Game theory – Ainsworth set for big things

Founder and Chief Investment Officer of Montgomery Investment Management
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While I cannot understand why people play poker machines, the likes of Jamie Packer, Steve Wynn, and founder of Ainsworth Game Technology Limited (AGI) Len Ainsworth, know it is better to own the casino or make the machines and don’t begrudge others who enjoy “gaming” as their entertainment.

Len Ainsworth founded Ainsworth in 1995, at the age of 72. The gaming machine industry veteran had previously founded Aristocrat Leisure Limited (ASX:ALL). Both companies design, develop, manufacture and service gaming machines.

AGI has recorded an extraordinary recent three years to June 2013. Revenue has risen from $69 million to $198 million, while pre-tax earnings have jumped from a $2 million loss to a $69 million profit. AGI’s share price has accordingly risen from under $0.20 per share to the current $4.07. With 322 million shares on issue, AGI now has a market capitalisation of $1.3 billion.

Top marks

AGI’s FY13 results were impressive. Revenue of $198.1 million was up 32% while the pre-tax profit of $69.3m was up 50% on FY12. Net profit after tax was down 19% to $52.2 million, but that is because in FY12 the company didn’t pay any tax and this year its tax rate was 25%. On that basis you are better off looking at the pre-tax numbers for signs of change. Return on average equity of $183 million was 28.5%, and the company finished the year with net cash of $39 million.

Domestic revenue grew 21% to $124 million, but the real excitement was the international revenue, which grew to $74 million – a 55% increase on the preceding year. Assuming these trends continue, AGI will soon be announcing larger international than domestic revenue. When presenting the FY13 results, management noted: “Further revenue growth is expected within all international markets.” Growth in South America was 77% but total revenue was just $19 million – less than 10% of AGI’s total revenue – although AGI has only relatively recently started selling its products there.

In the US, the biggest market in the world, total revenue was $49 million or 25% of AGI’s total revenue. The company now has 602 gaming operating units installed at casinos across the US, after the installed base grew by 186 units from 416 at 31 December 2012. And keep in mind that the personnel at AGI has plenty of experience managing much bigger operations in the US.

Australia’s revenue growth of 21% was the lowest annual growth since 2008, however it seems there are still large market share gains available. AGI is understood to have around 15% of the clubs and hotels market, while the two largest operators, Aristocrat Leisure (ALL) and IGT, have a combined 65% market share. There is optimism surrounding the approval and installation of the A560, the Premium Mega Top, the Wide Boy Quad Shot and the Multi Pay Big Time 11.

AGI sold a total of 2,021 total units in FY13, up 57% compared with 1,288 in FY12. The second half saw 1,196 units sold, compared with 825 in the first half and 1,052 in the previous corresponding period. In other words, AGI is ramping up. A key indicator of future orders, ‘units on trial’, looks healthy with 354 units on trial as at the end of June 2013, representing a significant increase on the 229 trial units on trial at December 2012 and 142 on trial at 30 June 2012.

Pricing power

Importantly, not only is the company selling more units, each unit is generating stronger returns. For other businesses, this is tantamount to selling more products at a higher price. After releasing its new range of games into the gaming operations market, Ainsworth saw a 39% increase in its average revenue per day during the year. Over the course of the year, the company achieved a yield of about US$39 per day, compared with $10 less per day in FY12. In some venues in the US this is as high as US$60 per day.

Management went on to note that profit after tax in the first half of FY14 is expected to be at least 15% ahead of the $22 million reported for the half year ended 31 December 2012. Consensus net profit forecasts for the year to June 2014 are for $61 million and growth of 17% (or 19 cents per share), with some analysts predicting figures as high as $65 million (24% year-on-year growth) or 20 cents per share. So the prospective PE at $4.40 is around 22 to 23 times.

In short, AGI is growing strongly and has enormous potential. However, the remaining part of the investment puzzle is value. The company’s shares are not a bargain at the moment, and while we own plenty in The Montgomery Funds, we’d want to buy more if the price fell back somewhat. That might seem unlikely, but in the stock market it is amazing how often the odds can fall in your favour.

The Montgomery Fund and The Montgomery [Private] Fund own shares in Ainsworth Game Technology Limited.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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