Description

Global Cash Access is a special situation with an asymmetric risk/return profile. This is a highly cash generative business model with a management team using FCF to buy back every share in sight. The market is mistaking a steep cyclical decline in casino gaming for permanent impairment in credit usage. With reasonable assumptions around stabilization in gaming trends and favorable capital allocation, GCA should be a $16-18 stock over the next 12-24 months with a node to the upside closer to $22. My worst-case downside is $6. I base the $16-18 case on $1.25-1.50 in FCF/share (~8-9% FCF yield vs current 15-17%)

Brief background: GCA is a provider of cash access services to the gaming industry with ~90% of revenue coming from domestic operations. When you get cash at the casino, GCA gets a cut whether it's at the ATM, debit/credit cash advance or a check (some people do still use this dated form of payment). These fees you pay to get cash are split with the casino, and in return GCA stocks and services the ATMs. GCA has ~80-85% market share domestically with a unit of Global Payments (GPN) providing the only real competition and some small ISOs with the final ~5% of the market.

Why this is a special situation: a look at the 2007 implosion in the stock would turn up some colorful stories. The ex-CFO departed in July 2007. The ex-CEO resigned in Nov 2007. You can get some more color here by Googling a combo of Xyience, bankruptcy, and ultimate fighters. This ex-CEO under a new competing entity just filed an antitrust lawsuit against GCA. Finally, according to news articles, one of the co-founders had been accused of miscoding Visa transactions, embezzlement and didn't cooperate in the 1982 murder investigation of his wife (http://www.lasvegassun.com/news/2009/jun/22/casino-vendor-faces-legal-trouble-arizona/). The new team is solid and the last of these ties was severed in fall 2009 when a co-founder supposedly sold his remaining shares on the open market. The company's checkered past is one of the reasons it arguably trades at a high-teens FCF yield.

1. Industry consolidation leads to stable margins and cash flow

First, why could this be a decent business at all with a plethora of financial institutions out there vying for fee income and processors at the mercy of price increases from V/MA? The moat is twofold. First, regulatory compliance and sharing information with the casino customer is complex. Wells Fargo used to be in this business years ago and withdrew in part due to regulatory complexity - it was untenable to be a bank and worry about gaming regulations on a state by state basis. Second and more importantly, competition among banks creates a niche in the gaming industry. A typical split on a $4 ATM fee would be $3 to the casino operator and $1 to GCA. You don't see a branded BofA ATM on the casino floor because a BofA customer expects free ATM fees. Every time its own depositor takes out a few hundred dollars to play blackjack, BofA would owe the casino $4 and generate no revenue with additional costs. That dynamic ruins the economics of the business for a traditional financial institution and creates a niche for GCA. Scale is a third leg on the stool given that GCA and GPN combined control ~95% of the industry. While it's possible to bootstrap of white label a solution (e.g. USB provides ATM processing to GPN's casino customers), it's atypical.

Casinos typically have 3-5 year deals with processors like GCA. In the past, margin compression was a feature of renewals; casinos had strong buyer power. Switching costs were low given that you could change out the ATMs at 3am on a random Wednesday night without upsetting too many patrons. But in 2008 as the gaming industry began a steep cyclical decline, GCA went on the offensive when the outlook was very bleak. It acquired Cash Systems for $33m or $0.50/share vs CKNN's 52-wk high of $7.37. Then GCA took out Certegy's Game Cash for $25m or ~3.5x EV/EBITDA. Not only did these look like sweetheart deals, they removed two aggressive bidders from the industry.

Fast forward to today and it is a two horse race between GCA (80%+ share) and GPN (10-15% share). One sign that this could become a duopoly with favorable economics is a lack of 'marketing allowance' dollars or signing bonuses. When a contract renewed in the past, a customer like LVS would get a large upfront payment from GCA. GCA was basically ponying up the present value of certain cash inflows like reverse interchange fees. Those marketing allowances are a thing of the past and a sign that the power in the relationship has shifted somewhat towards the ATM provider. With low capex requirements and margin stability, this business throws off a lot of cash and will see ROIC climb towards the mid/high teens over time.

2. New management acting like shareholders

CEO Scott Betts, CFO George Gresham and the BOD understand how to allocate capital. Right now, its own stock is one of the best investments the company can make. The diluted share count has shrank by nearly 13% in the 9 quarters that Gresham has been CFO, and the company recovered a co-founder's outstanding shares for $36.2m in Jun-09 as well. After acquiring two key competitors and investing in some growth opportunities, ostensibly 100% of FCF over the past two years has gone towards share repurchase.

Both the CEO and CFO check out as capable and ethical managers and have changed the culture since late 2007. Customers say that bidding processes and service levels have been more professional. Betts' experience is with First Data and Gresham helped turn around and sell eFunds to FIS.

While many management teams talk big on buybacks and never fully execute them, GCA has walked the walk. The company completed a $50m program in 1Q08, $25m in 4Q09 and approved another $25m program in 1Q10. The 2.7x gross and 1.7x net leverage on the balance sheet are relatively conservative with maturities in 4Q11 and 1Q12. These shareholder-friendly measures will be stepped up further as management gets more comfort that gaming isn't in secular decline.

