December 29, 2011 - 6:38pm EST by
2011 2012
Price: 1.09 EPS $0.00 $0.00
Shares Out. (in M): 7 P/E 0.0x 0.0x
Market Cap (in $M): 8 P/FCF 0.0x 0.0x
Net Debt (in $M): 1 EBIT 0 0
TEV ($): 9 TEV/EBIT 0.0x 0.0x

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PokerTek makes and leases electronic table games with the bulk of their tables historically being electronic poker tables.  The Nasdaq-listed stock has been a disaster since its Oct. 2005 IPO at a reverse-split adjusted price around $25 per share.  Tax-loss selling drove the price down to ridiculous levels at the end of 2011 and the current price remains low.  The business, however, has performed well since a new CEO introduced a new marketing and product development strategy in 2010.  The company's legacy poker table business is worth about $16 million and a promising new product platform introduced in 2011 (Pro-Core) adds significant additional upside.  A director well-known in the gaming industry was just promoted to chairman of the board to take a "more active" role in long-term capital planning for the company.  The sale of the company, a partnership with Shufflemaster, or some other type of transaction is likely in 2012.  An investor is likely to at least double their money on PokerTek and more likely to make three or four times.  Liquidity is currently relatively good with hundreds of thousands of shares trading daily.

History and Background

Poker popularity has increased significantly in recent years.  Television coverage of the World Series of Poker and other factors have led to an increase in commercial poker table counts from 4800 tables globally in 2000 to 11,000 in 2010.  North Carolina based PokerTek went public around $25 (reverse split adjusted) a share in October 2005 to take advantage of the growing market.  Their Poker product was and still is an electronic table utilizing touch-screen technology.  The tables have a large shared display screen at the table center and 10 individual player touch screens.  The individual touch screens display individuals hands and allow them to place bets, call, and fold.  A computer server located in another room manages the games and keeps track of the money.  No human dealer is needed.  An electronic poker game moves faster than a human dealt game as dealing is instantaneous and computer-controlled time limits for players to make a decision keeps the game moving along.  Electronic PokerTek games will play around 44 hands per hour while a human dealer manages 20-24.  There is obvious cost savings in not paying or tipping a dealer and casinos like the higher play rate as gamblers can lose their money faster.

PokerTek hoped to replace human-dealt tables in casinos in Las Vegas and elsewhere.  Their electronic tables did not gain acceptance, however, and today they have only about 200 electronic poker tables deployed out of 11,000 total poker tables globally.  Casino operators and gamblers who were accustomed to human dealers apparently wouldn't  accept the computer-operated games.  PokerTek does, however, have the dominant share of the relatively small electronic poker table market.  The disappointing penetration of the poker market led to huge losses for PokerTek and the dramatic drop in the stock price following the IPO.

The current CEO, Mark Roberson, joined the company in 2009 and a change in strategy was adopted shortly thereafter.  There were three parts to the plan:

1.  Reduce operating expenses to get to cash-flow positive quickly.

2.  Cease efforts to replace human dealt tables.  Instead, they would market their electronic poker tables where they could gain acceptance.  Some casinos are entirely electronic (sometimes required by law) and others prefer electronic equipment.  Today, 25% of PokerTek's tables are in North America mostly in non-Vegas casinos, 25% are on cruise ships, 25% are in Latin America, and the remaining 25% are in Europe and the rest of the world.  Penetration in Asia remains low but new marketing efforts by the company are intended to rectify that.

3.  Develop additional products.  This led to the development of the new Pro-Core platform.  This table is smaller than their original poker table seating 6 players rather than 10.  It uses the latest touch screen technology and electronic components resulting in a cost that is only about half that of their original poker tables.  The Pro-Core platform can be programmed to play any card game with a software change.  The Pro-Core tables were designed to have a very small physical footprint so as not to occupy much casino space.  The first game introduced was black-jack (called Blackjack Pro) and initial trials in 2010 and early 2011 showed an enthusiastic response from players and  operators. 

4.  Change to a recurring revenue model.  Rather than table sales, PokerTek switched primarily to a leasing model either on a monthly rate and/or by taking a cut of the house revenue.

Company sales initially fell as the switch to a recurring revenue model was implemented. Revenue is predictable now, however, and running at a $6.5 million annual rate.  Gross margin runs about 70% as there is some software and table maintenance expense and significant depreciation on the expensive tables.  Since the changes in the marketing focus were implemented the company has continued to place tables.  Revenue growth in the just reported quarter was 13% quarter over quarter and 14% year to date.  The company has been EBITDAS positive now for several quarters.  Profitability has not yet been achieved as the S (stock-based expense) and depreciation on their tables still drives them to report losses.

Investment Thesis

The investment case for PokerTek rests on three ideas

1.  The stock is cheap.  Recurring gambling revenue is typically valued at 2 to 3 times revenue.  The  most recent buyout price was Amaya gaming's purchase of Chartwell at about 2.5 times revenue.  That price/sales ratio would value PokerTek's $6.5 million of recurring revenue at $16.25 million.  PokerTek's business deserves at least an average recurring revenue gaming company valuation.  They dominate electronic poker tables and the electronic poker table business is currently only 1/3 rd penetrated.  There's revenue potential of $18 million in the poker business and the company is working to place tables in Asia, France, and Canada.  Further, the rent on leased tables typically pays for a PokerPro table's capital expense in 9 to 12 months.  This is potentially a 100% return on capital business for table placements at the margin.

