Description

Quick Facts

• Provider of payments services (ATMs, credit card advances, compliance software) to casinos and manufacturer of slot machines

• +70% market share of casino payments services and 2-3% slot machine market share

• Based in Las Vegas, NV

• 900 employees

• Capital structure summary:

Thesis

Everi (fka “Global Cash Access”) is the largest casino payment services company in North America and completed the transformative acquisition of Multimedia Games (slot machine manufacturer) in 2014.  The acquisition underperformed expectations and shares declined from over $9.00 in 2014 to $2.48 today.  The acquisition failed to meet expectations because a key product was reaching its saturation point (Tournevent slot machines), planned synergies didn’t materialize and management had left little room for error by financing the transaction with debt.  

The CEO responsible for the deal was fired and the new management team has turned gaming operations around in the last two quarters.  We believe there are two ways for the shares to meaningfully appreciate: i) Everi continues along its recent trajectory and benefits from deleveraging through FCF generation (FY17E FCF yield 23.9%) and EBITDA multiple expansion (price target $7.20, 8.0x FY17E EBITDA of  $196.8mm) ii) the recovery stalls and the slot and/or payments businesses are sold to strategic buyers, of which we believe there are several (price target $3.66, 7.5x payments FY16E EBITDA of $69.1mm and 7.25x gaming FY16E EBITDA of $119.8mm)

*Note: our EBITDA excludes the stock compensation add-back included in management’s EBITDA

History

Everi was created when Global Cash Access (“GCA”) acquired Multimedia Games (“MGAM”) in 2014.  The acquisition of MGAM was entirely debt financed and MGAM was purchased for $1.2B (9.1x LTM EBITDA/7.2x LTM EBITDA including synergies which did not materialize).  The architect of the transaction was CEO Ram Chary, who joined GCA in January 2014 from Fidelity National Information Services and had no background in the gaming industry.  After less than a year on the job he announced the MGAM acquisition.  The rationale behind the deal was that GCA could leverage the relationships they had with most major casinos on the payments side (+70% market share) to expand MGAM’s reach (2-3% market share) and pocket a number of synergies from consolidating the management teams. Unfortunately, this plan did not work for a number of reasons:

i) Payments products and gaming equipment are purchased by different groups at the casinos, so there was limited ability to leverage existing relationships

ii) MGAM was reaching a saturation point with their hit product Tournevent (slot tournament machines) and didn’t have a robust enough pipeline to replace Tournevent sales

iii) Cost savings realized from the deal synergies were eaten up by expanding from one gaming development office to three

iv) MGAM was in the midst of retiring third-party games they leased to large Native American casinos

After badly missing EBITDA targets, slashing guidance and buying a private jet, Ram Chary was dismissed in early 2016.  Board member and gaming industry veteran Mike Rumbolz stepped in as CEO and instituted a plan to turn the gaming business around.  Since Mike took over, the gaming business has stabilized and we believe it is likely to begin gaining meaningful share.  

Some of the key factors driving this turnaround are:

i) New games developed with licensed content (Penn & Teller, Fruit Ninja, Casablanca, Richie Rich, Casper) which will start hitting casino floors in 2017, historically MGAM did only non-licensed slots (eg. Meltdown, Peking Fantasy, Jackpot Inferno etc.) and Everi was able to hire several talented developers to run their new branded content-focused offices in Chicago and Reno (due to recent M&A in the industry)

ii)  Great results with their new HDX slot cabinet which was introduced in 2016, conversion rates from trials to sales/leases have been over 80% due to the strong win per unit vs. house average

iii) Getting licensed to sell slots in new jurisdictions, the company was recently licensed in Canada and made their first slot sale there; there are a number of states the company is still working on getting licensed in

iv) Gaming operators looking to diversify away from two of the largest slot manufacturers, Scientific Games (“SGMS”) and International Game Technology (“IGT”) who recently completed large acquisitions in an effort to consolidate the industry

These positive factors have helped the company more than offset the decline in Tournevent unit sales (eg. Tournevent 6% of total unit sales in 2Q16 vs. 29% of total unit sales in 2Q15) and retirement of third-party games leased to Native American casinos.  We believe the slot business should begin to grow meaningfully in the second half of 2017 for the reasons listed above after the company has completed their planned retirements of third party game leases.

Gaming Segment

The slot machine industry has faced two key headwinds in recent years:

i) The shrinking of gaming floors in favor of entertainment amenities

ii) A lengthening of the replacement cycle and increase in the average age of the installed base

We believe that shrinking gaming floors are a secular headwind which is likely to continue, however we also believe that the trend of increasing age in the installed base in unsustainable.  

