Scientific Games: Positive Secular Trends, Stretched Valuation

Scientific Games Corporation (SGMS) develops and sells technology used in gambling. Its products include floor games for casinos, lottery games, and digital gaming. The company operates in the United States and internationally.

I am neutral on SGMS stock. (See Analysts’ Top Stocks on TipRanks)

A Tremendous Comeback

Early in the pandemic, many were questioning whether Scientific Games could even survive. The Las Vegas Strip, and other gambling meccas, were completely shut down. The stock dropped like a rock to under $5 per share. This amounted to an 85% drop from January 1, 2020, to March 18, 2020. Scientific Games not only weathered the storm but has gained nearly 2,000% in the months since it reached its March lows.

Part of this comeback is driven by the proliferation of gambling across the country, including the boom in sports betting. The company acquired SportCast in the first quarter of 2021 to further take advantage of this trend. SportCast delivered proprietary technology to the company.

SportCast is the developer of the "BetBuilder" product, which allows bettors more options to make complex wagers. Given that betting platforms are taking in billions of dollars in revenues from sports betting, this is a positive play for SGMS.

In addition, Nevada casinos topped the $1 billion mark in winnings in September 2021 for the seventh straight month. This is a terrific sign for the entire nation and shows that the secular gambling trends are strong.

The Numbers

Scientific Games posted $880 million in revenue for Q2 2021. This is up significantly from the $529 million posted for the same period in 2020. The 2020 period was the lowest point in the pandemic, however. Revenue was up only 4% from the $845 million posted in 2019.

While revenue is essentially flat since June 30, 2019, the stock price is up 313% over this period. The price-to-sales ratio is also up over 384% and trades well above historical multiples. This suggests that much bullishness is already priced into the stock.

Another concern for the company is the amount of long-term debt that it has been servicing for many years. Scientific Games has carried over $8 billion in long-term debt for several years. This comes at a significant cost.

Over the trailing twelve months, the company has paid nearly $500 million in interest expense. In fact, looking back at the last five full fiscal years, the company has paid almost $3 billion just in interest. This eats up a significant chunk of operating income each period.

Management does finally seem eager to reduce debt despite its persistent nature over many years. The company has agreed to sell its lottery segment to Brookfield Asset Management for nearly $6 billion in cash. Management is expected to use some of the proceeds to tackle the debt load.

However, selling off profitable portions of the business is not a bullish move overall. The high valuation coupled with the massive debt may limit shareholder returns.

Wall Street's Take

Turning to Wall Street, Scientific Games has a Moderate Buy consensus rating. Four analysts have Buy ratings, joining three Holds and one Sell rating. Notably, the sell rating comes with a $39 price target, or more than 50% lower than the current price.

The average Scientific Games price target of $83.75 implies just 1.2% upside from the current price.

Summary on Scientific Games

Scientific Games proved many doubters wrong by emerging from the pandemic with massive gains in the stock price. The company is successfully capitalizing on the positive secular trends in gambling, specifically, sports betting and lottery.

The stock now trades at much higher multiples than at most times in the company's history and the debt load is substantial. I believe that Scientific Games is not a buy at this price.

Disclosure: At the time of publication, Bradley Guichard did not have a position in securities mentioned in this article.

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