Description

Buy Global Cash Access (NYSE:GCA) equity for a one to three month trade.  The story is complicated – requiring pro forma modeling, an understanding of gaming supplier M&A and also historical GCA context, but upside is material for those willing to do the work.

This write-up is time sensitive, as GCA reports FQ4 earnings next Tuesday, and bridge syndication should begin shortly thereafter.  Happy to get into more detail or address other topics in the Q&A.

Pro forma metrics:

·         66mm shares, $465mm market cap

·         $1.2bn net debt and $1.65bn enterprise value

·         LTM September 2014 pro forma EBITDA = $190mm.  Note this is adjusted for stock-based comp and MGAM transaction fees

o   The Company has guided to ~$30mm in operating synergies, with ~80% realized by December 2015.  Synergies are comprised of headcount reductions and overlapping corporate functions, and explained in depth in IR decks.  Pro forma adjusted EBITDA = $220mm

·         GCA at 7.5x Pro Forma EBITDA, 10x EBITDA – Capex and 17% FCF yield

·         These data are all pro forma, given MGAM closed in December.  Reporting services have not yet updated numbers and the Company is sparsely covered

There are two primary reasons why I think this trade works:

·         Regional Gaming Strength – Gross Gaming Revenue (GGR) trends have improved since November, when the credit market last looked at GCA.  Legacy GCA revenues have a high, positive correlation with regional GGR, with the core money transfer business a first derivative play on regional gaming.

a.       Given GCA’s >70% share and high correlation with slot spend, GGR strength should provide a tailwind in 2015.  Comps will also improve optically as the Caesar’s contract loss is lapped.  These dynamics should be obvious but GCA has lagged every liquid, non-bankrupt regional gaming-related security that I track.

·         Debt Syndication / Information Flow – GCA’s $1.2bn purchase of MGAM was debt financed, comprised of ~$860mm and $350mm in secured and unsecured debt.  The ‘bottom’ half; $700mm of secured and unsecured notes was hung and still sits with underwriters. 

a.       Why couldn’t they move this financing?  The high yield and distressed markets blew out in October and November 2014, and gaming was no exception given the CZR bankruptcy and Sci Games financing.  Between market weakness and an already complex story, GCA’s unsecured notes would’ve priced at a 15-20 point discount, and the financing was shelved.

b.      The high yield market has since improved, along with regional gaming sentiment.  Scientific Games’ benchmark bond is up 10 points, easing relative value comparisons.  GCA’s bridge launches and likely clears after earnings along with a material overhang for both existing and prospective investors.

I think shares can trade up at least 20% over the next few months, clawing back LTM losses as the financing clears, information flow improves and management better communicates the story.

For credit-oriented funds, unsecured bonds should come at ~11/12% through ~5.5-6x leverage with operating liquidity, modest (and likely increasing) equity cushion and good free cash flow dynamics.  The downside to both the debt and equity is size and trading liquidity.

Today’s Global Cash Access is the product of two formerly standalone public companies:

Legacy Global Cash Access – Industry-leading supplier of money processing services to domestic casinos.  With over 70% market share, GCA dominates the small but important business of sending money to customers within a casino.  GCA installs ATMs, kiosks, integrated software and sometimes provides staffing support, to provide these money-processing services.

From a product perspective, the two material drivers are (i) ATM transactions and (ii) Credit Card Advances.  GCA charges retail customers a fee, 2-4% of the net transaction requested (gross revenue), pays ~40/50% to casinos and either receives or pays an interchange fee depending on the type of transaction.

This business is mature and competitive but differentiated versus regular-way ATM or processing businesses due to unique regulatory considerations.  Specifically, the transfer of money to consumers at casinos is fraught with risk and requires licensing at any and every casino where GCA is hooked into a slot management system.  This process is cumbersome, intrusive and together with GCA’s 3-5 year contracts, creates barriers to entry.

Core GCA generated LTM revenue and EBITDA of $584mm and $73mm, basically flat with FY 2013.

Multimedia Games – Austin-based gaming supplier with ~4% domestic market share.  MGAM grew up in the Class II (Bingo) Tribal Market, largely in Oklahoma and Washington, but extended a unique, differentiated product set into the Class III market.  MGAM operates on both a merchant or for-sale model and also through participation or leased games.

MGAM has grown share through both IGT’s weakness and new, innovative products.  The flagship product, TournEvent, allows operators to offer seamless slot tournaments without having to change out equipment.  TournEvent, in turn drives greater traffic, revenue and lower costs for the operator.  TournEvent is an example of several innovative, growth-oriented products launched over the last few years.

MGAM’s prospective growth is slowing from historical growth rates; however, with ~75% recurring revenue and very low Class III penetration, upside remains.  For example, MGAM has minimal penetration in Nevada, the nation’s largest slot market with ~100k machines – where GCA dominates.  MGAM generated LTM revenue and adjusted EBITDA of $218mm and $117mm, up from ~$107mm in 2013 and $80mm in 2012.

Broader Context – GCA, having basically invented the casino cash access market, dominates with 3-5 year contracts and ~70%+ market share, but competition is fierce and has intensified in recent years.  This dynamic is apparent in Caesar’s, who switched from GCA to Global Payments in 2010 due to pricing.  GCA later purchased MCA Processing for a nominal amount in 2011, in an attempt to retain the other 50% of CZR business, but this also churned in 2014 – again due to pricing.  The Caesar’s contract was low margin and seems isolated, however, the core GCA business faces continual pricing pressure.

New CEO Ram Chary joined GCA in early 2014, inheriting a company with minimal net debt, stable cash flow and $100mm+ in NOLs.  These characteristics, coupled with recent supplier M&A – WMS / SHFL / BYI / VGT – prompted GCA’s leveraged purchase of Multimedia Games.

The MGAM announcement caught the market by surprise – a payment processing business buying an upstart, rapidly growing slot supplier at a full price?  The strategic rationale still doesn’t make much sense – both sell to casinos but the context –

slot manager versus a controller or treasurer – is different.  Financial benefits – $30mm of operating synergies and the ability to use GCA’s NOLs are readily apparent, but the verdict is out regarding strategy.

Given this backdrop, why should we care? – We don’t need the MGAM purchase to be brilliant for this trade to work.  Coming full circle, there are two key drivers:

• Regional Gaming Strength – GCA is a first derivative play on regional gaming, with weather and lower gas prices driving strength.  Regional operators like PNK, PENN, BYD or ISLE are up 20-40% YTD, and while there are some unique situational dynamics like M&A or OpCo / PropCo speculation, the point is that regional gaming trends have improved materially.  Macquarie, a regional gaming bull has good information on trends, as does Eilers Research
• Debt Syndication / Information Flow – GCA shares have lagged due to financing concerns and more limited coverage.  The next two weeks, with FQ4 earnings and the bridge syndication are important steps forward.  I expect the information flow to improve materially.

We’ll revisit and get more specific along with FQ4 earnings and FY 2015E guidance.  With suppliers trading around 7-9x, depending on leverage, synergies, liquidity, etc., I think 8x 2015E EBITDA of $230mm gets you to ~$10, before considering the free cash flow and debt paydown.

This write-up is brief given next week’s earnings print and the summarized nature.  [One could write for days regarding either GCA’s history or supplier industry M&A].

Catalyst

FQ4 earnings

Bridge syndication and removal of the overhang

Improved information flow and marketing