Multimedia Games (MGAM)

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Multimedia Games (MGAM) designs and produces standalone and networked gaming terminals for Native American and commercial casinos in North America along with state lottery operators^[1].

Business Overview

Multimedia Games has positioned themselves as a competitive leader in the business of interactive gaming systems such as tournament-style slot machines and electronic community games like horse racing. Multimedia Games focuses on the development and supply of comprehensive systems, content, electronic games, and player terminals for the casino and charity organizations^[2]. The company primarily focuses on turning most casino activities-player tracking, slot machines, bingo systems, lottery terminals, and even creating electronic scratch-off tickets. MGAM makes it apparent that delivering the best gaming experience to the customers comes before making a profit for the owners and operators.

Economics of the Company

Product Portfolio

Multimedia Games, though defined by its classic mechanical and video slot machines, has a large variety of products that appeal to its customers. MGAM widely deals in the Class II and Class III markets, which will be explained in more detail shortly, as well as the charity market, the state video lottery market, and the international commercial bingo market.

Class II Gaming

Class I, II, and III gaming are the classes of casino gaming that mainly affect Native American casinos. Class II gaming mainly refers to bingo and any games that are played within proximity to Class II bingo, such as pull-tabs or Keno machines. When revenues were further segmented into a subsection of Class II gaming a year ago, it accounted for 16% of total revenue at $15 million.

Contents 1 Business Overview 2 Economics of the Company 2.1 Product Portfolio 2.1.1 Class II Gaming 2.1.2 Class III Gaming 2.1.3 State Video Lottery 2.1.4 International Commercial Bingo 2.2 Geographic Segments 2.3 Business Segments 2.3.1 Gaming Operations 2.3.2 Gaming Equipment and System Sales 2.3.3 Other 3 Industry Analysis 3.1 Competition Comparison 3.2 Porter's 5-Forces Analysis 3.2.1 Bargaining Power of Consumers/Suppliers 3.2.2 Threat of New Entrants 3.2.3 Threat of Substitute Products/Services 3.2.4 Intensity of Competitive Rivalry 3.3 SWOT Analysis 3.3.1 Strength 3.3.2 Weaknesses 3.3.3 Opportunities 3.3.4 Threats 4 Financial Metrics 4.1 EV/EBITDA 4.2 Return on Invested Capital (ROIC) and Asset Turnover 4.3 Market Cap, Enterprise Value, and Beta Levels 4.4 Multimedia Games' Cash and Debt 4.5 Key Industry Ratios 5 References

Class III Gaming

Class III gaming is the broadest of all 3 categories of gaming because it entails everything that is not Class I or Class II. Class III gaming can only be held in Native American casinos when an agreement is struck between the tribe which owns the casino and the state. This typically includes slot machines and table games such as blackjack, craps, and roulette. The lone player in this class for MGAM is the slot machine which brings in the majority of MGAM's revenue.

State Video Lottery

Multimedia Games is responsible for the technology and system used by the state of New York in its lottery operations. The technology provided by MGAM includes all software, hardware, and networks that are necessary to run the system. As of the first quarter of FY11, 12,500 total terminals were up and running in the state of New York providing a revenue of approximately $2 million. This represented an 18.3% increase from the previous year's first quarter^[3].

International Commercial Bingo

Multimedia Games' international business takes place in Mexico with the bingo market. In the first quarter of FY11, MGAM realized $1.9 million in revenue from the Mexico bingo market, but this was a 7.5% from the previous year's first quarter. According to the company, this is due to its strategic initiative to go from Class II gaming to Class III gaming in the country^[3].

Geographic Segments

Due largely to agreements set between Multimedia Games and specific regions, MGAM's revenues can be divided by segment fairly easily. The largest of these regions is Oklahoma which accounted for $14.6 million, over half of the company's revenues, in the most recent quarter. Though MGAM saw an increase in unit sales with its Oklahoma region, it saw decreases in its other three regions, most notably in Alabama. MGAM recognized a 95.4% decrease in unit sales to Alabama due to the closure of three Alabama charity bingo facilities^[3].Decreases in other geographic segments for MGAM were insignificant decreases for the company, seeing only a 17% decrease in unit sales for Mexico and a 3.3% decrease in other which includes Washington, Wisconsin, Texas, New York, Minnesota, California, Kansas and Rhode Island.

