The last time I covered International Game Technology (IGT) in depth, I spent most of the article real estate defending its business strategy and cutting Patti Hart some slack. Here’s a quick recap of what I wrote back on March 24:
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.
Before we go into the $6.4B merger deal with GTECH (GTKYY) at $18.25 a share, first a quick look into the last two quarters of 2014. In line with the pattern of falling revenues and increasing earnings leading to an overall tighter, more efficient company, revenue for the Hart-led IGT continued to fall in both Q1 and Q2 2014 from $541M in Q4 2013, to $513M next quarter, and then $467M last quarter. Nevertheless, net income has increased 180% since last quarter, and is in fact higher than what it was in Q3 2013 when IGT raked in $632.4M in revenues.
There are a lot of numbers in that last paragraph, but the point is this: IGT continues to tighten up, foregoing unprofitable operations and decreasing its cost of business, while increasing its overall earnings. The most notable improvements were in gross profit margins, from 57% last quarter to 61% this quarter, and an impressive 17% reduction in its administrative expenses.
IGT was trading at $14.80 on March 24, and is now being bought out at $18.25 a share. Though I did not call a bottom at the time, I was impressed by the company’s recent efficiency, and the bottom turned out to be one month away.
Those who are not fans of Patti Hart should like this plan too, because it provides for Hart joining the board of directors for 3 years, but only as vice chairman. She will not be CEO of the merged company, to be known as Holdco. In my view she’s done quite a good job with the cards she was dealt starting in 2009, but if GTECH is willing to put up $6.4B to replace her, then I’m not going to argue.
So what does GTECH get out of the deal and what are they looking for? A cursory flip through its last annual report shows that the only part of the company currently growing is its revenues coming out of the Americas. Everything else is shrinking. So GTECH is going with what works in its point of view – America. Some quick snapshots:
Product sales increased 65.5% for GTECH in the Americas from 2012 to 2013, but shrank 35% internationally. Italy was even worse. Service revenues grew 6% in the Americas but shrank 4% everywhere else. Total revenue grew 14% in the Americas, and shrank 14.4% internationally and 4.3% in Italy. Since service revenues follow product sales for these types of companies, it’s clear that the key to growth for GTECH is in the Americas, where product sales are booming. Acquiring IGT made sense on that score.
As for debt, GTECH’s management of its debt seems to be smart and levelheaded. Part of the $6.4B deal with IGT was to pick up $1.7B in debt, which will be added on to its pile of €2.6B. That seems a lot. However, the key once again is what portion of that debt is exposed to floating interest rates. The answer, only 15% as of the end of 2013. (See page 100 of its 10-K.) Protecting 85% of its debt load from rising interest rates cost the company €150M in swaps, well worth it in my opinion.
Why now? GTECH has fallen sharply since February, all the way from €24 to €15.43 a share earlier this month. Perhaps they felt they had to do something drastic in order to stir the pot. Shareholders were not too happy about this move at the beginning, but the stock has undergone a sharp turn around since August 7.
The strange move in its stock, turning seemingly on nothing after falling following this merger, is reminiscent of the mixed feelings many have about IGT itself. Falling revenues but rising revenue? Poor performance relative to the broader market but improving efficiency? Is Patti Hart a genius or a fool? Hard to tell.
That’s why, as I said back in March, it is important to just forget the people and stick to the numbers. The trajectory with IGT is to improve the bottom line while cutting away the dead weight, like pruning a plant. GTECH’s aim is to go with what’s working and continue to grow in the American market. Product sales first, service sales next. It’s what’s been working for them recently and they went with it.
Patti Hart fans rejoice. She’s kept the company profitable enough to attract a suitor. Patti Hart naysayers rejoice. She will no longer be CEO once this merger is completed. Everyone can go home happy, and we’ll see how the new GTECH bosses will manage the whole thing when they take over next year.
