Bally Shuffles Its Deck

By Will Ashworth | July 17, 2013 AAA

Bally Technologies (NYSE:BYI) announced July 16 that it was buying its competitor--SHFL Entertainment (Nasdaq:SHFL)--for $1.3 billion. On paper, the deal looks like a winner. Should you buy Bally's stock? I'll discuss.

Bally's Existing Strengths
Investors clearly liked the deal as Bally gained 7% on the day while SHFL Entertainment was up 22%. Bally's on a roll and this deal only cements that notion. In the third quarter ended March 31, Bally delivered record revenues and earnings. More importantly, each of its three revenue streams (gaming equipment, gaming operations and systems) accounted for at least 28% of its overall revenue. This is one diversified business.

SEE: What Makes An M&A Deal Work?

In terms of growth, it grew its revenues by 13% year-over-year to $259.1 million, gross margins by 200 basis points to 65% and adjusted EBITDA by 14.3% to $85 million. Business is so good the company upped its fiscal 2013 EPS guidance to at least $3.35 from $3.20 in the second quarter and $3.05 in the first. Over the course of a fiscal year its guidance moved up 9.8%. It's not spectacular but it's plenty.

Considering Bally's stock is trading within 2% of its all-time high of $66.15, its current earnings yield of 5.1% is truly amazing. I would have to say given how it's performing that its current valuation is fair, if not, undervalued. I definitely wouldn't consider it overvalued by any means.

What SHFL Entertainment Brings
The company formerly known as Shuffle Master generates about 46% of its annual revenue from recurring sources such as electronic table systems and proprietary table games. Its iGaming business, although new, has the potential to bump that percentage up significantly. Even without this fifth stream of recurring revenue, they've increased in each of the last 18 quarters. Margins for the most part have been holding steady resulting in record revenue and profit in the second quarter.

Just two years ago its electronic gaming machines accounted for just 20.4% of its overall revenue. Fast forward to 2012 and its electronic gaming machines were responsible for 31.5% of its overall revenue, a 54% improvement from 2010. Countries like Australia, New Zealand and elsewhere have really taken a shine to video slot machines and other games featuring cartoon characters like the Pink Panther and the Flintstones.

With the success overseas with the EGMs, its revenue outside the U.S. and Canada in the second quarter was 56.4% compared to 53% in Q2 2012. Its become more diversified both in terms of revenue streams and geographic mix. That's always a good one-two punch.

SEE: The Evolution Of The Gaming Market

The Combined Entity
In Bally's presentation about the deal, it presents six reasons why this acquisition is a transformative, value-creating transaction. The two that resonate for me: an enhanced product offering and a much stronger international presence. Bally goes from three streams of income to seven with 24% of its revenue outside Canada and the U.S., up from 16% before the deal.

Even more important, it goes from a distant third in the gaming equipment market before the deal to a strong third nipping at the heels of a combined Scientific Games (Nasdaq:SGMS) and WMS Industries (NYSE:WMS), who are scheduled to merge by the end of the year. Bally will have trailing twelve month revenue of $1.25 billion, $644 million on a recurring basis and adjusted EBITDA of $445 million including $30 million in synergies.

That's a 36% EBITDA margin, which isn't too shabby. While it will have $2.05 billion in total debt once combined, the growth potential of the merged businesses should be able to significantly reduce its leverage from four times EBITDA in the 12-24 months after closing. This is an example where debt makes sense.

Bottom Line
The thing that kills most acquisitions is bad execution. Bally and SHFL Entertainment must move with precision and efficiency if it wants to benefit from the meshing of businesses. Personally, I don't see anything that presents this combination from being a home run.

I'd have no hesitation owning Bally stock before or after the merger.

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