3. Market does not understand MGM Mirage contract

Customer concentration is another feature of the business and MGM is a top 10 customer. After going public in late 2005, the pressure was on to sign some big names. In Jan-06, GCA landed MGM Mirage. At the time, it bent over backwards to win that deal and likely won the business near cashflow breakeven kind of margins. While it's hard to isolate entirely, we know that same-store comps were positive through those quarters yet we still see a huge drop in 1Q06 gross margins, down 430bps yr/yr.

Margins from four years ago are relevant because this contract is up for renewal in pieces throughout 2010. The market is worried because the MGM/Dubai World JV chose a different cash access provider for Aria @ City Center. That was a different operating team that negotiated the Aria deal and it reportedly cobbled together vendors based on price. While it would have been nice to see GCA win that business given that major operators are usually one-vendor companies, it doesn't mean that GCA will lose the MGM properties upon renewal this year. There are pieces to the contract that will be negotiated separately for ATMs, debit/credit cash advance, and central credit. Even if GCA loses part of this contract (headline risk), it could ironically be margin accretive. GCA currently offers ATM, cash advance and central credit to MGM but does not yet offer check warranty or marketing services.

If they keep the contract, even in a difficult operating environment where the operators are trying to squeeze vendors on costs, I would still expect some normalization of margins based on broadening the portfolio of services offered (there's room to grow the relationship, not just renew it). GCA owns all the ATMs and redemption devices which are almost fully depreciated but doing fine from a useful life standpoint - for someone to come in and undercut them will be difficult. But even if they do, the fixed costs they must shoulder would be a body or two in the processing department while variable costs of servicing the account, stocking the cash, etc all go away. Understanding this relationship and the bidding of the contract in 2006 helps me form a view that gross margins may not just stabilize but may even rise back towards the low 30s.

4. Any growth opportunities would be gravy given the FCF

I model in none of these opportunities which could help the gross margin line due to better revenue, customer retention, or lower expenses from less cash in the ATMs.

• Information services. An underappreciated part of the story, this may somebday be considered a competitive advantage. Owning 80%+ of the cash advance market, GCA can aid in player marketing in ways that the best at Harrah's or MGM never could. For example, MGM could say "send a mailing for a free stay to people who have withdrawn at least $5,000 in cash on the Vegas Strip over the past year at non-MGM properties." Voila, MGM is chasing market share in a targeted, effective way with a data set it never could have built on its own. I haven't modeled this opportunity into my numbers because it makes most sense for smaller properties competing against larger peers where as MGM, LVS, et al might not want their data sold in such a fashion. At the very least it could be a powerful customer retention tool for GCA on cash advance.
• TITO ATM. In the final stages of approval after a dismal effort in 2006-07, this would be a product extension where you dip your card at the ATM and it spits out a slot ticket instead of $20 bills. The idea is that you're much more likely to spend all of a $100 slot ticket than feed the machine one bill at a time. This would reduce cash holding costs for GCA and drive incremental coin-in for the casino and reduce slot maintenance costs. This failed the first time around due to social concerns (dipping your card AT the actual slot machine), but the current version is easier to stomach and GCA has a former chairman of the Nevada Gaming Control Board on board to help guide the process.
• State budgets. The conventional wisdom is shifting towards states opening casinos to plug fiscal deficits and generate jobs. Four casinos in Ohio might be a 2012 opportunity, PNK just opened a property in St Louis, etc. We'll see a slow but steady increase in the points of distribution for GCA over time - not a huge tailwind, but it doesn't hurt. 

5. Undemanding valuation

While valuation is not a true margin of safety, the bearish node on the decision tree here is supported by a lot of free cash flow that is being deployed favorably for shareholders. Even if I assume that gaming and consumer discretionary spending are in for a multi-year decline from current levels and the changing credit landscape permanently impairs the economics of a cash advance transaction, I still get close to 70c in 2012 cash EPS in the bearish scenario- I use cash EPS as the company has $148m in deferred tax assets from its incorporation and $30m in federal NOLs.

RISKS

Multi-year depression for Las Vegas and permanent changes in consumer credit. The top 5 customers account for ~35% of revenue with Harrah's as the largest customer at 14%. While same-store trends remain negative and there's more sensitivity around an expensive credit card cash advance fee, business appears to be troughing as the folks who are still gambling are captive inside the casino (i.e. they're not carrying $5,000 in cash on the plane to Vegas). GCA's same-store sales trends are positively correlated with gaming revenue in Nevada (22% rev) and California (14% rev).

Margin headwinds in 1H10 trump evolving business model. GCA switched from in-house processor USAP to TSYS. In the near-term this results in lower reverse interchange to GCA and higher interchange to the card network because routing through Interlink (Visa) is more expensive than using Star, Nice, Etc.

Loss of major customer = headline risk. Conceptually, losing a contract like MGM at cashflow breakeven wouldn't hurt much but the headline would seem dire. It would be good for GCA to maintain status quo industry share from here on out.

Competition comes from somewhere besides GPN. Small ISOs like Itronics pop up from time to time and do business with casinos, but they really only win a handful of one-off accounts. The non-competes of the former mgmt expired in mid-2009 and they're trying to cobble together a solution leveraging the equipment and processing power of other hardware/software providers.

Catalyst

Continued share repurchases with FCF

Margin improvement as major contracts like MGM renew

Incremental opportunities in information services, TITO ATM in 2010-11

Casino gaming stabilizes, laps easy comparisons

Company eventually goes private or is an attractive deal for a larger bank/payment processor