Sandstone insights: Light & Wonder opportunity for big discount and high growth potential

ASX code: LNW

Suggestion: Buy

Need to know

• Big valuation discount to Aristocrat
• Debt reduction creates capital management opportunities. $1 billion buyback announced
• Consensus 3-year EPSA CAGR 33% per annum.

Business overview

Formerly known as Scientific Games, Light & Wonder has been colonised by former Aristocrat (ALL) executives. There are many other similarities to ALL but also some notable differences that create an investment opportunity.

LNW is a global land-based and online gaming company, headquartered in Las Vegas. It supplies gaming content and machines to casinos and other licensed gaming entities through its hardware and technology solutions. LNW’s gaming segment, a top-two player in the US, generates about 75% of group operating earnings. Its online/digital revenue businesses provide the remaining 25%, with a goal of achieving 50% of group revenue.

The people

Most of LNW’s senior management team and its chairman cut their teeth at ALL. Chairman Jamie Odell was previously CEO of ALL, while LNW’s CEO Matt Wilson was previously ALL’s MD of its America's division. LNW’s ranks (6000 employees) are liberally sprinkled with former ALL employees, so the collective industry experience is a strength of the business. This is an important factor driving the turnaround story at LNW following the sale of the Lottery and Sports Betting businesses in 2022.

Financials

The sale of the Lottery and Sports Betting businesses allowed LNW to significantly deleverage its balance sheet. As of 31 March 2024, its net debt leverage sits in the middle of its 2.5-3.5x leverage ratio range and is expected to trend lower. This enabled LNW to complete a $750 million share buyback early and announce a further $1 billion buyback through to June 2027. LNW does not currently pay a dividend, but its capital management framework is clearly shareholder friendly.

Net debt vs ND/EBITDA chart: leverage is declining, target arget range 2.5-3.5x

Earnings growth

With just over two-thirds of revenue generated in the USA and three-quarters of earnings before interest, taxes, depreciation, and amortisation (EBITDA) sourced from gaming, LNW’s immediate earnings outlook is oriented to these factors. Future growth can be enhanced by its social casino publishing in SciPlay and the iGaming content and systems aggregation business. We see a 3-year revenue CAGR of about 33% per annum and an EBITDA CAGR of 14% per annum over the same period.

Divisional EBITDA chart

Valuation appeal

LNW trades on a 2025 financial year (FY) forecast price-to-earnings (PE) ratio of about 14x EPSA, compared to ALL at 19x and a 58% discount to global gaming peers. On an enterprise value (EV)/EBITDA basis, LNW is valued at 13x FY2025 forecast compared to ALL at 14x and the global peer group at around 16x. There may be some recognition of LNW’s higher leverage of 2.6x relative to ALL’s 0.5x, but we see leverage declining quickly over the next year.

EPSA chart: growth is 33% per annum

Gaming

LNW’s core operations are in land-based gaming, providing slot machine software and content together with hardware and casino management systems. Customers are casinos and gaming venue operators, with most of the business concentrated in North America. Customers can either buy the hardware and software outright (average unit price is around US$18,000) or lease it.

Lease options and revenue generation

The lease options are either via a fixed daily fee or a ‘participation share,’ typically 80/20 (customer/LNW) based on the daily net win from the machine. The most recent data shows LNW’s average daily net revenue per unit was US$47.57 in North America and US$14.01 for international. In FY2023, LNW had an installed base in the US and Canada of about 31,000 units with around 22,000 units in international markets.

Premium leased games and product performance

LNW’s share of premium leased games in North America has stabilised at around 17%, with new product installs matching the churn on legacy products no longer being serviced by LNW. The company will try to lift its mix of premium leased games to around 50% of total installs from around 47%, which will drive higher average daily fee per day revenue.

The performance of the machines on main gaming floors is crucial for casinos. The product content is the key element, and LNW’s latest product, Dragon Link, is performing strongly at around 1.9x floor average. The industry Eilers & Krejcek Game Performance database ranks LNW’s products highly against the competition, although Aristocrat Leisure Limited (ALL) has maintained a meaningful lead in the market overall.

LNW’s share of outright sales has steadied at around 21%. ALL retains a lead in this aspect too, but LNW could potentially take share from a weaker player like IGT.

LNW va ALL chart: LNW at a clear discount to ALL on EV/EBITDA

SciPlay

LNW’s SciPlay business is ranked as the third player globally in social casino games, taking share from market leader Playtika. ALL’s Pixel United is ranked second as a global competitor.

SciPlay generates revenue mainly from in-app purchases such as virtual coins, chips, and cards, which players can use in online games.

SciPlay’s library will leverage successful content, including third-party content, from other platforms to drive growth.

iGaming

The smallest of LNW’s segments, iGaming has a large potential market in real money gambling (RMG) estimated at US$27 billion. LNW provides its platforms and content to other online gaming providers globally. It also provides a player account management system called Open Platform Systems (OPS) that gives operators control over reporting and administrative functions.

LNW peer group metrics chart: digitisation of gaming powering earnings

Investment view

A deleveraging balance sheet with high-growth earnings and cash flow is giving LNW room to accommodate capital management and investment in its products and services. That is a good combination, but the market is yet to fully recognise this in the share price.

In many respects, LNW is a carbon copy of ALL and yet the valuation gap is perceptible. They are competing in the same markets, but the market itself is growing, particularly in iGaming, so there is room for both companies to prosper.

Risks to investment view

Unfavourable changes to the regulatory and legal frameworks could affect the way LNW conducts its business. This risk varies across the many jurisdictions in which LNW operates. There are risks associated with the timeframe to receive approval for new land-based games and for states to legalise online gaming. LNW may also face litigation risks.

The economic cycle could affect earnings growth and consumer preferences for spending choices. There is risk from competition from new products and technology development. The company faces talent risks if its key design and development people leave or if key executives leave. The company faces financial risks from changes to interest rates or lending conditions.

R&D chart: spend is low but trending to 10%

• _{The information provided by Sandstone Insights does not constitute investment advice and does not have regard to the specific needs of any person who may receive it. No warranty is given as to the accuracy or completeness of the information and any person acting on it does so entirely at their own risk.}