Description

SUMMARY

Galaxy Gaming, Inc. (GLXZ) sells games to traditional casinos (“felt”) and, more recently, online casinos (“iGaming”).  It has an enterprise value of $81M ($1.50/Share * 21.6M S/O = $32M Market Cap + $50M Debt - $3M Cash + $3M Required Cash for Ops = $83M EV, rounded).  $39M of the debt deserves special consideration, as it reflects a forced equity redemption of the founder and carries a stipulated 2% interest rate due in 2029 at the latest (more detail at the end).

GLXZ is both (1) a COVID-reopening play [felt side of the business] and (2) an opportunity to ride the coattails of Evolution Gaming Group AB (EVO) [iGaming], a now richly valued, high-growth iGaming product provider to which GLXZ is a supplier of online games.  While many companies battered by COVID have rebounded following the vaccine announcement, GLXZ remains substantially depressed from its pre-COVID level of closer to $2.00/share—despite an excellent iGaming acquisition, improvements in its licensing footprint, and a recent $4M Main Street Loan to shore up liquidity concerns.

GLXZ has a couple of levers that will drive revenue growth, all of which comes at 99-100% gross margin due to the nature of both the felt and iGaming businesses:

• During COVID, GLXZ’s August 24, 2020 acquisition of PGP at a favorable price (reportedly 4x Adjusted EBITDA) will strengthen GLXZ’s online presence and simplify its position as a supplier to EVO.
• Post-COVID, GLXZ has a clear path to revenue growth by adding “progressives” to existing tables in states where GLXZ has progressive licenses.  Progressives are fancy jackpot bets that, when added to a table, tend to triple GLXZ’s table revenue.

GLXZ organically grew revenues at a steady ~15-17% clip pre-COVID, and the combination of iGaming growth (largely on the coattails of EVO) and “progressive” penetration should enable GLXZ to maintain that sort of growth post-COVID.  Additionally, GLXZ management is steadily adding gaming licenses in new states (for adding tables and progressives in those states), but this is typically a slower process.

In my base-case modeling (link at end of summary), I build up to a 13% post-COVID revenue growth rate and 10% growth in SG&A, R&D, and share-based compensation.  These are more conservative than management indications of ~15% revenue growth and ~8-10% expense growth.   Due to the low valuation and extreme operational leverage (revenue drops to the bottom line), a conservative 11x EV/EBITDA multiple produces an over 30% IRR and $6-7/share in 5 years.  GLXZ has the makings of an early-stage compounder that can organically grow revenue ~15% at +40% EBITDA margins (increasing toward 50% given the operational leverage).

US peers Scientific Games Corp. (SGMS; $4B market cap; went public in 1984 and has been a massive compounder) and PlayAGS, Inc. (AGS; $200M market cap) have tended to trade in the range of 9-11x EV/EBITDA in recent years—and SGMS has a much weaker growth profile than GLXZ (but better scale and predictability).  As we emerge from COVID, I believe GLXZ can justifiably receive a higher EBITDA multiple in the 12-15x range—given its higher growth and potential as it grows into its cost structure (GLXZ’s opex / revenue is approximately 70% vs SGMS at 45%).  And bear in mind that EBITDA is hardly “bullshit earnings” here.  The vast majority of D&A is uneconomic amortization of intangible assets.

On the management side, CEO Todd Cravens joined because he saw strong assets within what was a mom-and-pop-run business under former Founder/CEO Robert Saucier.  Todd and his team have aimed to professionalize the business.  In our conversation, I was encouraged by his focus on growing revenues at mid-teens while keeping cost growth to high-single-digits.  CFO Harry Hagerty (Princeton, HBS) is a heavy hitter within the gaming industry—a former MD at Deutsche Bank, CFO at Caesars, on the Board of Trump Entertainment Resorts.  Board Chairman Mark Lipparelli owns 7.6% of GLXZ shares and was President of Shuffle Master (publicly traded company bought by Bally’s for $1.3B), an executive at Bally’s, and a former Chairman of the Nevada State Gaming Control Board.  Independent director Gavin Isaacs was CEO of SGMS for a few years and is a current Director at DraftKings.  In sum, the management and board saw something special in GLXZ and wanted to take it to the next level.

