SuperModels Community
Join the discussion in the MSN Money SuperModels Community.
Purchase
Jon Markman's book
"Swing Trading"
at MSN Shopping.
|  | | Price | 14.480 | | | Change | +0.130 | |
Research Wizard
Add to MSN Stock List
Message Board
Related Sites
GTECH
Scientific Games
SuperModels
Recent articles:
• Revenge of the small and strange stocks, 4/7/2004
• For American brands, the world turns ugly, 3/31/2004
• A fund fires a winner -- and keeps it quiet, 3/24/2004
More...
| | SuperModels
2 winning tickets to lottery riches
In addition to your good tax dollars, states are relying heavily on lotteries to pay for all kinds of services. Here are your best bets for getting a piece of the action.
By Jon D. Markman
Its common to marvel that the $40 billion spent on video games worldwide dwarfs the motion picture industry. But there is another form of mass entertainment that dwarfs them both -- the lottery business. According a Morgan Stanley study, sales of lottery tickets around the world will top $160 billion in 2004.
You should be thankful for the phenomenal size of the lottery business this week as you write a check for your tax bill, because you would probably owe a lot more if it were not for your fellow citizens crazed desire to get rich quick: Forty states and the District of Columbia currently sponsor lotteries to raise money for everything from old-age homes and kindergartens to veterans services and state parks. Six more states that have resisted so far are edging closer to getting in the game. By the end of this decade, experts expect that the only states that will not have a lottery will be Nevada, where the casino lobby will block it until Doomsday, and Utah, where the anti-gambling Mormon church holds sway.
For investors, the curious thing about the lottery biz is that once you peel back the glossy governmental layer it is virtually a duopoly, as practically all games in this country are managed directly or indirectly by just two companies: GTECH Holdings (GTK, news, msgs), based in Rhode Island, and Scientific Games (SGMS, news, msgs), based in New York. And it is even more curious that these two midcap companies, while not wildly cheap at the moment, arent really expensive, either. Each sports a forward price-to-earnings multiple of around 20. For GTECH, the larger of the two, thats only about half again as big a multiple as its estimated 12% to 15% growth rate, while for Scientific its considerably less than its estimated 20% to 35% growth.
An industry you can bank on
It doesnt take the hyperactive imagination of a weekly Lotto punter to figure out that an investment in either of these two companies is a lot smarter than playing the numbers. If you believe the growth estimates, which might actually be a little low, you should be able to earn 20% to 25% annually on Scientific Games over the next few years. Compare that to the 1.4% youd earn for investing the same amount of money in the U.S. government via a one-year Treasury bill, or the 8% annual return you can probably expect out of the national roulette wheel known as the S&P 500 Index ($INX), and the idea starts to become more compelling. The nice thing is that you dont have to make any bet on economic growth to get at these numbers, because states tend to boost the number of games during downturns to make up for a shortfall in payroll taxes. In better times, lottery growth may slow, but historically it has never declined.
The steadfastness of the industrys strength is most impressive when you compare it to the iffiness of just about any other. No one can say for sure whether the wireless Internet will be around for more than another couple of years, or whether fuel cells, nanotech or gourmet coffee will be viewed as curios or commonplace by our kids. But if there is one thing you can count on lasting until the end of time, its governments desire to separate citizens from their money without using the dreaded T word. Morgan Stanley reports that 200 jurisdictions around the globe have authorized lotteries; Oklahoma is probably next in line in the United States to add one, and it could be followed thereafter over the next few years by Mississippi, North Carolina, Alaska, Alabama and Arkansas. Overseas, lottery fever is reportedly flaring up in Russia, China and Thailand.
Lotteries arent new, of course. Historians say the Great Wall of China was funded, in part, by a form of lottery, as were Harvard and Yale universities in the 18th century. A type of lottery funded much of the Revolutionary War. Lotteries funded a variety of U.S. state functions in the 19th century, but corruption and scandals led to a congressional prohibition on interstate lotteries until the 1960s, when New Hampshire set up a lottery that it coyly called a sweepstakes. New York and New Jersey timidly followed in 1967 and 1970, and soon industry and state lobbyists managed to get federal law changed to permit the rapid expansion of games elsewhere.
