Description

Here is your chance to partake in a management/leveraged buyout. The
offer is a bit unusual in that they are offering $1.25 in cash per
share, plus an additional $1.50 of deferred payments rights of $0.50
each to be paid on the 1st, 2nd and 3rd anniversary of the deal
closing. I calculate the IRR at 67.5%, assuming the deal closes in 6
months, and 38.0% if it closes July 2004.

What does PDS Gaming do? They sell, lease and finance slot machines to small casinos, particularly Native American ones. They do not have any
analyst coverage and minimal institutional ownership because they are small and because you can't own 5% or more of the shares without approval from the Nevada Gaming Commission. There is a nice moat because lease-financing, where PDSG retains the asset interest, requires a gaming license in each jurisdiction, which is considerable when factoring each individual tribe. They finance about 25% of their sales, as slots run about $10,000 per machine.

Late 2001, PDSG initiated a new strategy involving gaming tables,
like video blackjack, and selling used slot machines. They promoted
it at a conference hosted by Roth Capital Partners in February, 2002.
A major selling point was their lease accounting, where they
depreciate on an accelerated basis, so that they have this *big*
residual value gain left after five years when they resold the slots on the used market. Three months later, the shares tank when they announce poor results and that they will write-off two divisions. Their strategic initiative failed because apparently there is no demand for five year old slots.

Book value is $2.76 as of 9/30/02. There are 3.8 million shares outstanding and the management team owns 31%.

Risks:

1. One of the cons is that you can't trust the CEO. Nevada - gambling - who knew? While the company president and CFO (who later resigned) were giving the dog & pony PowerPoint presentations last year, the CEO and the corporate secretary, a husband and wife team, were busy selling shares like crazy because the stock was trading over $4 at that time.

2. The deal is contingent upon them receiving approval from the Nevada Gaming commission.

3. The deal is contingent upon them receiving consents from their commercial lenders.

4. The deferred payments carry no voting rights and as far as liquidity, the PR said this: "…the rights themselves will not be transferable except pursuant to testamentary disposition or by operation of law." Thus, equity holders are being asked to become subordinated debt holders.

Catalyst

1. Management wants to optimize shareholder value.

2. Paying $1.37 for $2.75 over 42-52 months.