Scientific Games (SGMS) released its latest earnings yesterday, and they were not as bad as feared. The stock jumped and maintains its climb off lows of $3.76 in the aftermath of the corona crash. Shares are now up about 250% since bottoming. The company also remains a clear market leader, so has a new long term uptrend been established here? No. Back in January 2018 the company was a clear short at $56 a share for 2020. If shares keep climbing past the $15-$16 range, which is around technical resistance, then consider reloading your shorts for a 2022 expiry. Scientific may be a market leader, but that’s not enough to keep a company in business.
It takes more than just selling great products to be a great company. You have to be able to sell your products for more than it costs you to produce and maintain them. Otherwise you may have 100% market share and maybe your products are even really popular and beloved in an industry. Still, if the revenues you can command from selling them do not exceed whatever it took you to make or develop them, then it doesn’t matter. You’re going to go bankrupt regardless of the quality of the product or how many customers you may have.
Consider the housing bubble. Were the houses that were built, bad houses? Were they built haphazardly by homebuilders that built inferior real estate? Maybe in some cases, but that wasn’t what caused a systemic housing collapse and homebuilder bankruptcies. Those houses are by and large still standing today, and so will Scientific’s products if and when it goes bankrupt. In the housing crash, it wasn’t the product that was bad, but the financing for it that caused the crash. It’s the same with Uber or Tesla or any of the other company with good products that just can’t be supported by the revenues that can be commanded on the market for them.
Look at Scientific’s latest earnings presentation released yesterday and there are all kinds of impressive numbers in it. 41% market share in North America in the gaming systems market. The deepest portfolio of table games in the world. Some of its games are in the top of their respective categories, which I’m not denying is an accomplishment. Its partnerships are extensive and solid. It has 19 of the top 20 instant game lotteries worldwide. 75% of U.S. instant game retail revenues and 70% global. It is making a big deal about a 10% jump in digital revenues, which is nice and is a result of people stuck in lockdown. But all told it’s only an increase of $7 million in quarterly revenues. That’s nowhere near enough to plug a leaking hull.
Don’t mistake Scientific’s leadership position as a bullish reason to buy the company. It is dominant in its industry, but it has still lost $1.1 billion over the last four years. Accumulated loss is now running $3.119 billion and this will only climb. Scientific Games can only continue as a going concern if people are willing to lend it more money or buy any upcoming equity financings in case nobody wants to lend it more. But if nobody wants to lend it more money as it drowns in debt service costs, then who is going to want to buy the equity?
Debt service costs alone are consistently higher than operating income. Zombie companies can only succeed in paying debt interest. Scientific can’t even do that. It’s not like these costs are going to fall any time soon either. Can revenues rise to raise it to the level of zombie? Well, let’s consider. Operating margins annually are between 14% and 16%. In order for the company to break even at those margins, annual revenues must rise by at least 10%. Maybe that was possible back in December, but with new coronavirus regulations prohibiting casinos from operating at full capacity, I don’t see how that’s ever going to happen before Scientific must attempt to refinance in 2021.
The $4.091B in variable rate debt due 2024 is unpayable. Scientific has $967 million in total liquidity available now, and it’s not going to get much more than that if any. All revolvers are drawn down. $341 million in principle is due in a year, which brings that lifeline down to $626 million. Last year’s loss was $130 million and that was its best year in the last 4. Assuming that can be replicated despite the COVID-19 situation (which it probably cannot) that gives the company less than 5 years at most before it completely runs out of cash. By then $4.1 billion will have already been due, so I just don’t see a way that the company survives into 2024 without at least a bankruptcy and restructuring.
The end will could come before that though, as either interest rates or price inflation starts to rise significantly as economies open up for business again. If interest rates rise, then servicing that $4.1 billion will become impossible. If they don’t, price inflation will keep gamblers from visiting casinos. Demand for its games will fall and it’ll drown that way. 50% of its top line business is regional, as in Penn and Boyd, both of whom are in debt trouble themselves.
SGMS shares have a history of rising strongly on bullish sentiment shifts. There is a good chance that the stock will rise further as casinos open up again and sparks of optimism keep bullish hopes alive. If that happens again and the stock rises to around $16, then it can be shorted again into 2022, at which point it should be below the lows just established at $3.76. It could even become a penny stock by then.
The only way I can see this being prevented is if a giant comes in and buys it, but considering its debt load I can’t see why anyone would want to take that all on. Better to let it go bankrupt and then someone will come in and pick up the assets for cheap.
