Description

Adding it all together (including $60MM of EBITDA for Digital/Sportsbetting, deducting $40MM related to a payments business sold out of the Lottery segment in 1H’22 which will close later this year, ~$80MM of corporate overhead, and including $15-20MM of margin impact in Q3’22 which are related to expected restructuring/project activities), the business is going to do $1.65BN of EBITDA on a normalized basis (which it will realize on a cleaner basis in FY’23), with upside as it grows iLottery and Gaming capitalizes on its cost savings / revenue recovery.

This EBITDA generation corresponds to nearly $500MM of FCF, net of cash interest ($330MM), capex of $350MM, cash taxes of $200MM+ and a distribution / return of capital to Italian NCI of $300MM. The FCF represents a yield of >12% on the Company’s market cap of nearly $4BN. This foots with the Company’s longer-term projections, which imply ~$600MM+ of CFFO-Capex through 2025 (excluding a one-time Italy license renewal fee of $300MM expected in 2025). 

The right way to look at EBITDA is likely net of NCI payments, which are structural and recurring, which would imply valuation EBITDA of $1.35BN for the core business. Using this level of EBITDA, IGT trades ~7x EBITDA.

Valuation:

The Company’s peers have traded for a significant premium to where IGT trades - and recent precedents have set high valuation comps for the lottery business:

Most notably, SG Lottery was purchased by Brookfield for ~$6BN in early 2022, which represented a multiple of nearly ~12x 2022 EBITDA. SG Lottery has more exposure to instant tickets (which have grown faster than draw games), but we’re not sure that a 5x premium was warranted for that business.

Other trading comps that are on the market seem to trade at a big premium to IGT, although we would caveat that some if it is warranted due to the faster growing jurisdictions they are involved in (Australia / France for TLC/FDJ vs. Italy is more mature for IGT). 

On the Gaming side, Light & Wonder, the legacy SGMS slots business, trades 8x 2023 EBITDA, which seems like a reasonable valuation to me for this business. This is likely a little close to the high end for multiples historically, and IGT is losing a little bit of share still, so we use a slight discount to this level for IGT’s business.

IGT’s digital operations are a trickier business to compare - IGT is a B2B technology partner to FanDuel, NBA-Boyd, and PointsBet. While I view this as a higher value business than its high-flying B2C customers, the entire digital (sportsbetting / iGaming) space has rerated lower in 2022. Accordingly, I use a nominal multiple (big discount to where OpenBet was purchased by Endeavor (near ~11.5x), to value these assets).

Situation Overview:

IGT is not a new name for the VIC community, but there have been a number of developments over the past 18 months since it was last posted. The Company is a leading player in slot manufacturing and lottery, with significant presences in Italy and North America. The current business is made up of 3 remaining reporting segments - Global Lottery, Global Gaming, and Digital / Sportsbetting. Lottery operations are ~65% of revenues and ~85% of EBITDA today.

The lottery industry significantly outperformed during COVID-19, reaching new / younger players over that time frame. New technologies, such as iLottery, are creating new growth opportunities in the space (and present the possibility of TAM expansion for the first time in well over a decade in IGTs mature markets).

Away from Lottery, the slot manufacturing / global gaming segment was heavily impacted by COVID and capex deferrals from gaming operators - revenues declined 45% in 2020. However, the Gaming segment has significantly recovered in the last 2-3 quarters given a heavy emphasis on cost management along with the general recovery from COVID - EBITDA is runrating at $350MM, back to the highs from 2019 (with incremental upside as the Company represents that they have taken out almost $200MM of costs, and revenues are still at ~80% of pre-COVID levels). While the Company has lost share over the past few years, IGT still controls ~25% of the market, and would be poised for continued improvement in profitability upon recovery.

The company has faced some operational and financial challenges in 2022 related to (i) supply chain issues and (ii) the depreciation of the Euro (given its significant Italian operating exposure). We view these issues as temporal drags on the earnings power of the business – on a normalized basis, our belief is that IGT trades <7x EBITDA, representing a 12%+ FCF yield at current levels, with a management team actively returning capital to shareholders via a dividend and repurchases on the open market. Comps / recent precedents have occurred at huge premiums to IGT’s equity (12x+), which we do not view as a warranted valuation gap.

Business Overview / Segment Earnings Power:

I’ll be brief here as mimval and aviclara181 have both gone through the business in some detail in the past, but IGT has 3 ongoing operating segments - Global Lottery (US & international lottery operations - international = mostly Italy), Global Gaming (sales of gaming machines / slot management systems to casino operators), and a small Digital/Sportsbetting operation. The most notable one is the Global Lottery business, which is the largest contributor to EBITDA, and was actually a beneficiary during COVID, vs. the Gaming business which was negatively impacted by the pandemic.