Regarding the lawsuit, GLXZ justifiably booted Saucier for business reasons.  For conservatism, I have assumed that the 2% interest being paid on his forced redemption increases to 5% and that in the coming years GLXZ begins paying down the $39M principal owed to Saucier (due 2029).  A settlement is more likely.  I address this in detail below.

About $50,000-75,000 worth of GLXZ shares trade daily, so this opportunity relates to investors investing a few million dollars or less.  I currently hold it as a 4% position.

That’s the short, VIC-friendly summary.  I’ll explore a few more topics below because of the unusual business and lawsuit, and I’m happy to field questions in the messages.

GLXZ Excel model: https://drive.google.com/file/d/1NTNy7EhpscWUtlfZmMvABCM7ylwfxK7F/view?usp=sharing

TOPICS

• Business Overview
• Growth
• Returns on Capital
• Acquisition Target Potential
• Presence
• Competition
• Triangulum Debt and the Pending Lawsuit with Former Founder/CEO Robert Saucier
• COVID-19 Billing
• Insider Ownership
• Valuation
• Why is GLXZ Cheap?
• Risks

BUSINESS OVERVIEW

Currently, the bulk of GLXZ’s business centers on licensing table games to traditional casinos.  Table games like blackjack, craps, and roulette are public domain table games.  GLXZ assets include full proprietary table games (“full games”), proprietary side bets for table games (“side bets”), progressive bet systems (“progressives”), and internet games (“iGaming”).  Given the asset-light, IP-centric nature of the business, GLXZ generates 99% gross margins (with the 1% being the “Cost of ancillary products and assembled components”).  Management has indicated that the customer churn rate is ~1%.  I’ll spend some time discussing the lines of business since they’re a bit unusual.

Felt

“Felt” refers to live GLXZ games.  Felt games come in three forms:

• Full games
• Side bets
• Progressives

At the end of 2019, GLXZ earned on 5,500 table games in approximately 600 casinos.  GLXZ receives a flat rate for most table games, billed to casinos monthly and cancellable with 30-45 days’ notice.  It looks as though GLXZ typically receives an average fee per table of about $250/month.

Full games are stand-alone table games.  GLXZ proprietary table games include:

• “Heads Up Hold’em” (variant of Texas Hold’em) (https://www.youtube.com/watch?v=z459r7k4yNs, https://www.fulltilt.com/casino/games/headsupholdem/, https://wizardofodds.com/games/heads-up-hold-em/)
• “High Card Flush” (variant of poker) (https://www.youtube.com/watch?v=z4QcH-9duVg, https://wizardofodds.com/games/high-card-flush/)

Side bets are bolt-ons to traditional table games (e.g., blackjack, craps).  In live play, the bet parameters and spots to place chips are written on the felt—no fancy technology here.  For example, during normal Blackjack play, a player can make a Lucky Ladies bet (side bet) that has different payouts if the player gets a 20.  GLXZ proprietary side-bet games include:

• “21 + 3” (side bet for blackjack; #1 side bet globally) (https://www.youtube.com/watch?v=qir_fJu2KMY, https://www.telegraph.co.uk/betting/casino-guides/blackjack/21-plus-3/, https://wizardofodds.com/games/blackjack/side-bets/21plus3/)
• “Lucky Ladies” (side bet for blackjack; invented by Saucier in 1997) (https://www.youtube.com/watch?v=Hn8WIDNDq4k, https://wizardofodds.com/games/blackjack/side-bets/lucky-ladies/)
• “Bonus Craps” (side bet for craps) (https://www.youtube.com/watch?v=Sgivc7KqVls, https://wizardofodds.com/games/craps/side-bets/bonus-craps/)

Side bets tend to have worse payouts than regular play—as confirmed in the Wizard of Odds analysis in those links above.

Progressives layer on jackpots that are more involved than just changing the felt design (see “Enhanced Table Systems” on Page 4 of the 2019 10-K for more detail).   Unlike the table games, where GLXZ receives a fixed per-table fee, GLXZ receives a share of the progressive bet profits and losses (from the casino’s perspective).  This, in turn, is a win-win for the casino and GLXZ: adding progressive bets increases a table’s revenue for the casino and can triple GLXZ’s table revenue—thereby creating plenty of value for both the casino and GLXZ.  Also the table becomes stickier for players.