Business Segments

Before Q2 of FY10, MGAM used three main categories to classify its revenues: gaming revenue, gaming equipment and system sales, and other. Gaming revenue was further divided into four subcategories: Oklahoma Compact, Class II, Charity, and All Other. These subcategories separated gaming revenues by the source of the revenue. As of the 2nd quarter of MGAM's FY10, the company has segmented its revenues into the same three categories; however, it has omitted the subcategories of gaming revenue and renamed it gaming operations.

Gaming Operations

Gaming operations is MGAM's most significant revenue generating segment. With revenues of approximately $22 million in the most recent quarter, gaming operations is responsible for 77% of the company's total revenues. The majority of this revenue is a result of lease participation agreements with its customers regarding player terminals and back-office equipment. When MGAM leases out its gaming equipment, it retains ownership and enters into an agreement granting the company a certain percentage of the net win per day from the machine. This revenue is decreased by the contract rights guaranteeing MGAM's machines floor space in the casino which increases business and rate of play. A smaller portion of the revenue generated under gaming operations comes from back-office fees such as general maintenance and software updates. These fees are both realizable and considered earned at the end of each day.

Gaming Equipment and System Sales

The second largest component of MGAM's revenues is its gaming equipment and system sales segment. This segment generated revenues of approximately $6 million in MGAM's FY11 Q1 which accounts for 21% of the company's total revenues. Gaming equipment and system sales are exactly what the segment title depict, the direct sales of player terminals, licenses, back office systems and other related equipment to outside customers.

Other

The final and least significant segment is titled "Other" in MGAM's income statements. Contributing less than 2% of total revenue in MGAM's FY11 Q1 income statement, other expenses include maintenance and service arrangements not already included in gaming operations^[3].

Industry Analysis

Competition Comparison

Multimedia Games has several sources of tough competition in the industry of designing and manufacturing gaming technology. This competition includes companies who design and manufacture software and technology for the gaming industry which include slot machines, shuffling devices, chip manufacturers and other casino associated devices.

Porter's 5-Forces Analysis

Bargaining Power of Consumers/Suppliers

With the amount of competitors MGAM has in its industry, it is clear there is fierce competition between all companies who choose to participate in the designing and manufacturing of video gaming devices such as slot machines. The bargaining power of the buyers, in this case the casino, can be determined by just looking at the number of slot machines in some of the most famous casinos. The Bellagio, which has its own floor specifically for slot machines, boasts over 2300 slot machines for its customers to play on^[4]. The Flamingo has a respectable 1700 machines for its visitors to partake in^[5]. To give an example of Native American casinos, Mt. Pleasant, Michigan's Soaring Eagle Resort has a staggering 4200 slot machines throughout its entire building^[6]. Taking a look at these quantities of slot machines, it would appear buyer power in the industry is incredibly high giving the casinos the ability to pick and choose which manufacturer they believe their customers will enjoy the most. The number of possible suppliers and this power in the casinos renders supplier power fairly low, but not insurmountable. It is important in the industry for companies to get exclusive rights to new designs and technologies as to not allow breakthroughs to become commonplace in the industry. Companies need to carve their niche in the industry and capitalize on it.

Threat of New Entrants

To analyze the threat of new entrants in the casino game manufacturing industry, all entry barriers, customer loyalty, brand equity, and capital requirements must be considered. The biggest entry barrier for companies trying to break into this industry is the patent. Companies make or break themselves on the technologies they create and patent quickly before getting that intellectual property stolen. With patents alone, entry barriers are considered fairly high in the industry. Customer loyalty is the desire of a customer to continue business with a certain business due to either good work experiences, good pricing, or excellent product/service. In this particular industry, many regions stay loyal to certain companies due to agreements signed between two companies. For example, Multimedia Games constantly posts unit sales in the range of 7000-8000 units in Oklahoma due to certain agreements it has between Native American casinos in the state and itself. In addition, it posts approximately 5000 units in sales to the Mexico region and until recently numbers between 2000 and 3000 units between intself and Alabama^[3]. However, customer loyalty does not necessarily mean the casino will buy exclusively from one manufacturer, so customer loyalty is not much of a barrier.

Threat of Substitute Products/Services

Threat of substitute products/services in this particular industry is not of great concern. An alternative to a casino patron going into gamble can be thought of as basically doing anything else for entertainment that is not gambling. Gambling is such a popular source of entertainment that it has entire cities dedicated to it(Las Vegas and Atlantic City). This popularity leaves the gaming industry fairly free of substitution worries.

