SciPlay: Cards Are Not Dealt Right (NASDAQ:SCPL)

SciPlay (NASDAQ:SCPL) is an interesting name to cover here, with M&A activity across the gaming sector being a hot issue. This and the pandemic period makes it much needed to update a dated thesis, going back to the summer of 2020.

In the summer of 2020, I concluded that I was not playing along with SciPlay as it has seen real struggles amidst a rapid growth slowdown following the public offering of the business in 2019. Slow growth was due to mature games, making SciPlay a cash cow in my eyes, rather than a real growth opportunity, as the impact of the pandemic was seen as a transient factor by myself.

Former Thesis

SciPlay develops and publishes mobile and web platform games. It had the ambition to create the largest casual mobile gaming company in the world, offering free entertainment games, while offering premium options to make progress within the game. Actual games focus on slots, casino and monopoly-inspired themes, to be accessed from all the major platforms.

The business was spun off from Scientific Games (SGMS) as SciPlay traded at $16 per share following the separation. The 126 million shares outstanding resulted in a $2.0 billion equity valuation at the time of the spin-off, amidst a flattish net cash position.

The business generated $418 million in sales in 2018, the year ahead of the spin-off, with three quarters of sales generated from mobile games. The company posted GAAP operating profits of $74 million and adjusted operating earnings of $100 million. After taxes and modest interest expenses, that worked down to a 23-24 times earnings multiple based on the adjusted numbers.

With growth seen at 20%, that looked quite compelling, yet the fact that this was a controlled company (due to the majority ownership by Scientific Games) and the observation that IP royalties had to be paid to the mother company, I was quite cautious.

Given this setup, shares fell to $7 per share early in 2020 ahead of the pandemic. Growth came to a standstill as my concerns played out. Shares rallied to $11 in May in 2020 and to $15 in July as I pegged the earnings run rate at $1.50 per share, obviously driven by the pandemic.

What Happened?

Since voicing a cautious outlook at $15 in the summer of 2020, shares have traded in a $12-$22 price range ever since. They have sold off to $13 at this moment on the back of the current retreat in shares of technology names and pretty much all pandemic plays.

In November 2020, the company posted solid third quarter results, continuing to benefit from the pandemic with third quarter sales of $151 million being up 30% on the year before as operating profits rose to $36 million. Fourth quarter revenues fell a bit to $147 million on a sequential basis, but were still up 30% on the year with operating profits coming in at $35 million. In the meantime, net cash holdings rose to $269 million. Earnings were reported at $0.86 per share for the nine-month period.

The company started 2021 on a solid note with first quarter sales up 28% to $151 million as operating profits rose sharply to $40 million. Second quarter sales of $154 million came in strong, but were down 7% on the back of very tough comparables. Mother company, Scientific Games, furthermore, offered to buy the remaining 19% of the share outstanding which it did not own yet, in a deal in which it offered 0.25 of its own shares. Towards the end of the year, Scientific terminated the deal.

Third quarter sales of $147 million were down 3% on the year as well. The company earned $119 million on an operating basis in the first nine months of the year, in line with the year before as earnings came in around $0.90 per share share here. With just over 150 million shares outstanding, the net cash balances of $330 million came in above $2 per share.

With shares now trading at $13.50 per share, operating assets trade at roughly $11.30 per share, while I peg earnings power this year at around $0.90 per share, resulting in a 12-13 times earnings multiple for the operating assets. The reality is that despite the impact of the pandemic in the second and third quarters, growth is negative amidst difficult comparables, as the question is how far earnings and sales will fall back if the pandemic is hopefully finally on its retreat.

Final Thoughts

It feels as if investors are in status quo. The company trades at just 12-13 times earnings, while the balance sheet is very strong. This means that investors are performing a balancing act on the true run rate of profits, as the current profits being posted seem to be elevated by the pandemic and would likely fall this year, based on the working assumption that the pandemic is on its retreat.

On the other hand, M&A is tricky as well as SGMS has aimed to buy the shares, but has pulled off the deal, while the majority ownership by SGMS prevents other players from being interested as well. This is despite the aggressive M&A having taken place in the industry, which includes the deal between Zynga (ZNGA) and Take-Two (TTWO), as well as Microsoft (MSFT) and Activision (ATVI).

While shares look cheap, I recognize that earnings will likely come under pressure this year. I have learned in investing that quality is what counts. I am impressed with the current financial performance but not the quality of the actual operations (read games). This makes it a relatively easy pass, despite the perhaps compelling (current) earnings multiples.