As a side note for additional color, GLXZ has gotten away from the life-changing progressive payouts (e.g., $500,000) in favor of smaller but more frequent payouts (e.g., $20,000).  This produced better results since it made winning more realistic.  In fact, in YouTube comments people talked about their wins, describing how exciting it was.

It doesn’t make sense economically for a given casino to develop its own progressive bet games, but GLXZ can make a compelling data-driven sales pitch that adding progressive bets will add to the casino’s bottom line.  One investor with industry contacts described it like writing a hit country song.  It takes skill and expertise, and it wouldn’t make sense for a radio station to write its own country songs. 

Note that when all of GLXZ’s felt business was on a flat fee (before progressives), management could predict revenue extremely accurately.  Progressives have introduced some volatility since GLXZ shares in the upside and downside of the progressives (from the casino’s perspective), so a month with a bunch of jackpots will dent GLXZ earnings.

iGaming

Two types of iGaming have emerged:

• Random-number generator (“RNG”).  RNG games simply require software.  GLXZ licenses its content to, say, GVC.  GVC then builds the games on a remote server and integrates them into iGaming online platforms like that of the Golden Nugget or Borgata.
• Live tables.  GLXZ licenses its content to EVO, which then sells to a platform like Golden Nugget.  When a user logs on, there is an actual dealer in a Golden Nugget uniform dealing.  EVO uses big warehouses and lower-cost labor.

With the recent PGP acquisition, GLXZ bolstered its iGaming position.  A comparison of revenues from Q4 2019 (pre-COVID when all casinos were open) and Q2 2020 (when all casinos were closed) indicates that 12-15% of GLXZ’s revenues came from iGaming pre-COVID.  iGaming revenues presumably began to increase starting in September 2020 due to the August 24, 2020 closing of the PGP deal (deal terms decided upon February 2020).  GLXZ’s iGaming growth via the PGP deal is key to the investment thesis.

Before the acquisition, PGP sat between GLXZ and EVO in a bad contract for GLXZ.

GLXZ (content) >> PGP (middleman with favorable contract) >> EVO (client-facing product) >> Online Casino (e.g., Golden Nugget Online Casino) (platform)

The PGP acquisition brings over only one consultant (who GLXZ has worked with for years) and removes PGP as the middleman.  Management did some tough negotiating and is currently very excited about the deal.

GLXZ (content) >> EVO (client-facing product) >> Online Casino (e.g., Golden Nugget Online Casino) (platform).

In my financial model (link in summary), I attempted to split revenues by segment since that seems the natural way to think about GLXZ revenue growth: (1) Felt: Table games + Side bets, (2) Felt: Progressives, and (3) iGaming.  I got my estimates with a bit of triangulation (e.g., Q2 2020 was all iGaming because the casinos shuttered; 10-15% progressive penetration).  Then I did a build-up based on a table estimate, revenue per table, progressive penetration, etc.  I’ll try to run this by management next time I can.

GROWTH

For felt games, adding progressives to existing felt provides the clearest path to revenue growth.  GLXZ is in the process of adding progressives in CO, IN, MS, and PA.  For example, before getting the progressive license in MS, GLXZ had felt in 29 of the 30 casinos in MS, and in late September GLXZ did its first install of progressives in MS.  GLXZ has felt in the other states as well, making it easier to expand revenue in those states than in, say, CA—where GLXZ must reacquire clients after a 6-year absence due to the Robert Saucier debacle.

GLXZ management believes that the license expansion will strengthen its relationship with big players in the industry.  GLXZ’s patchy licensing for its full range of products made conversations with bigger players like Penn National Gaming (PENN) and Caesar’s Entertainment (CZR) challenging.  Filling in the license map makes it easier for GLXZ to offer its full product range to bigger players.

In Europe, GLXZ received the green light to expand progressive gaming into Switzerland and France and has begun doing so.