Limiting the players
Two key types of games are run today: Instant ticket, in which players scratch a rubbery coating from a printed ticket to determine whether it's a winner; and online, in which a player picks five to seven numbers at random and learns whether hes a winner in a weekly televised drawing. GTECH and Scientific Games make most of their money by skimming a percentage of all revenues of the games that they create -- typically $6 to $12 per thousand tickets -- so they are incented to create increasingly fun contests in dizzying variety with names like 10 Times Lucky and Payday Tripler that both draw in new players and encourage regular players to bet more.
The companies also take hardware and software development, licensing and maintenance fees, and they're moving into the more comprehensive role of running entire lotteries on an outsourced basis in place of an entire state bureaucracy. Most of the growth is in instant-ticket sales -- about 15% in 2002 and 10% in 2003 -- because they feed gamblers quest for a quick adrenaline rush. In May, the Iowa lottery will debut a Scientific Games game that resembles the dynamics of a slot machine. A push is on to ramp up distribution by creating self-service kiosks, and partnerships with IBM (IBM, news, msgs) and NCR Corp. (NCR, news, msgs) have led to cash registers that can print lottery tickets.
Investors always need to focus on businesss barriers to entry, because competition drives down prices and profit margins -- and this is where GTECH and Scientific Games sparkle. Several factors have limited the number of players, but the most important seem to be:- The need to prove the security of the ticket-printing process.
- The difficulty in managing the regulatory process and the need for proprietary software.
- Hardware terminals that inter-operate across state boundaries with 99.999% reliability.
Every lottery director fears the week he might need to put out a press release that says the weeks drawing is canceled because of a software glitch. Contracts are awarded for three to five years and typically auto-renewed. Historically, once a company has won a states business, it rarely goes on to lose it.
The smarter bet
Which one is the better bet? GTECH is no slouch, but the nod now probably has to go to Scientific Games. Its the pioneer in instant-ticket games, the fastest-growing segment of the business, and recently bought an online unit from industry titan International Game Technology (IGT, news, msgs) to bolster its ability to expand in that area.
New contracts include an instant-ticket win in Wisconsin, worth about $3.5 million per year. Analysts believe the company will win a comprehensive lottery services contract in Virginia at the end of April that would start at $4.6 million per year. it's on track to win the California instant-ticket business. The companys efforts in Europe are paying off with an Italian instant-ticket contract, and Germany and Spain contracts also loom.
Plus, Scientific Games has leveraged its know-how in secure printing into the creation of a large prepaid-phone-card business. Lastly, you cant leave out its growing business in horse racing, where its totaliser systems provide the hardware and software required by tracks to take wagers, figure odds and payouts and manage the entire pari-mutuel betting process.
Scientific Games has guided analysts to expect earnings of 76 cents to 83 cents in 2004, but given the gaming that goes on with such guidance, so to speak, you can probably expect it to come in at more like 85 cents to 90 cents. A company growing at 30% that sports a forward P/E multiple of around 20 is not much of a gamble. Because there is some earnings risk in the first quarter due in part to the lack of big Powerball jackpots, you might wait until after it reports next Thursday and try to pick it up under $18.
Stick the IRS in the eye by investing some of your tax refund here, and, maybe in a couple of years, you could win back all of your 2003 taxes.
Fine Print
In 2000, a pari-mutuel betting company called AutoTote purchased Scientific Games and took its name. The debt burden weighed the companys shares down to under $2 before new management got a recovery under way in 2001. To learn more about Scientific Games, visit its Web site. Robert J. Evans, analyst at the boutique Minnesota investment banking firm Craig-Hallum, said in a research note last week that Scientific Games has one of the best business models we have come across, with a highly predictable revenue stream, numerous growth opportunities, a diversified customer base under long-term contracts and large barriers to entry.. . . To learn more about GTECH, visit its Web site. It explains lotteries on this page. . . . To learn about an instant lottery game, visit this page. . . . Jim Williams of the Williams Inference Center is leading a workshop on The Art of the Inference in Enfield, Conn., on May 10. Cost is just $200, which seems like a bargain. See details here.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdmmail@fastmail.fm. At the time of publication, Markman had a position in the following securities mentioned in this column: GTECH.
|
