Analysts see tough times for slot makers

LAS VEGAS, Nevada -- It's becoming vogue for Wall Street to have a negative view about slot machine manufacturers' financial prospects.

In the past few weeks, analysts from three investment firms offered research reports to investors that discussed the gaming equipment sector. All contained less than glowing recommendations.

Some believe it could be well into 2011 or 2012 before slot machine makers start seeing a boost in sales.

"Even a modest pickup in replacements next year could prove to be a best-case scenario," Janney Montgomery Scott gaming analyst Brian McGill reported after a week of meetings with contacts in the casino industry.

"We heard little to nothing to lead us to believe that replacements are a priority for next year's operator budgets, and were surprised by the negative tone of the majority of our meetings when discussing this subject," McGill said.

Goldman Sachs gaming analyst Steven Kent, who has been following the manufacturing sector for nearly a decade, told investors he has a cautious view on slot machine makers because there are very few opportunities for new sales this year.

One possibility -- Illinois is looking at allowing bars and taverns throughout the state to offer customers video slot machines -- may not happen until the last half of 2011.

"States have continued to decrease the number of machines they have on their floor," Kent wrote in a report to investors. "We had previously thought new states rolling out would cause old states to replace their machines to stay competitive. However, just the opposite has occurred. Markets such as Atlantic City and Connecticut have simply decreased the number of machines."

Jefferies & Co. gaming analyst David Katz, who recently initiated coverage of equipment makers, has a somewhat more positive outlook. He said Wall Street has cast manufacturing in a poor light.

"The Street has a myopic view, driving the stocks off of slot sales rather than the recurring elements," Katz wrote. "The slot machine business has been challenging but remains a fundamentally good business and should improve over the next two to three years."

McGill said he also has a negative view on the slot machine industry over the long term.

"The lack of a growth pipeline next year combined with the belief that replacements will not see any upside, has caused us to re-evaluate our ratings on IGT and WMS Industries," McGill said. "If this proves to be correct, we believe the stocks will experience multiple contraction as time unfolds. For this reason, we will move to the sidelines and wait for a more attractive entry point to resume a more positive outlook."

Canada is now the largest growth pipeline.

Quebec awarded a contract a week ago to replace half of its 12,000 slot machinelike video lottery terminals with games manufactured by Reno-based International Game Technology. The other half went to Canadian-based slot machine maker Spielo.

The provinces of Ontario and British Columbia are also planning to replace their video lottery systems. Equipment suppliers, including IGT, Bally Technologies and WMS Industries, are expected to submit bids.

Katz said Canada could provide an opportunity for sales of between 85,000 and 125,000 machines.

However, he isn't counting out a turnaround in the American gaming market.

"While the financial pressures of the economy remain for casino companies, our view is that improvement is definitively on the horizon, albeit of still uncertain trajectory," Katz said. "We note that through this challenging period, pricing, profitability and capital structure have all generally improved."

He thought the best opportunities for equipment sales will be at the end of 2011 and heading into 2012. Expanding markets include Italy and Illinois while new casinos could finally open in Illinois, Ohio, Kansas and Maryland.

Kent said rivalries in the slot machine sector could also increase once the market turns around.

"Competition remains extremely fierce," he said. "Historically, it has been the big four of IGT, Bally, WMS and Aristocrat Technologies. But we increasingly believe that other players ... will be able to take market share."

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