated merger with Italian gaming technology company GTECH which, if it goes through, essentially means that current IGT investors will be owners of shares of a new company as soon as early next year. Let's explore each before deciding whether IGT is a buy.

Double-digit revenue decline, but growing profit
For the fiscal third quarter, which ended on July 29, the company reported a 19% decline in revenue from the same period of 2013. This was mostly due to lowered unit sales and less revenue per machine. Unit sales revenue dropped 35%, mainly driven by decreased need for new gaming machines in North America. During the quarter, IGT shipped only 7,100 units, compared to 13,600 during the same period last year, with average machine price dropping from $13,300 to $11,900.

However, the company still increased net income by 10% year over year. Management has been stringently focused on cost controls and improving efficiency, which IGT CEO Patti Hart said in a prepared statement "has positioned us for future market opportunities." Growing profits amid flatline revenue could sustain the company for a short time. But more products will eventually be needed to boost revenue. For that, social gaming might be the answer.

Like-able gambling
This portion of IGT's interactive business segment could lead growth for the company going forward. With growth in smart devices and social network gaming, as well as consumers becoming increasingly comfortable with online gambling, IGT could be positioning itself in front of a growing industry.

Source: IGT website.

IGT's interactive segment reported nearly 15% year-over-year revenue growth in the most recent quarter, the only company branch to report revenue growth. Social gaming revenue increased 17% during that time, and is up 31% year to date. This growth was mainly attributed to DoubleDown Casino, a game that operates through Facebook.

Unfortunately, social gaming still accounts for only a small portion of the company's overall operations. Despite the growth in the interactive segment, IGT management has lowered the company's 2014 earnings guidance to $1.00-$1.06 per share from the $1.28-$1.38 range given at the start of this year.  

IGT vs. Bally
With this lowered guidance, investors might wonder if it's just IGT that is feeling strain so far this year, or whether the hurt is on the entire industry. IGT's main competitor, Bally Technologies, does not seem to be feeling that same revenue squeeze.

Bally reported record revenue in its most recently reported quarter, with 22% revenue growth year over year on increased unit sales. The company reported nearly 40% adjusted EBITDA growth over the same quarter last year, with a better operating margin than IGT.

Data Source: Yahoo! Finance. YOY = year over year; TTM = trailing 12 months.

Bally is more expensive than IGT now by the price-to-earnings ratio. At 18.4 times for IGT and 25.3 times for Bally's, investors might believe IGT is a better play at its cheaper P/E. Of course, if IGT is struggling to stop the bleeding of declining unit sales and is reporting lowered guidance, there is cause for its cheaper shares.

However, one final highlight makes investment in IGT particularly interesting now: the coming merger with GTECH.

Courtesy: GTECH.

The coming merger and new company
IGT put itself up for sale this year and in July announced it had agreed to be bought by GTECH for $6.4 billion in cash and stock. The merger will result in a new U.K.-headquartered company, likely still called GTECH, with shares listed in the U.S.. While there is no definitive date for completing the merger, it is moving quickly so far. Following the closing of the sale, GTECH shareholders will own 80% of the new company, while IGT shareholders will own the remaining 20%. In the deal, IGT shareholders will get $13.69 in cash plus 0.1819 shares of the new company for each of their IGT shares. The companies put the total value of the deal at $18.25 per IGT share, about 8% higher than IGT's current share price.

But will the merger actually go through? Investors often get excited over a coming merger, only to see it fall apart, often very near the end. However, the merger is going according to plan so far, and GTECH said the deal received early termination of the waiting period required under antitrust rules. Still, the deal is now subject to more reviews; the companies expect to get everything done by the first half of 2015.

Assuming the deal is going to be complete early next year, should investors be excited about owning the merged company? IGT had revenue decline issues during the most recent quarter reported, but was still able to grow profits. GTECH also experienced lowered revenue year over year in the quarter ended July 31, but reported a 10% decline in both EBITDA and EPS year over year. The company does have strength in international contracts, including new contracts throughout the U.S., such as a seven-year contract with the Tennessee lottery, and in Europe with new contracts in Greece and other countries. The combination of each company's international market share could eventually be a long-term growth driver for the merged company. Still, investing in GTECH on its own without consideration of this merger is a risky bet, and adding IGT's own current operation hardships may not be much help.

Is IGT a buy before it's no longer a company?
Tough economic conditions, particularly in the U.S., have reduced IGT's ability to continue producing revenue growth. In fact, with barely more than half as many gaming units sold in the second quarter of 2014 compared to the same time last year, it's a wonder IGT only decreased revenue by 19%. Impressively, the company boosted profit during that period. One area in which IGT has posted solid results is social gaming; this business might lead the company forward, but it would be nice to see a few quarters of social gaming actually pushing revenues up before using that as an investment catalyst. The industry itself cannot be completely blamed for the drop in revenue. Bally, for example, increased revenue by 22% year over year, and income by nearly 40%.

However, the really interesting thing for potential IGT investors now is the coming merger with Italian gaming technology company GTECH. However, with uncertainty about whether the deal will be finalized and what the share price will be afterward, along with questions about how well shares of the new company will perform with neither IGT nor GTECH showing much investment potential right now, IGT looks like a good company for your watchlist for how the merger goes, instead of adding it to your portfolio now.