Description

(GTECH is listed on the Italian Exchange, but we could not choose "Italy" as an option under the country tab) 

Summary:

GTECH S.p.A. (GTK) is a well-managed, significantly undervalued company undergoing a major transformation and at current prices, represents a compelling, asymmetric investment opportunity. GTK has agreed to buy International Gaming Technologies (IGT), and concurrent with the close projected to be in Q2 2015, the company will re-list on the NYSE (currently listed on the Milan exchange) and re-domicile in England. GTK is using the deal as an opportunity to re-lever, will benefit from a significantly lower tax rate due to the re-domiciling (21% in England vs. 40% in US and 30% in Italy), and should benefit from a multiple re-rating subsequent to its NYSE re-listing. Ignoring synergies, and the potential for both secular and cyclical growth of the underlying business, and assuming the stock will continue to trade at a discount to its relevant comps (albeit a smaller discount), GTK retains significant (50-75%+) upside. In our view, a number of temporary factors (complicated, long lead time cross-border deal requiring approval from multiple regulators, current Italian listing, poor sentiment in gaming, complex deal structure) have turned away almost every class of investor, save opportunistic ones. Based on LTM numbers, pro-forma GTK trades at a 7.0x EV/EBITDA vs. an average of 11.9x for its peer group. Temporary factors depressing the valuation should subside upon deal close in Q2 2015 at which time we expect the stock to appreciate meaningfully from multiple expansion. We view the undemanding valuation (trailing FCF yield >15%) as a margin of safety and are advocating GTK’s shares as an outright long.

This report seeks to highlight the investment idea, its compelling deal structure, and the milestones toward deal close. In time, we intend to post a more fullsome analysis of newco’s various businesses and their fundamentals. Suffice it to say that currently we believe the overall business will remain stable to +5 - 10%/yr over the next few years and expect upside will come from a multiple re-rating post deal close. We encourage you to view the GTK presentation from the deal announcement as it contains valuable information about the standalone and combined companies:

http://www.gtech.com/sites/default/files/2014%200716%20GTECH_Investor_Slides.pdf

Description:

GTECH S.p.A (GTK) is the world’s largest lottery gaming solutions operator and technology provider. Listed on the Milan stock exchange, 57% of GTK’s revenues are derived in Italy, 33% from the Americas, and the remaining from the rest of the world. The company operates and provides a full range of services and leading-edge technology products across all gaming segments (as % of GTK revenues): lotteries (56%), machine gaming (29%), sports betting (~10%) and interactive games (~5%). Historically, the lottery business has enjoyed some counter-cyclical qualities as cash strapped governments seek to replace or buffer softer tax revenues.

On July 17th 2014, GTK announced that it was acquiring International Gaming Technologies in a deal that is worth $6.4B, at 15x P/E and 8.5X EV/EBITDA valuations based on 2015 consensus forecasts, representing a value of ~$18.25/share of IGT stock. IGT is the world’s largest slot machine manufacturer. It manufactures and operates gaming machines and central systems for casinos internationally. In addition, IGT is also a leading gaming content developer, having developed “hit” games such as Wheel of Fortune, Sex and the City, Deal or No Deal etc. IGT also has a social gaming segment, albeit small, as it runs an online social gaming casino, which is the #3 top grossing app on Facebook.

On August 11th 2014, the proposed merger received antitrust approval. Currently, we await shareholders to vote for/against the deal.

The combined entity, “NewCo” will be re-domiciled in the United Kingdom, and be listed on the New York Stock Exchange.

The Opportunity:

Firstly, GTK currently trades at a large multiple discount to many of its peers. Based on LTM numbers, GTK trades at a 6.1x EV/EBITDA vs. an average of 11.9x to its peer group. GTK’s multiple discount can be explained in large part to the company’s significant exposure to Italy (on the brink of recession, among other political issues), and also because GTK trades on the Milan exchange, where multiples tend to be far lower than other developed markets.

As such, we believe that the first catalyst of this investment would be the closing of the acquisition and IGT, which would allow the company to re-domicile in the UK, and re-list in the NYSE. We think that when that occurs, valuations will be adjusted accordingly. Every 1x increase of the multiple represents a 41% appreciation of the stock, hence, if GTK trades from its current valuation of 7.0x  EBITDA to 8.0x  (vs. comps at an average of 11.9x) the stock would appreciate 41%. Currently, based on 2015 estimates pro-forma GTK trades at 6.0x EBITDA and thusly would appreciate 40% should it simply retain its current 7.0x multiple into 2015.