For iGaming, the US is undergoing an online gambling boom.  While currently only a handful of states have opened up to online casino gambling (DE, MI, NJ, NV, PA, and WV—see playusa.com for a map of states only allowing sports betting vs both sports and iGaming) and only two are meaningfully participating in iGaming (NV and NJ)—JPMorgan sees iGaming revenue growing from $1.4B in 2020 to $4.6B in 2025 (and it appears the $1.4B estimate will be low).  NJ rakes in substantial tax revenue from online gambling (e.g., NJ Oct 2020 online gambling tax report), and I gather many of the bets are placed in Secaucus by people leaving NYC.  Other states will want to relax regulations for the tax revenue.

GLXZ has positioned itself to ride the wave.  Post-PGP acquisition, EVO is GLXZ’s largest customer.  As EVO partners with companies like BetMGM, DraftKings, or Flutter, EVO brings GLXZ’s products with them.  And people actually play more side bets online than they do in physical casinos.  In 55% of EVO’s hands dealt in Blackjack, there is at least one sidebet, and GLXZ owns the #1, #2, and #3 online Blackjack side bet games.  iGaming is where Todd sees the business going.

Currently, most iGaming revenue comes from Europe, and that has grown a bit during lockdown, but hasn’t boomed like I would have expected.  William Hill and GVC (sportsbook makers) are also GLXZ customers because GLXZ’s products play well with users after they have placed sports bets (e.g., during a soccer match).  It is worth noting also that in Europe people tend to play roulette, blackjack, and a bit of baccarat; whereas the US has a wider basket of games—craps (GLXZ has #1 side bet game), flush games (GLXZ has #1 side bet game), and blackjack (GLXZ has #1, #2, and #3 side bet games). 

RETURNS ON CAPITAL

By my measure, GLXZ earned solid returns on capital during 2016-2019, averaging 17% (and ranging from 15%-19%)—when I included acquisitions as capital investments and never counted any D&A (with the intent to avoid amortizing the purchase price).  That ROIC figure will increase as GLXZ expands, because GLXZ completed the $12.4M PGP acquisition at a good multiple (reportedly over $5M of revenue and 4-5x Adjusted EBITDA) and incremental revenue has 99% gross margin with tons of operating leverage.  I think the bull case in reviewing GLXZ’s incremental ROIC is the massive operating leverage and white space to expand.  Bears might be concerned over the potential dangers of acquisition-driven growth.

• Bull: Massive operating leverage.  GLXZ has 99% gross margins, so any additional sales (or lost sales) flow right down the income statement.  This will remain true as online gaming becomes a bigger share of the business mix.  GLXZ was organically growing revenues at 15-20% pre-COVID—via a combination of increased table count, increased prices, and more recently progressive penetration and iGaming.  Still, GLXZ was not yet operating at scale  GLXZ now has a lot of potential to further increase revenues by layering progressives onto table games—i.e., improve progressive penetration—and growing iGaming.
• Bear: Potential dangers of acquisition-driven growth.  The acquisition-led growth cooled after the big October 2011 acquisition.  GLXZ hasn’t been too acquisitive lately, but the fear would be if they were too eager to expand and started doing bad deals.  To give a sense, I compiled a list of acquisitions by going through the 10-Ks.
  • 2010 [$0.2M]: Deuces Wild Hold’em Fold’em and Random Wild from T&P Gaming, Inc.
  • Oct 2011 [$23.0M]: 20 different table games, including 21 + 3, Two-Way Hold’em, and Three Card Poker from Prime Table Games (played in US, UK, and the Caribbean).
  • Nov 2011 [$1 + contingent consideration]: Bonus Craps, Four the Money, Rainbow Poker, and Roulette Craps from Lakes Entertainment, Inc.
  • Mar 2012 [$0]: Double Action Blackjack as a result of a legal settlement with Unax Service, LLC
  • Sep 2012 [not disclosed]: High Card Flush from Red Card Gaming, Inc.
  • 2014 [not disclosed]: Lucky Win for Baccarat.
  • 2014 [not disclosed]: SpectrumVision (card-marking detection system that they ship to casinos)
  • Mar 2015 [not disclosed]: TRIO-lette.
  • Aug 2020 [$12.4M]: Progressive Games Partners LLC (“PGP”)

GLXZ is positioned to grow without doing acquisitions by (1) scooping up more state licenses, (2) furthering progressive penetration, and (3) riding the coattails of EVO into the exploding iGaming space.  Still, acquisition-led strategies can go bad with one or two errant moves—and management has indicated that GLXZ is subscale (and I agree)—so it wouldn’t be shocking to see more acquisitions down the road, particularly as the stock rises.  SGMS has made many acquisitions, typically acquiring companies at between 5-10x revenues, bundling the games into the SGMS offering, then removing the overhead.  It has been a successful strategy for SGMS.

