Wednesday, August 10, 2005

Place Your Bets Nice Odds: Stock of the Week

It's International Gaming Technology (IGT).

They are a leader in the design and distribution of computerized gaming machines.

IGT earned record revenues and sales in 2004, earning a No. 18 spot on Business Week’s list of 50 best performing large companies.

Here's why.

Compelling business model.

IGT produces innovative games and remains committed to research and development.

Always on the edge of innovation, IGT is typically first to market.

It spends nearly three times as much on R&D as its closest competitor.

In 2004, it launched over 150 new games—twice the # they did in 2003.

We believe the product mix management boasted about on a recent conference call should generate margin growth.

That's not all.

IGT is focused on moving aggressively beyond North American slots and into casino systems and international markets.

It is critical IGT deliver on this promise since the North American gaming market is A) highly competitive and B) phasing into maturity.

With that said, we believe international opportunities will fill the potential revenue gaps brought about by a squeeze.

One caveat: Sustaining of desired levels of market share may come at the expense of lower profitability.

The main thorn in my side here isn't IGT's competitors, though.

It is that gambling is always susceptible to socio-economic factors.

If the economy falls out of bed, expect to see less people throwing quarters at Atlantic City.

Investors should also know about replacement cycles, an integral part of how the gaming industry makes money.

The replacement cycle simply says that the better the game, the higher the replacement demand.

This is obviously hard to predict.

Companies like IGT have to be restlessly installing new bases to keep up with industry expectations.

Fortunately, IGT's mammoth distribution channel should buffer against such a mishap.

We also like Alliance Gaming, but we're initiating coverage on IGT with a hold recommendation for its international orientation and product development committment, not to mention irresistable valuation.

IGT trades at a discount.

The industry as a whole is trading at relatively low multiples and we believe that (based on both a DCF valuation model and peer industry comparison) a higher multiple is justified.

So place your bets.

As more US casinos open locations abroad and operate casinos in newly regulated US States, IGT will continue to meet demand, service the leisure needs of retiring Baby Boomers, and reward patient investors.

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