Secondly, we believe that both GTK and IGT have been facing a period of tough comparisons on a YoY basis in CY2014, due to a large order placed with the Canadian VLT replacement cycle, which was completed in CY 2013. As such, gaming equipment stocks like IGT and GTK have been cyclically depressed due to a pause in the product cycle.

Thirdly, the merger will create the worlds largest end to end gaming company with the newco enjoying a significant presence across all segments. For example, #1 in global lottery, #1 in global gaming equipment, and and strong positions in social gaming and interactive wagering. NewCo’s diversified product and geographic footprint will be superior to either of the standalone companies, as NewCo will essentially diversify IGT/GTK’s geographic footprint as well as its sources of earnings. Post-merger, NewCo’s geographic footprint will be further diversified away from a large, single market (Americas for IGT, Italy for GTK), as a percent of their revenues and operating income:

In addition, NewCo will also be able to diversify its earnings stream across product segments. Previously, 56% of GTK’s revenues came from the lottery segment, and 88% of IGT’s revenues were derived from the gaming equipment segment—leaving each of these companies highly susceptible to replacement cycle cyclicality and/or fluctuations in lottery regulations. Going forward, with NewCo, the combined entity will see its product segments (as a % of total revenues) broken out as follows:

•         Gaming Equipment: 51%
•         Lotteries: 35%
•         Interactive: 8%
•         Other: 6%

We find that this set-up presents a good opportunity for long-term investors to accumulate shares.

“NewCo” Dynamics

Pursuant to the transaction details, IGT shareholders will receive ~20% of the equity value in NewCo and GTK shareholders will receive the remaining 80% of the NewCo:

IGT Shareholders

IGT Shareholders will receive ~$13.69 in cash/share, with the remainder in GTECH stock (~0.1819 GTECH shares per IGT share)

GTECH Shareholders

GTECH Shareholders will receive NewCo shares at 1:1

GTECH has announced that it will be raising debt to complete the merger, and the company has guided for additional costs (to refinance debt, and other legal and advisory fees) to amount to ~$600M.

We estimate that NewCo’s Pro-Forma capital structure to look like this:

In addition, management expects that the deal will be able to generate ~$280M of synergies within the first 3 years, post-closing. This $280M of synergies will stem from: Industrial efficiencies ($85M), Overlapping corporate activities ($125M), R&D spend optimization ($20M), and revenue synergies of $50M. For our model, we model revenue synergies as such (of total target of $280M): 20% in 2015, 40% in 2016, and the remainder in 2017.

Pro-Forma NewCo Financials, Turning it into numbers

We first looked at revenues and EBITDAs for GTK and IGT on their own, and then combined them to form NewCo estimates:

Based on NewCo 2015 estimates, we calculate the implied equity value per GTECH share and derive a 89% upside based on today’s trading price of GTECH shares post-merger:

Sensitivity Analysis

Here is a sensitivity analysis based on various EV/EBITDA multiples and NewCo EBITDA, highlighting our “low”, “base” and “high” cases:

Once NewCo gets re-domiciled and NewCo gets re-listed on the NYSE, GTECH should see a multiple re-rating to 8-8.5x EV/EBITDA multiple or higher, which come 2015, which gives us a base-case upside of 78% at 8.0x.

Risks:

1. Deal breaks due to regulatory resistance (unlikely, key approvals have been garnered and GTEK has previously cleared similar U.S. regulatory hurdles in a past deal).

2. GTEK’s Italian Lotto contract expires in 2016. They could lose the re-bid (unlikely, they remain the go to lottery player in Italy and own all of the infrastructure needed to run the programs nationwide).

3. Gaming enters a prolonged period of cyclical decline in North America and globally (possible but unlikely in our investable time frame of 1-3 years).

4. Gaming equipment made by IGT goes into rapid secular decline (unlikely in our investable time frame).

Key milestones to deal close:

1) Antitrust approval- Has been met

2) Board of directors to approve of the prospectus - Has been met

3) Shareholder approval- Has been met at IGT, pending at GTECH (but GTECH has 73%+ of its shareholder base approving the transaction as per its last earnings call on 11/10/14, and it needs ~80%)

4) Creditor approval

Catalyst