ACQUISITION TARGET POTENTIAL

On that note, it’s useful to think of what GLXZ would be worth to an acquirer.  Given the nature of GLXZ’s business—IP-like products with software-like economics at 99% gross margins—the subscale GLXZ becomes a natural acquisition target.  An acquirer like SGMS could potentially provide GLXZ with (1) better business economies of scale (e.g., SGMS has operating expenses / revenues of 45-50% vs GLXZ’s 60-70%, depending on special charges—noting that GLXZ may need some of those operating expenses to support its high growth rate), (2) better distribution by bundling it into a fuller product line, and (3) more favorable contract terms with casinos and EVO through its sheer weight in the industry.

One could imagine SGMS looking at GLXZ’s post-COVID EBITDA of, say, $8M-10M (including the recent PGP acquisition), plus $2M or so should GLXZ’s overhead get folded into SGMS’s structure, plus additional gains from pumping GLXZ’s well-proven content through SGMS’s sales distribution network.  That might get you to $13-$15M EBITDA, growing at, say, 13-17% (due to the 99% gross margins).  Given those growth economics, a company like SGMS would be getting a good deal at around 13-15x EBITDA, implying a $170-$225M enterprise value—well above the current $83M.

Though GLXZ management may favor playing out the story given the upside potential; and potential acquirers may prefer to wait until GLXZ first resolves the Robert Saucier drama.

PRESENCE

This is old, but for context GLXZ broke out its jurisdictional presence in 2011.

GLXZ has table games in Las Vegas’s six big casino companies—MGM Resorts International, Caesars Entertainment, Wynn Resorts, Las Vegas Sands, Boyd Gaming, and Stations Casinos.

GLXZ has since expanded its presence, but no longer breaks it out state-by-state.  GLXZ couldn’t do business in California from 2013-2020, due to Saucier’s history.  In a January 23, 2020 press release, GLXZ indicated that since the May 2019 redemption of Saucier’s shares, it has gained 13 new licenses, including CA, MD, WI, AR, and Ontario.  Research and conversations indicate that GLXZ is further working on IA (no longer need to use a distributor that was basically getting 15 points for doing paperwork), MA, MO (appears to have gotten the license), NJ, and PA.  GLXZ also received regulatory approval to roll out 21 + 3 (side bet for Blackjack) in Switzerland and France and they have “quickly placed a number of the blackjack side bets in French and Swiss casinos.”

COMPETITION

On the felt, GLXZ is the #2 provider of table games in the US—a distant second to SGMS.  The GLXZ 2015 10-K Strategy section has better competition info than the more recent reports, in my view.  SGMS has a complete product line that it offers to casinos (game content and utility products—card shufflers, smart dealing shoes, baccarat displays, etc.).  GLXZ has expressed hope to scale up to offering “turn-key systems rather than compete solely as a purveyor of individual products.”  I think we may be a ways from that goal, but GLXZ has worked to tighten that up with an upcoming roulette product—which they think will help open Latin America.

I asked whether GLXZ has been able to raise table prices over the years, and management raised prices somewhat, but have run into SGMS bundling—making it sound like it was getting competitive.  Management indicated that casinos like GLXZ because it helps to keep SGMS honest on pricing.

On the iGaming side, I admit I’ve struggled to get comfortable with the competitive landscape.  I instinctively thought that power would tend to flow toward the platforms (e.g., Golden Nugget Online Casino) at the expense of suppliers like EVO and GLXZ.  But as the NJ report (NJ Oct 2020 online gambling tax report) showed there are loads of platforms and no companies with the economies of scale of EVO.  Anyway, I am sure they’ll do well and this GLXZ writeup isn’t meant to deconstruct the downstream platforms, but I’d be interested in comments from anyone who has studied the space.  I fear that as GLXZ moves to digital, the economic rewards might disproportionately flow toward someone beside GLXZ.  On the other hand, it is nice that iGaming reportedly has higher EBITDA margins and has no physical constraints.