After years of declining unit volumes, we think industry volumes are likely to inflect for the following reasons:

i) Caesars is exiting bankruptcy and after years of under-investing in their floors due to cash constraints imposed by their heavy debt load, they are poised to begin to increase slot spending again; this has the potential knock-on effect of incentivizing the local casinos Caesars competes with to do the same

ii) The most recent slot survey published by Goldman Sachs on 7/18/16 indicates that “For the first time since 2012 and only the second time since 2009, managers have indicated that on average they expect slot budgets to rise” and “when we asked slot managers what percentage of the floor they intend to replace over the next year, the percentage of ‘large replacers’ was the highest we have seen since 2009 at 27%”

iii) Casinos are opening in new gaming jurisdictions (ie. Massachusetts) as state governments look to expand their revenue base by legalizing gaming

We believe Everi is well positioned against the improving industry backdrop and likely to gain share as the market rebounds thanks to their new slot products.  It is worth noting that Everi has historically generated most of their slot segment gross profit from leased slots (est. 85%/15% gross profit split in FY16 between slot leases/sales) which are leased under multi-year contracts, so the company has a stable recurring revenue base upon which to build.  The company also has historically been stronger in class II slots (used in certain Native American casinos) than in class III machines: 60%/40% split in leased slots between class II/III machines, <2% market share in class III and +20% market share in class II slots.  If Everi successfully grows their class III market share to the mid-single digits it will mean a large increase in segment profitability.

Publicly traded competitors SGMS/IGT/ALL AU trade at 8.0x/7.4x/11.9x forward EBITDA respectively, justifying our 7.25x EV/EBITDA SOTP valuation.

Payments Segment

ATMs in casinos are heavily regulated; operators are required to be licensed by the respective gaming control boards and banks do not place their ATMs in casinos.  Daily limits on ATM withdrawals also create demand for cash advances on credit cards, which Everi’s integrated kiosks can also handle.  Everi splits the fees they receive from operating their kiosks with casinos and over time those fees have become an important revenue source for the casinos.  Due to the high barriers to entry, Everi has enjoyed significant market share (+70%) for a long period of time.  

Recently, several competitors have tried to take share by undercutting Everi on price (putting pressure on margins), however operational results for gaming operators that have switched have been mixed and we believe Everi could win back some of the customers it recently lost.  Everi does not have any major contracts up for renewal next year and contracts typically run 3-5 years.  

Outside of gaining or losing casino customers, revenue in the payments business has historically closely tracked the trend in overall cash to casino floors.  A common misconception of gaming neophytes is that Everi’s payments business is akin to a melting ice cube in the same way a traditional ATM operators business might be.  We do not believe this is the case for the following reasons:

i) Casinos are not incentivized to move to cashless systems because ATM fees are an important revenue source for them

ii) Cashless systems have been tested by a handful of casinos but have seen limited adoption by patrons

iii) Everi is at the forefront of cashless system development and demoed the most impressive cashless system on display at G2E, if the industry moves in that direction they are likely to benefit given their superior product, relationships and reputation

iv) Everi provides compliance and credit tracking software which will be necessary regardless of how patrons place wagers

v) Cashless systems increase the risk of fraud and face significant regulatory hurdles before there can be widespread adoption

Everi’s payment business has performed well through the recent turmoil at the company and we expect that to continue to be the case going forward.  The most recent quarterly results saw an uptick in payment segment margin and we believe that margin expansion is sustainable because it is tied to recent changes in ATM card chip technology.

There are no publicly traded pure-play competitors so a comp analysis is impossible.  We look to the historical 10 year pre-MGAM acquisition average EV/EBITDA multiple of 7.4x to justify the 7.5x multiple used in our SOTP valuation.

Summary

Everi is a levered equity with significant operational and financial leverage to a turnaround in their business and the industry.  There is real-time evidence that both the business and industry turnarounds are in their early stages.  In the event the turnaround does not materialize, the company is trading below its sum of the parts valuation on today’s level of profitability and we believe there are multiple potential buyers of both businesses.  If the company does see an inflection in its profitability, shares are likely to appreciate meaningfully and the company may still seek to break itself up at higher EBITDA levels and multiples than used in our SOTP valuation.  

Operational downside is protected by multi-year contracts in both the payments business and slot leases; only 8% of estimated company gross profit is tied to the actual sales of slot machines.

Catalyst

* Multiple potential buyers of both businesses

* Inflection in profitability

* Continuation of business and industry turnarounds