International Game Technology Ordinary Shares (NYSE:IGT) scored a very favorable deal with the sale of its Double Down Interactive unit according to commentary made by Philip and Christopher Mittleman’s Mittleman Brothers LLC in its recently released first quarter investment letter.
The fund, which delivered 5.4% returns net of fees in the first quarter to push its returns since its inception in 2003 to 863.8%, blamed International Game Technology Ordinary Shares (NYSE:IGT)’s social gaming division (Double Down) for the company’s lackluster fourth quarter results and 2017 guidance, and praised the April 17 sale of the unit to an affiliate of DoubleU Games for $825 million. IGT was Mittleman Brothers’ second-largest position on March 31, containing 1.73 million shares valued at $41 million.
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Mittleman’s commentary is in contrast to the market’s reaction to the deal, which resulted in shares slipping by 2.5% on April 17, contributing to their 15% year-to-date losses. The bearish reaction was puzzling, given that IGT got rid of what Mittleman described as its “worst performing business” and one that accounted for just 5% of its revenue in Q4, for a premium of 10.5x that unit’s 2016 EBITDA (while IGT as a whole was trading at just 7.5x EBITDA). In addition, IGT also secured a game development, distribution and services agreement with DoubleU Games that will go into effect after the closing of the deal and result in royalties being paid to IGT in exchange for IGT’s library of casino games being offered on DoubleU’s platform.
Some of the proceeds from the sale will be used to pay down International Game Technology Ordinary Shares (NYSE:IGT)’s debt, which will help it further delever to as little as 4.2x 2017 adjusted EBITDA by the end of 2017 according to the fund, while rival Scientific Games Corp (NASDAQ:SGMS) has a leverage ratio of 6.9x. Meanwhile, the fund continues to like IGT’s leading position in the lottery business, which it states has massive barriers to entry and strong EBITDA margins (34% in 2016).
However, the company’s recent renewal with the Italian government to continue running that country’s national lottery for the next nine years will come with an upfront $195 million price tag, which will hurt the company’s free cash flow near-term. There could also be a dearth of near-term catalysts for IGT in general, with demand for its physical gaming equipment expected to be flat in 2017 due to fewer U.S casino openings according to Argus analyst John Staszak, who downgraded the stock to ‘Hold’ from ‘Buy’ in March.
That could explain why several major names sold out of the stock in Q4, including Daniel Och, George Soros, and Crispin Odey. We’ve also witnessed four more funds sell out of the stock in Q1 out of the limited pool of funds that have reported their Q1 moves thus far, while none have taken a new position in it.