In that vein, I asked management, “Why doesn’t EVO copycat GLXZ’s games (e.g., 21 + 3), call it something else, and then cut out GLXZ?”  Apparently, EVO tried to do that, and in the gambling business it can be difficult to enforce IP since you can’t patent math.  When EVO rolled out its version, players didn’t like it because they were used to the GLXZ version.  Players asked for it and EVO brought on the GLXZ products.  I’m not sure if that constitutes a moat per se, but sometimes weird moats are the good ones.  I still don’t feel I fully understand this dynamic despite asking plenty of questions, otherwise I would have gone bigger on the stock.

TRIANGULUM DEBT AND THE PENDING LAWSUIT WITH FORMER FOUNDER/CEO ROBERT SAUCIER

If you’re still with me, I saved the messy bit for later on.  It would be hard to consider investing without first having a grip on the dealings with the founder and former CEO, Robert Saucier.  In 2017, then-CEO Saucier resigned as CEO and board chairman after Nevada gaming regulators threatened to reject GLXZ’s license application due to Saucier’s questionable past (falsifying his college credentials, hiring accountants who were indicted or convicted of crimes, filing a “train-wreck” 2013 California licensing application).  Regulators in Nevada, California, Oregon, and Washington have gone after Saucier in recent years, with Nevada threatening to stamp his application as a “Denial”, a scarlet letter that tells others in the industry to stay away.

Because of Saucier’s run-ins with the regulators, on May 6, 2019, GLXZ management used GLXZ’s articles of incorporation to force Saucier to trade his stock for debt (“Triangulum Debt”) at $1.68/share (average price 30 days prior to the swap).  This explains GLXZ’s odd current capital structure.

The Triangulum Debt bears 2% interest and technically matures May 5, 2029, though it Is likely GLXZ will resolve things sooner given the pending lawsuit brought by Saucier against GLXZ.  Galaxy can prepay the principal at any time.

GLXZ has argued that they had to boot Saucier for business reasons, since his presence prevented GLXZ from getting critical gaming licenses.  For instance, CFO Harry Hagerty said in November 2018 that GLXZ sought licenses in other jurisdictions, but regulators “were unwilling to move forward” due primarily to the 2017 investigation in Nevada and Saucier’s continued majority ownership stake (at the time).  The judge in the Saucier vs GLXZ case has already said GLXZ made a prima facie case (i.e., that he would favor GLXZ, provided its evidence is not rebutted by Saucier).

A problem may lie with how GLXZ has compensated Saucier for his shares.  GLXZ argues that its Articles of Incorporation do not dictate a specific means of paying for the shares, allowing for discretion in how they compensate Saucier.  The judge has expressed concern regarding how GLXZ compensated Saucier.  Forcing Saucier to accept 2% on unsecured, subordinated debt may appear aggressive given GLXZ’s loan from NSB pays LIBOR + 3.5%-4.0% (depending on GLXZ’s leverage ratio)—and GLXZ issued it in connection with the $39M Triangulum promissory note.  However, a Wynn dispute provides precedent for GLXZ’s approach: Wynn once booted Wynn Resorts Co-Founder Kazuo Okada for bribing officials in the Philippines and similarly forced-swapped his equity for a 10-year bond paying 2%.

A lawyer friend reviewed the case materials and believes that GLXZ and Saucier will likely settle.  

• Best-case scenario: GLXZ win.  The judge rules in GLXZ’s favor.  GLXZ pays the stipulated 2% interest until May 2029.  Then GLXZ pays off the $39M of principal with, say, a mix of cash and fresh debt.
• Most-likely scenario: GLXZ-Triangulum settlement.  A lawyer friend reviewed the case materials and suggested a settlement as the most likely outcome.  One can imagine GLXZ paying a lump sum upfront, followed by yearly payments.  This outcome seems most likely since Saucier has reportedly employed a litigation finance firm (e.g., Burford Capital) and is paying 9% monthly.  Saucier has too much to lose if GLXZ wins handily, which could leave him waiting 10 years to get compensated—particularly since he is now 66 and reportedly has financial troubles.  Also, given that the word is out about Saucier receiving litigation financing, GLXZ’s lawyers gain from delaying since Saucier is bleeding in 9% per month.
• Worst-case scenario: Triangulum win.  Exercising control and in need of cash (as he is rumored to be), Saucier forces a sale of the business.  This may not be all bad, given that GLXZ appears undervalued and could fetch a good price to bigger players like Scientific Games (NASDAQ: SGMS, ~$2B market cap).