Global Lottery:

IGT’s lottery business is recession-stable with highly recurring attributes. It supplies 90 customers worldwide, including 37 of the 46 US lotteries - the Company operates both draw based and instant scratch ticket games through 5-10 year contracts with multi-year extensions. These contracts are awarded at the state level - and our understanding is that they are fairly sticky, with minimal turnover between different competitors (as there is a degree of switching costs in lottery operators - new contracts are capital intensive as operators must build out terminals/vending + the RFP process sounds like it is heavily impacted by existing relationships). 

IGT has 80%+ market share in draw/numbers based games, which represent a ~$20BN market today and are a little more volatile year to year than scratch tickets. Historically, this segment has grown at 2-3% over the 10 years prior to COVID, with general stability during the recession in 2008.

In 2020, the industry had a step change to revenues / profitability, as it meaningfully outperformed during the COVID-19 pandemic. Retail lottery sales were +11% in 2020, despite being down 15-16% in Q2’20 due to the stay-at-home measures enacted during the pandemic. This growth continued into 2021 and represents a near-new normal in 2022 -> and our understanding is that the Company has inflationary adjustments to its contracts, which means that the current levels of revenues might be here to stay. An additional tailwind to lottery performance is iLottery, which is significantly expanding its presence in the US as more and more states approve it - IGT has won several iLottery contracts in states where it is the incumbent lottery provider (Georgia, Kentucky, North Carolina, and Rhode Island), allowing it to offer a full suite of solutions to the state between both physical and online lottery. The Company believes the entire Global Lottery segment will continue to be a low-to-mid single digit grower from here due to these tailwinds.

Away from the US, IGT’s revenues are 40% from other countries, including 30% in Italy and 10% spread across LatAm and EMEA countries predominantly. IGT’s Italian operations have had the most near-term volatility on a Y/Y basis - the Company had a windfall benefit to EBITDA in 2021 from gaming hall closures in Italy, which it believes caused a one-time benefit to the Italian lottery operations of $165MM in revenues and $140MM of EBITDA. Additionally, the Company’s results as reported in USD are negatively impacted by the depreciation of the Euro, which I estimate will reduce EBITDA by $60MM this year. After all is said and done, I expect the lottery segment to do $1.35BN of EBITDA in 2022, with modest growth thereafter.

Global Gaming:

The Global Gaming segment offers a clearer trajectory of growth, with some headwinds that seem a little more temporary in nature, but a strong tailwind to earnings power from (i) the ongoing recovery from COVID-19 and (ii) $200MM of cost savings that were taken out, predominantly in this segment. 

This industry is mature and seeing a reduction in TAM due to (i) slot floor reductions at facilities, (ii) generally reduced capex by operators, and (iii) no new US facility openings. IGT’s revenues pre-COVID were half from slot management fees / revenue share with casinos (more recurring), and half from sales of new machines which are lumpier quarter to quarter. Frankly, IGT was not a premier content producer in the space, and has seen market share gradually erode as Companies like Aristocrat (and SGMS to a lesser degree) invested more heavily in the slots business.

The new machine sales dropped significantly during COVID as gaming operators deferred capex to maximize liquidity / interim FCF, and revenue-sharing fees declined alongside industry Casino GGR. 

The Company has significant momentum in 2022, both from the tailwinds highlighted earlier and a renewed capex cycle by gaming operators. Some gaming operators have discussed the desire to increase slot investment in 2022 after years of rightsizing prior to 2020. Accordingly, results have accelerated in the most recent periods - EBITDA was $404MM pre-COVID, and dropped to -$38MM in 2020. In Q2’22, EBITDA was a runrate of ~$350MM despite being impacted by supply chain issues that have hurt unit shipments, and has been improving by $10-15MM sequentially on average since Q2’21. And revenues are still only at FX may have a $30-40MM impact for the full year. My view is that this business will do $370MM of EBITDA this year as the supply chain issues begin to normalize, and exit the year at a runrate of $400-$450MM. The higher normalized earnings power vs. 2019 is due to the significant cost reductions taken out during the COVID period, which we understand to be permanent. 

