A lot has been said about International Game Technology CEO Patti Hart being the cause of the languishing of IGT stock. It is a common strategy to pin blame on one person, and that does have validity especially if that one person is on the very top. But that’s easy, and it doesn’t give you all that much useful information to work with. She took a lot of heat specifically for her $500M purchase of Double Down Interactive back in 2012. But if we follow company development since she took over in 2009, a clear picture begins to emerge. I will try to piece that picture together here.
On identifying the What rather than the Who
Let’s say it’s true that a bad CEO can affect a company negatively. This is certainly common sense. But it doesn’t tell me what specifically is going wrong with the company or what has to be fixed. It just gives me a who, a scapegoat, a face to pin the blame on, not a what. It doesn’t tell me what I should watch out for as an investor, regardless of the name of the person at the helm.
What’s the difference? If I attribute IGT’s problems to Hart entirely, I may theoretically go long once I see a replacement. But what if that replacement is even worse? Or asked another way, how do I know if the replacement is better if I don’t know what was going wrong?
Back to Basics
As Jim Rogers wrote in one of his latest books “A Gift to My Children” (highly recommended), 90% of investors don’t read filings. They just read headlines, following what is obvious. 99% of investors don’t read filing footnotes. So just read those and you’ll be ahead of at least 9/10ths of the competition.
So let’s forget about Hart for a minute and go under the hood. What makes IGT tick, what are its weak points that need to be fixed? Bottom line, if you go back to the reason stock markets exist in the first place, it’s to pool capital, to give the average Joe the opportunity to become a capitalist by buying parts of companies. Fundamentally, entrepreneurs issue stocks to accumulate capital and expand earnings. Investors buy stocks to share those earnings. Everything else is baseball cards.
So fundamentally, it’s all a numbers game. And where are the numbers going wrong for IGT? Let’s take a look at what was happening when IGT was at its lows versus when it was at its highs in February 2008 versus recent lows in August 2012.
Over the last three years and over the course of its history, IGT generally has had stable gross profit margins of 54-58%. SG&A payments have fluctuated between 15 and 20%. At its highs in early 2008, gross profit hit 56%, towards the lower end of the range, but SG&A was at the low range of 15%. In 2012, gross profit was a bit higher at 57%, but SG&A was 4% higher at 19%. So gross profits margins are not the issue, but SG&A seems to be a sign of something even though the differences between high and low are not considerable.
Taking it one step further, by far the biggest cause for the larger proportion of SG&A expenses has to do with lack of revenue growth rather than actual growth in expenses. The absolute difference between SG&A at IGT’s highs and lows (2007 vs 2012) was only $12.5M. The difference in earnings between those two points, however, is huge. IGT’s earnings are down 48% from 2007. The real issue then, is growth. So where is it going to come from?
There is light at the end of the tunnel for IGT, and that comes in the form of its interactive sales. These have increased from $36.6M in 2011 to $265M (page 55) in 2013. That is an increase of 624%.
Most of this growth has to do with Hart’s acquisition of Double Down two years ago. She bought it for $500M as mentioned and so far has made $409M back in interactive revenue since 2012. It seems that now, with New Jersey’s legalization of online gaming, that this growth will skyrocket in the years ahead, and even more so if Colorado joins in. As I wrote previously, Colorado, Illinois, Pennsylvania, and Massachusetts seem to be the most promising legalizers going forward.
Hart bought Double Down back before Chris Christie legalized online gaming. How much would she have had to fork up for it if she had bought it today? How much will it be worth if Colorodo, Illinois, Pennselvania or Massachusetts join in the legalizing trend?
One more interesting thing about Hart’s tenure at IGT since 2009: Just looking at the raw numbers, from 2009 until 2011, revenues were down 3%, but net income grew 123%. For those two years, Hart was streamlining operations, making the company more efficient to readjust post Great Recession. It worked. Then in 2012 came the move for growth in acquiring Double Down. It looks like the plan was first to tighten up operations, and then to make investments for growth. We are now in the growth phase.
Was that her plan all along? Maybe. I don’t know. Maybe it was all an accident and she really has no plan. Maybe IGT could have a better CEO. But that doesn’t matter if you follow the what instead of the who. The numbers are getting better, and it looks like they will improve even further in 2014.