2.  The ProCore platform and Blackjack Pro in particular has potential for significant growth and financial returns.  The new ProCore tables cost only about half as much as the PokerPro tables.  Return of capital is likely to be more like 6 months or less.  The company hasn't released return on investment numbers for the Blackjack Pro trials in 2010 and early 2011.  There comments indicate that results were better than they expected.  Their behavior also indicates that they are optimistic.    Following the completion of the trial, the company did a private placement of shares at $1.35 a share.  Proceeds of the placement were used to build the first production run Blackjack Pro tables.  Several insiders participated significantly in this private placement.  This wasn't their first investment in the company either.  The total investment in PokerTek stock by company insiders since the change in strategy is around $2 million.  I believe the Blackjack Pro trials are showing a very attractive return on investment sparking the insiders to invest more of their own cash.  Importantly, the entire $2 million invested recently has been at prices above the current market price.  The Blackjack market is huge but here PokerTek has competitors.  Blackjack Pro's use of a large central table display and individual touchscreens is unique and I believe attractive to users.  I have nothing to base this on other than managements comments, however.

3.  Some kind of deal is likely in 2012.  PokerPro named Joseph Lahti as chairman of the board recently.  An excerpt from the press release follows:

MATTHEWS, N.C., Oct. 3, 2011 /PRNewswire/ -- PokerTek, Inc. (NASDAQ:PTEK - News) today announced that its Board of Directors has appointed Joseph Lahti to serve as Chairman of the Board effective October 1, 2011. Mr. Lahti has been a member of the Board of Directors since 2006 and also serves on the Audit, Governance and Compensation Committees.As Chairman of the Board, Mr. Lahti will have an increased role in providing guidance for PokerTek's strategic planning and long-term capital planning activities. Lyle Berman, who has served as Chairman of the Board since the Company's inception, will continue to serve as a member of the Board, including as a member of the Audit, Governance and Compensation Committees of the Board."PokerTek has established itself as the industry leader in electronic poker. With its new ProCore platform, PokerTek has now gained access to the blackjack and specialty electronic table markets. Both products provide the opportunity for significant high margin recurring revenue growth," said Joe Lahti. "I am excited about my increased involvement with the PokerTek team and hope my past experiences will prove useful in creating shareholder value."

Joseph Lahti is the former CEO of ShuffleMaster, the leading gambling equipment company.  ShuffleMaster has a stated goal of increasing the portion of their revenue that is recurring.  PokerPro and the ProCore platform would be an attractive addition to ShuffleMaster.  The press release indicates that Joseph Lahti's role will be related to long-term capital planning.  PokerTek needs capital to pay for Blackjack Pro tables to place on lease.  A sale or some kind of partnership seems imminent quite possibly with or to Shufflemaster.   An outright sale would make investors a quick buck.  A partnership could be even more lucrative over a longer period of time.   As PokerTek insiders own about 40% of the outstanding shares, any deal should be in the best interest of shareholders.

The current valuation around $7 million for this company with $6.5 million in high margin recurring revenue is too low.  It reflects the terrible history of this company.  A new CEO with a new strategy that seems to be working at least partially negates the poor history in my opinion.  I think PokerTek purchasers at current prices are likely to do well.  Value the PokerPro business at 2.5 times $6.5 million in revenue to get $16.25 million.  Throw in some value ($5 million) for the emerging ProCore platform with a successfully tested Blackjack Pro game.  In total you're looking at $21.25 million in value or roughly 3 times the current stock price.  I don't pretend this is an accurate valuation;  just good enough to make me confident I'm doing okay buying at a $7 million valuation.

Finally, I'll note that the stock has recently caught the imagination of day traders.  Just after Christmas the Justice department made a ruling that may legalize online gambling in the United States.  I don't think this has much effect on PokerTek as they don't currently have any online gambling operations.  It has taken the volume way up temporarily and may give an opportunity to acquire shares as the day traders get out.


The stock had fallen below $1 recently so they got a Nasdaq delisting warning in early December.  They had the same warning  the prior year which they rectified with a 1 for 2.5 reverse split earlier in 2011.  If the stock stays below $1 they may have to do another reverse split.  Doesn't matter to me but the last reverse split sent the stock into a deep dive of which I've happily taken advantage.

The company could raise capital by issuing shares (likely to insiders) at depressed prices.  This is the most serious risk I see.  A significant portion of salaries are paid in stock so there is some automatic dilution too.

Mexico just booted all card games out of Mexican casinos back in August.  PokerTek's management thinks the Mexican government will let the games return early in 2012, but who can know for sure.  This may actually turn out to be a good thing in the end.  Competition from unlicensed Poker operators had driven PokerTek's gross margins on the tables they placed there down to 45%.  If only licensed operators are allowed to return to Mexico, PokerTek believes their margins will recover back up to the 70% range they get everywhere else.

If online Poker is legalized in the US it's not clear what effect that might have on PokerPro's operations.  North America is just 25% of revenues but there still is some risk.

A stronger U.S. dollar hurts as significant revenue is from overseas but most costs are in U.S. dollars.


Joseph Lahti does a deal
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