Intensity of Competitive Rivalry

Finally, the highest source of competition in the casino gaming manufacturing industry comes into play. The strongest particular players in this industry for competitive rivalry are product differentiation, level of selling and administrative expenses, and creating a convenient way for casinos to visualize products. To cover product differentiation, the importance of the patent comes into full play when trying to gain an edge on one's rivals. Multimedia Games boasts one of the most innovative forms of tournament slot action in its TournEvent technology. "First named one of the Top 10 Slot Floor Products of 2010 by Casino Enterprise Management, TournEvent has now been awarded a Gaming and Technology Award from Global Gaming Business in the category of Best Consumer Service Technology!"^[7] Innovations like these are what keep a company ahead in this competitive industry. Next, the level of selling and administrative expenses can make or break a company. This is mostly due to the fact most deals in the industry are done with the same terms and use the same strategy for revenue generation (a percentage of win per day). So, the problem arises of creating the cheapest means of getting the transaction done and keeping selling expenses to a minimum. These numbers for MGAM can be viewed in the figure to the right.

SWOT Analysis

Strength

Multimedia Games' strengths consist of its good faith business with casinos located in Oklahoma and its strategy for future growth in Mexico. In recent years, MGAM has only participated in Class II gaming with Mexico. This Class II gaming only consisted of bingo games and any games similar to bingo. In the future, MGAM looks to begin selling Class III gaming technology to Mexico's casinos and other gambling communities.

Weaknesses

Multimedia Games is not a big player in its industry as will be realized in the Financial Metrics section below. In summary, MGAM is far below the average market cap and enterprise value of its competitors and simply does not have the resources at the moment to experience the kind of growth companies like WMS Industries and International Game Technology have experienced in the last several years.

Opportunities

Multimedia Games biggest opportunity at the moment is the introduction of its TournEvent slot machine technology. This technology involves players being networked together in the casino to play in tournament-style action with slot machines. Previously in this entry, various awards and commencements were given to this technology.

Threats

One of the biggest threats for MGAM is currently its biggest strength. Its strategies to move into Class III gaming in Mexico may not work out the way Multimedia hopes it will and the transfer could become unprofitable for the company. Another threat comes from its weakness of being a small player in a big industry. Its competitors have a good chance of drowning out MGAM in the industry if any of its competition ever fell the urge to compete more intensely.

Financial Metrics

Before beginning with the financial metrics and comparisons with Multimedia Game's competition, it is important to note an unusual expense in this past year's income statement for the company. An out-of-court settlement took place between MGAM and Diamond Game Enterprises, Inc. for the amount of $16 million in favor of Diamond^[8]. This settlement was in regards to an unfair competition lawsuit by Diamond toward MGAM. This severely hindered MGAM's value and will show in most of the following ratios.

EV/EBITDA

The ratio of enterprise value to earnings before interest, tax, depreciation, and amortization is one of the most significant measurements in comparing companies in the same industry. It allows for comparison without taking into account capital structure which can put companies at a disadvantage if its capital structure is significantly different from its competitors. As of April 18, 2011, three game manufacturing companies vie for the lowest EV/EBITDA ratio. The lower the ratio, the more undervalued a company is believed to be. These companies are Lakes Entertainment, Inc.(NASDAQ:LACO) with 1.56x, Full House Resorts, Inc.(AMEX:FLL) with 2.67x, and Multimedia Games(NASDAQ:MGAM) with 3.92x^[9].

Return on Invested Capital (ROIC) and Asset Turnover

ROIC is one of the most important financial metrics in determining the quality of a company regardless of the industry the company is in. It is the measurement on how effectively a company puts its capital to use in the operations of the company. For competitive purposes, we will look at MGAM's ROIC compared with three of it's closest competitors: WMS Industries Inc.(NYSE:WMS), International Game Technology(NYSE:IGT), Bally Technologies Inc.(NYSE:BYI), and Shuffle Master (SHFL) .

MGAM's loss in the previous year causes a lackluster ROIC of -7.42% while WMS, IGT, and BYI show returns of 13.54%, 7.71% and 16.36%, respectively. Though WMS boasts an absence of long-term debt, BYI outperforms the company in ROIC due to its equal net income and lower total of long-term debt and equity. MGAM suffers in ROIC from its $16 million loss in its settlement with Diamond Game Enterprises being calculated into the period's ROIC causing a negative ROIC. To its credit, MGAM produced an ROIC of -0.73% in its most recent quarter, showing improvement from the previous year^[10].

