Slot machine sales slow but developing

LAS VEGAS, Nevada -- Last month's Global Gaming Expo was hardly sedate.

The leading slot machine manufacturers didn't skimp on promoting their new games and technology. Celebrities, celebrity impersonators, attractive dancers and other means were deployed along the trade show floor of the Sands Expo and Convention Center with the goal of drawing potential slot machine buyers into the game developers' booths.

What was subdued, however, was the industry's hope for increased slot machine sales.

Over the past few years, the gaming equipment sector has experienced declining revenues. Sales of new games hit all-time lows as casino operators, stung by a combination of reduced customer visitation and lower spending habits, cut back their purchases of new gambling equipment as a way to reduce costs.

The major slot machine manufacturers -- International Game Technology, Bally Technologies and WMS Industries -- didn't slow development of new products.

Whether the gaming equipment sector is just spinning its wheels, so to speak, is open to determination.

In a research report to investors, Jefferies & Co. gaming analyst David Katz said the slot machine companies have taken different approaches toward research-and-development spending.

What is clear, Katz said, is that casino operators aren't changing their spending habits in the next 24 months. He told investors that the demand for new slot machines will be focused solely on any new casino openings, such as the four properties in Ohio, and any other new markets that quickly open.

"The differences among management strategies in adapting to the prevailing market conditions and evolving demand are a critical element of stock performance looking forward," Katz said in the report.

The analyst went back to 2004 to compile an historical perspective comparing individually the percentage of total revenues IGT, Bally and WMS spent on research and development activities.

Historically, WMS spent the most aggressively on research and development, ranging from between 10.9 percent to 15 percent of revenues, with the past several years trending at the higher end of that range.

IGT and Bally allocated between 7 percent and 10 percent of the companies' revenues toward research and development activities.

"We would also note that there have been instances of exception and periods where all three of the companies were repositioning themselves and operating on a depressed revenue base," Katz said. "This is true for WMS in 2004 and for Bally in 2006 and 2007."

IGT, Katz said, "recalibrated its model" in 2009 and 2010 while managing research and development and capital expenditures at constant levels.

"Yet, the company appears to be generating more positive results," Katz said.

As a comparison, Australia-based Aristocrat Leisure Ltd. has been allocating between 15 percent and 16 percent of its revenues to research and development in the past few years.

What should investors take away from this analysis?

Proportionally lower research and development spending combined with improved overall demand for slot machines should lead to the strongest earnings growth and stock performance, Katz said.

"From an earnings perspective, there has not been any direct correlation between research and development budget and capital expenditures and earnings growth," Katz said. "While the product development cycle is measured over multiple years and it is difficult to measure when the impact of deployed resources is realized, there does not appear to have been any sustainable lead captured over a period of years."

During the 1990s and into the mid 2000s, IGT was considered the leading slot machine provider. WMS and Bally were interchangeable in the No. 2 and No. 3 positions.

IGT lost some market share when the economy tanked. In the past year, WMS has taken a hit due to poor quarterly earnings reports.

"All of the three companies have captured gains on the weakness of the others at one time or another," Katz said.

Ultimately, he thought WMS would need a slide by the competition for the company to completely regain its position.

The continued challenge for IGT is in the systems business. Bally and to some extent Japan based Konami Gaming, have gained ground on IGT, which has been repositioning its systems segment and is looking for an opportunity to regain momentum.