Friday, August 11, 2006

Calls of Note Part 2

- Stifel Nicolaus & Co notes shares of Shuffle Master (NASDAQ:SHFL) have traded off over 18% since the beginning of July. They have been asked by a couple of investors what the cause has been. Below are the three main reasons why the shares have traded lower, in firm's view:

1) CA Gaming Compacts-The governor of California is going through and renegotiating gaming compacts with many of the tribes in the state. But until these compacts are negotiated this could be a negative for SHFL since the governor wants each seat at multi-terminal games to be counted towards the current 2,000 slot machine max. If the tribes are forced to remove the multi-terminal games, this could put pressure on SHFL's revenues.

2) RFID and IGT-Last week, SHFL announced that it sold its remaining 50% ownership in the patents related to ENPAT to IGT. Combining the sale of the first 50% with the newer one, SHFL will receive in excess of $16M. SHFL will also get a 17.5% royalty on future revenues that exceed $17.4M. Firm believes that selling off the remaining 50% interest spooked investors for two reasons. First, some investors might look at this sale and say SHFL is in a serious cash crunch and needed the money to pay down its debt related to its Stargames acquisition. Second, since SHFL sold off its RFID patents some speculative investors who thought SHFL was going to be acquired might be alarmed that a possible acquisition won't be completed.

3) Shorts Have a Strangle-Short interest on SHFL is still high at 20% of the float. With the S&P down since the beginning of July and SHFL having a beta of 2.4, it is not a surprise the shares have been hit so hard. The shorts still point to the fact that management has taken on too much debt and the balance sheet is beat up. In addition, shorts still make the case that they shouldn't pay as high of a multiple as they have in the past since the company now receives only 35% of its revenues from leasing agreements (was 65% four years ago).

Firm believes that SHFL is the best positioned gaming company to capture the growth that should come from Macau over the next five years. They continue to forecast EPS growth of 25%"30% in each of the next two years due to: 1) favorable table trends especially in Macau, 2) new product launches that should benefit casino operators, 3) placement of new proprietary table games, 4) the continued domestic poker boom, and 5) contribution from Stargames.

Shares of SHFL are trading at 19.8x FY07 EPS estimate of $1.34 (pre-FAS 123). SHFL's forward multiple is now behind the rest of the gaming manufacturer group even though their future growth potential is much larger, in firm's view. They believe that SHFL will be able to grow earnings in the 25%-35% over the next several years as the company capitalizes on the growing international growth opportunities. $42 target price implies that SHFL shares can trade at 31.3x FY07 pre-FAS 123 estimate, in line with its EPS growth rate.

Notablecalls: Looking at the reasons said to be behind the recent weakness I'd say the decline is overdone. One must of course take into consideration the possibility there is something out there not known to Stifel. But overall I think SHFL is set to bounce as most of the problems are now known to the public. Would not hold below $26, though.

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