Earnings Power

Adding it all together (including $60MM of EBITDA for Digital/Sportsbetting, deducting $40MM related to a payments business sold out of the Lottery segment in 1H’22 which will close later this year, ~$80MM of corporate overhead, and including $15-20MM of margin impact in Q3’22 which are related to expected restructuring/project activities), the business is going to do $1.65BN of EBITDA on a normalized basis (which it will realize on a cleaner basis in FY’23), with upside as it grows iLottery and Gaming capitalizes on its cost savings / revenue recovery.

This EBITDA generation corresponds to nearly $500MM of FCF, net of cash interest ($330MM), capex of $350MM, cash taxes of $200MM+ and a distribution / return of capital to Italian NCI of $300MM. The FCF represents a yield of >12% on the Company’s market cap of nearly $4BN. This foots with the Company’s longer-term projections, which imply ~$600MM+ of CFFO-Capex through 2025 (excluding a one-time Italy license renewal fee of $300MM expected in 2025). 

The right way to look at EBITDA is likely net of NCI payments, which are structural and recurring, which would imply valuation EBITDA of $1.35BN for the core business. Using this level of EBITDA, IGT trades ~7x EBITDA.

Valuation:

The Company’s peers have traded for a significant premium to where IGT trades - and recent precedents have set high valuation comps for the lottery business:

Most notably, SG Lottery was purchased by Brookfield for ~$6BN in early 2022, which represented a multiple of nearly ~12x 2022 EBITDA. SG Lottery has more exposure to instant tickets (which have grown faster than draw games), but we’re not sure that a 5x premium was warranted for that business.

Other trading comps that are on the market seem to trade at a big premium to IGT, although we would caveat that some if it is warranted due to the faster growing jurisdictions they are involved in (Australia / France for TLC/FDJ vs. Italy is more mature for IGT). 

On the Gaming side, Light & Wonder, the legacy SGMS slots business, trades 8x 2023 EBITDA, which seems like a reasonable valuation to me for this business. This is likely a little close to the high end for multiples historically, and IGT is losing a little bit of share still, so we use a slight discount to this level for IGT’s business.

IGT’s digital operations are a trickier business to compare - IGT is a B2B technology partner to FanDuel, NBA-Boyd, and PointsBet. While I view this as a higher value business than its high-flying B2C customers, the entire digital (sportsbetting / iGaming) space has rerated lower in 2022. Accordingly, I use a nominal multiple (big discount to where OpenBet was purchased by Endeavor (near ~11.5x), to value these assets).

Our SOTP valuation incorporates a range of valuation multiples for the business, all of which are at a discount to comp valuations in the respective spaces. 

Overall, it is tough to paint a scenario where IGT is not worth above where it trades given (i) the high FCF yield, and (ii) the credible growth story, coupled with much higher public and private valuations for comparable businesses.

Capital Allocation:

A marked change for the Company over the past 18 months has been its increased focus on shareholder returns of capital vs. the Company’s historical conservatism surrounding leverage / FCF deployment. While the business is not run with a lot of leverage (and management is actively looking to delever the business to, it has begun returning capital to shareholders in a meaningful way. The Company’s share repurchase program instituted in their 2021 Investor Day allows for $300MM worth of buybacks over multiple years, representing the first buyback program in 7 years. The Company has already used almost $100MM of this program as of Q2 (only over the last 3 quarters). IGT also reinstated its dividend following a suspension during COVID, and is slated to payout $160MM per annum to shareholders (representing a 4% yield on the current stock). Altogether, the LTM capital return to shareholders represents 6.5% of the current market cap, and is growing.

Management is also willing to make smaller divestitures today that are value maximizing. The aforementioned sale of the proximity payments business was negotiated at a price of 15.75x EBITDA (representing 630MM EUR of proceeds), a huge premium to the prevailing trading price. These divestitures will drive leverage lower, closer to the 2.5x target management communicated at its investor day (PF for the divestiture, leverage will be ~3.4x).

Altogether, we view management as taking the right steps on capital allocation and aggressively deploying FCF to shareholders’ benefit, contrary to their historical predilection to not do so. 

Risks:

• De Agostini Family Ownership - the De Agostini family has 50% economic ownership and 65% voting ownership - they are long-term owners of the business. The family has historically driven conservative capital management / capital spend. New management is acting differently than the old philosophy, but a change in strategy driven by De Agostini presents a risk (and an overhang to the equity valuation)

• Continued loss of market share, particularly in gaming

• Risks surrounding major contract renewals, although our understanding is that most of the top 10 contracts are >5YRs away

• Prolonged FX and Supply Chain volatility

Catalyst

• FCF generation and continued capital return to shareholders
• Execution on 2023 EBITDA growth / targets