The best way to win in Las Vegas may not be at the craps or poker tables but actually by owning the casino. B400 investors, through the ETF that follows it (NYSE Arca: BFOR), have done so by owning Las Vegas Sands (LVS), for example, up almost 22% year to date. Or perhaps the best way to win in Vegas is by owning the companies that sell to the casinos. B400 investors have done that, too, with Bally Technologies (BYI), up 61% year to date. Better yet, the best way to win in Vegas might be, well, not to be in Vegas at all but to sell to casinos around the country, which is precisely what Multimedia Games Holding Company (MGAM), the subject of this week’s dispatch, does. Oh, B400 investors have also owned this one, up 142% year to date.
Multimedia Games, an Austin, Texas-based designer, manufacturer and supplier of gaming machines and systems to casinos around the country, with a $1.1 billion market cap, has traditionally sold its wares mostly outside of Las Vegas; or the state of Nevada, to be precise. In fact, 40% of the company’s 2012 revenue was generated in the great gambling state of … Oklahoma (think Native American tribes). The company actually sells and installs its games (more on this important distinction shortly) in at least 21 states across the country, an impressive run from selling in a single state just three years ago. But more importantly, it does so very lucratively despite the remarkable pace of its ongoing growth.
The company reported sales of $48.1 million for its 2013 fiscal third quarter, ended on June 30th, up 18.9% from the year-earlier period. More importantly, its operating margins improved to 29.1% from 19.1% also in the same year, which, in our opinion, underscores the beauty of the company’s business model. We’ll explain. The company breaks down its revenue into two distinct categories: “gaming operations,” which last quarter accounted for more than 71% of sales. This is their recurring revenue, based on revenue-sharing agreements the company has on its large—and growing—installed base of units. This is a high margin business since, once installed, all the company needs to do is collect on the machines’ earnings (we’re sure they’ll include the occasional steak dinner for the customer). In other words, another example of the razor blade business model we like so much. The second segment, called “gaming equipment and systems sales,’ refers to, well, just that, selling gaming machines. This accounted for about 28% of the company’s revenue last quarter but also a large part of its operating costs, including costs of goods sold and selling and marketing expenses. However, we think of it as an investment, since the larger the revenue-sharing install base gets, the more the company’s operational leverage increases as operating costs diminish in proportion to revenues. Based on recent results, we believe the company is beginning to hit its stride and seeing the results of such operational leverage based on the seeds it planted the last couple of years, particularly during a very strong 2012.
Over the last two years MGAM added 98 new customers and 146 casinos across 16 new states. In 2012 it extended its revenue-sharing agreement with its largest customer, through at least September of 2015, an arrangement that covers 90% of the current units at the client’s facilities. By the end of 2012 the company’s operating margin had expanded to 15.4% from 4.8% in 2011 and through the quarter ended this past June, trailing 12-month operating margins were an impressive 25.7%, ten points higher than the year earlier period. Not surprisingly, the company is beginning to generate serious free cash flow: $14 million last quarter, almost twice as much as the year before and $26.35 million in the last 12 months on $180.36 million in revenue. The company has no net debt to speak of since $30.52 million in total debt on it books is canceled out by the $92.48 million it has in cash on hand, with change to spare.
Investors could be forgiven for not wanting to jump in following such a furious run up in the stock price which, admittedly, isn’t cheap, trading at 33 times trailing and 31 times forward earnings per share. We, however, beg to differ, as everything could be about to change for the company’s growth story. After building out an impressive footprint around the country MGAM is finally entering the Las Vegas market, clearly the biggest gambling market in the country. It was licensed in the state of Nevada only at the end of 2012 and the rollout of its games there only started in earnest last quarter. Its main game, TournEvent, received final approvals in the state at the end of last quarter. We wouldn’t be surprised, then, to see the company beginning to roll (or is it high-roll?), as its installed unit base continues to rapidly expand now that so much fertile casino ground lies ahead. If so, we may finally be able to say that the best way to win in Vegas is, well, to play in Vegas. B400 does.
The latest B400 Diary entries by John Prestbo:
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