Asset turnover ratio is the measure of how many dollars in revenue are generated from every dollar in assets. As noted by the graph, MGAM is hovers about 10 cents below the average of $0.68, meaning they generate $0.58 in revenue for every $1 of assets. This is a lackluster performance in any industry; however, this is mostly due to MGAM's transition from Class II to Class III gaming in several regions. The abandonment of many Class II structures in Alabama leads way to lower profits across the board resulting in a lower asset turnover on the year.

Market Cap, Enterprise Value, and Beta Levels

Several of the most basic gauges of a company's size, industry presence, and market behavior are market capitalization, enterprise value, and the beta coefficient. Market cap is calculated by multiplying number of shares outstanding with the company and the price per share. This helps determine the company's size and presence in the market by keeping track of both the company's share count and the company's value and creating a measure to keep track of both.

Outlined in the chart of industry market cap, EV, and beta coefficients are each company's individual statistics and the averages of each measure between the companies. MGAM's market cap is significantly lower than the next lowest company (WMS at $1.8 billion) showing they have a much smaller of a presence in the industry. Enterprise value can be thought of a more accurate market capitalization which can be seen as the theoretical buyout price of the company. It will follow that a company with a low market cap will also have a low enterprise value and there is no exception in this industry. MGAM is once again at the extreme low end of the spectrum with EV in the industry showing its insignificant presence with the market. These two small figures, EV and market cap, are due to its much lower revenue values and the relatively small amount of outstanding shares of stock. The beta between all four companies fall relatively close to the average of 1.54, MGAM being the lowest at 1.4 and WMS being the highest at 1.6. These numbers show slightly above average positive correlations with the market and a difference of .2 is slightly significant, but not an indicator of anything abnormal.

Multimedia Games' Cash and Debt

In recent years, MGAM has focused on increasing its cash on hand and decreasing its total debt. Looking at the chart showing its cash and debt in the past 3 years, it has been very effective at both increasing its cash and decreasing its debt. From 2008 to 2009, cash on hand increased by nearly 100%; from 2009 to 2010, an increase of roughly 75% was again realized. These impressive gains in cash are almost wholly due to Multimedia Games' new consistent cash generation^[11]. Looking at debt, Multimedia Games was able to decrease its total debt by 14% then 40.5% from '08-'09 and '09-'10, respectively. These improvements in the amount of debt owed or mostly caused by the improvement on cash on hand, enabling MGAM to finance their company through actual cash rather than debt.

Key Industry Ratios

In the chart to the right are several key financial ratios indicating the profitability and health of each company in MGAM's industry. To begin, current ratio is a liquidity ratio indicating the ability of a company to pay off short-term obligations. MGAM's current ratio, 2.86, is roughly at the average of its competitors. Whether a company wants a lower or higher current ratio depends on the industry the company is in. For MGAM, its industry is not of a cyclical kind, so a lower current ratio is preferred. Cash ratio is another liquidity ratio and is the most conservative of all liquidity ratios. It only takes into account the assets of the company which are most liquid. This makes it a rarely used ratio in analysis of companies due to the lack of importance of a company to have enough cash to fully cover its liabilities. MGAM's .86 ratio is close to covering its assets and is as close to 1:1 as an analyst should expect. Return on assets and return on equity both measure how efficiently a company generates a profit off of its assets and equity. MGAM's low net income and recovery form its recent losses result in very low returns on assets and equity; however, it is still an improvement from its negative returns in previous years.

References

1. ↑ "MGAM Description," Google Finance
2. ↑ "Yahoo! Finance:MGAM"' MGAM Finances, 4/21/11
3. ↑ ^{3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9} "MGAM SEC Filing"' MGAM Finances, 4/20/11
4. ↑ "Bellagio Casino",Bellagio Slot Machine Information
5. ↑ "Flamingo Casino",Flamingo Slot Machine Information
6. ↑ "Soaring Eagle Casino",Soaring Eagle Casino Information
7. ↑ http://www.multimediagames.com/systems-technology/tournevent.php "MGAM System Technology Information" MGAM TournEvent
8. ↑ http://agreements.realdealdocs.com/Settlement-Agreement/SETTLEMENT-AGREEMENT-2486225/
9. ↑ "Zack's Research"
10. ↑ Multimedia Games Finances
11. ↑ Multimedia Games Annual Report