Unfortunately for investors, a 3-2 Nevada Gaming Commission vote in August 2020 saved Saucier from “The Big D”, which would have added him to a 137-name list of pariahs in the gaming industry.  Instead, he got a “Rejection.”  The Big D would have helped shareholders by emphasizing the point that Saucier himself inhibited GLXZ’s business, further justifying the forced share redemption.  Saucier told commissioners he just wanted out, promising never to return.  Let’s hope that’s true.

In my modeling, I assume that the 2% interest payments don’t last, instead stepping it up to 5% to be conservative.  I assume the trial and legal fees drag into 2022.  Then GLXZ begins making some big cash payments to Saucier to pay down the debt in late 2022 and early 2023—and then again in 2024.  A lawyer friend who studied the case suggested my assumptions are too conservative.

COVID-19 BILLING

In response to COVID, GLXZ stopped billing all table game clients in March 2020.  Then, in Jun/Jul/Aug 2020 GLXZ began charging 25% of the usual table rate; 50% in Sep/Oct; 75% in Nov/Dec; and they will resume billing 100% of the usual rate in Jan 2021.  Competitors (e.g., SGMS) were more aggressive with their billing practices, and GLXZ management expressed that GLXZ customers received this well across the board (naturally).  GLXZ has not lost a major customer.

Some casinos have reopened but haven’t yet reopened table games—or might offer, say, 3 positions at a table or have a partition.  Others may not reopen at all.  Management anticipates a 3-5% thinning of the herd.  Generally speaking, GLXZ has a big presence in WA with card rooms (not considered casinos).  They have been hit hard, with some taking the tables into the parking lots.

INSIDER OWNERSHIP

Aside from Board Chairman Mark Lipparelli owning ~8% of GLXZ shares, there is little insider ownership.  It would be nice to see more insider ownership, but management has been doing a nice job of keeping a lid on expenses (and an excellent job of reigning in expenses during COVID), and they’re a professional group with strong backgrounds wanting to build GLXZ into something big.

VALUATION

I linked to my financial model in the upfront summary.  It has all of GLXZ’s historical financial data too.  Inputs parameters have gray shading—tweak them as you see fit.  Bear in mind that it’s critical to value GLXZ on an enterprise value basis since the company forced Saucier to convert his equity to the low-yielding Triangulum Debt.  GLXZ’s financials state that the Triangulum debt matures May 2029, but my lawyer friend believes they are likely to settle with Saucier and pay him the $39M (or less) sooner—with the best guess being installments for which I was probably overly conservative in modeling.

I include my financial model summary results below.  The model has other important levers besides table growth and EV/EBITDA, such as progressive penetration and iGaming revenue growth—so it’s worth having a closer look if you’re interested in the stock.  The model runs on a quarterly basis but I rolled things up annually for the screenshot below.

WHY IS GLXZ CHEAP?

GLXZ is cheap because of the following:

1. Liquidity concerns
2. The Triangulum dispute
3. Misunderstanding the PGP acquisition
4. Poor screening
5. Too small for many serious investors
6. No coverage and no management calls

(1) LIQUIDITY CONCERNS.  When I bought into GLXZ, my biggest concern was cash liquidity and meeting debt covenants.  I bet that the PGP revenues would help to stabilize GLXZ’s COVID-related liquidity needs since online gaming thrives during COVID.  This appears to be happening, and I expect GLXZ to lose another $1M or so in Q4 due to continued lockdown (though they may do better than that since they are increasing table billing rates to 75% in November and December).  By my estimates, GLXZ has done did a good job of cutting non-rent, non-legal SG&A during Q2 2020, reducing it from $2.7M to $1.9M (as shown in Q2 2020 income statement of my model). 

Liquidity was a more serious risk a few months ago.  GLXZ had tapped its revolver ($1.0M) and received a government PPP loan ($0.9M) during Q2 2020, but cash was still tight.  Recently, however, GLXZ scored a $4M Main Street Loan backed by NSB that, in my view, provides a reasonably healthy cushion for GLXZ to weather COVID without having to turn to the capital markets.

(2) THE TRIANGULUM DISPUTE.  It takes a bit of digging to get a feel for the Robert Saucier situation, and many investors may prefer to stay away.

(3) MISUNDERSTANDING THE PGP ACQUISTION.  PGP used to distribute GLXZ’s iGames.  GLXZ owned the intellectual property, but by contract PGP had the online distribution rights.  The PGP acquisition cuts out the middleman, with excellent timing given that the deal was struck pre-COVID and COVID boosts online gaming.  PGP assets also include more tables games to add to GLXZ’s portfolio.  (Note that the acquisition accounting is a bit misleading because it looks as if GLXZ issues 3.14M shares at $1.27/share, but in fact the deal was priced at $1.91/share.)

(4) POOR SCREENING.  To screens, GLXZ looks like a heavily levered casino provider during a pandemic.  But, as discussed, the majority of the debt ($39M of $49M) reflects the forced redemption of Saucier’s shares at $1.68/share.  GLXZ stipulated a 2% interest rate, but I half expect the judge to revise that upward and/or require some upfront payments—as reflected in my modeling.  So that “debt” looks like debt to a screener but is a lot different than traditional debt.

(5) TOO SMALL FOR MANY SERIOUS INVESTORS.  At a $32M market cap and about $50,000-75,000 worth of stock trading per day, GLXZ is too small for many serious investors.

(6) NO COVERAGE AND NO MANAGEMENT CALLS.  At GLXZ’s size it does not receive any analyst coverage, and management does not do quarterly calls.

RISKS

GLXZ has a number of risks.

• Online disintermediation.  EVO tried cutting out GLXZ but ended up preferring to use GLXZ products on its online offering.  That is excellent because it exhibits the strength of GLXZ’s products.  But I still haven’t fully gotten over the fear that GVC and EVO don’t need GLXZ.
• Liquidity.  It looked touch-and-go for a bit during COVID.  Management did a nice job cutting costs.  The PGP acquisition and the $4M Main Street Loan relieve a lot of the liquidity concern and provide GLXZ with a path through COVID.
• NSB bank-loan covenant.  GLXZ could risk violating its loan covenant for its $10M term loan with NSB (the same bank that helped GLXZ secure the $4M Main Street Loan).  Page 15 of the 3Q 2020 10-Q details the increasingly lenient terms that NSB has granted to GLXZ.  Recently, NSB lowered the 12-month trailing EBITDA requirement to $2.4M.  Given that NSB is backing GLXZ’s $4M Main Street Loan, I expect NBS is willing to work with GLXZ on the loan covenants, but this is a risk.
• Triangulum lawsuit.  I hopefully covered this one adequately.  My modeling is probably overly conservative (assuming an interest rate step-up to 5% and prepaid installments of the $39M of principal).  GLXZ booted Saucier because it had to for business, and they structured the deal similar to the Wynn precedent using the same lawyer.  After Saucier left, GLXZ quickly regained its CA gambling license.  Still, an adverse outcome is possible, whereby Saucier comes out ahead and is owed a lot of money for the shares that were force redeemed at $1.68/share.
• Bad acquisitions.  I don’t think GLXZ necessarily needs to do acquisitions to grow in the mid-teens.  Following the big $22.3M October 2011 acquisition, GLXZ didn’t make any major acquisitions from 2012-2019 and grew at ~17%.  Still, SGMS has made loads of acquisitions because it makes a lot of sense to buy games with lousy distribution and excessive overhead, then plug them into the stronger distribution network and reduce the overhead.  GLXZ is subscale and would benefit from the same, and as investors we would be counting on management to do so prudently.
• Slow state license approvals.  The management team has been hitting the road, doing interviews to get licensed in more states and in more products (e.g., progressives).  With the well-connected board and management—and Saucier’s stink wearing off—GLXZ ought to be able to secure state licenses at a good clip.  Still, the bureaucratic license approval process can drag out.

Catalyst

• Emergence from COVID
• Reflection of the PGP acquisition in the financials
• iGaming legalization in more states
• Increased revenue from progressive penetration