Gaming Partners International (NASDAQ:GPIC) had a rough fourth quarter, though I’m not sure anyone noticed. The underfollowed maker of gaming chips, playing cards, and other casino products decided after Q3 not to even bother with earnings releases anymore. Volume has averaged just ~$40,000 a day over the past three months, and the bid/ask spread as I write this is quoted at over $1 (admittedly on a quiet day in the markets).
The good news for GPIC is that the issues seem largely one-time – and mostly related to better-than-expected demand in the playing card business. In the meantime, GPIC has pulled back after a steep early March decline – one that doesn’t seem related to the report (the 10-K wasn’t released until March 24). Giving credit for the disruption in Q4, GPIC still looks reasonably cheap – and there’s a clear acquirer that would make sense even at a modest premium to current levels.
The bad news is that GPIC still is illiquid, still is controlled by a majority shareholder, and still has shown no interest in a sale. Those issues at the moment are enough to keep the bull case for GPIC from being all that compelling. But a modestly lower price, or improvement in 2017 results, could change that, and make GPIC not just underfollowed, but undervalued.
A Q4 Disruption And A Decent 2016
The Q4 numbers for GPIC were hit hard by significant margin pressure. Revenue did decline, by about 1.5%. But gross profit fell by 30%, as margin dropped to 28.2% from 40.1% the year before.
The pressure appears to have come largely from operational issues at the company’s playing card manufacturing plant in Missouri. Per the 10-K, the facility already was running at over 100% capacity; Gaming Partners then had to expand the plant and upgrade certain unspecified manufacturing processes. The combination lowered efficiency and increased costs, leading to the Q4 margin compression and likely having lingering effects into 2017.
Obviously, this isn’t good news – but it’s not terrible news, either. Playing card sales grew over 10% in 2016, and at ~30% of total revenue are a reasonable driver going forward. The 2014 acquisition of Gemaco built up the product line (which generated barely 11% of total sales in 2013, the year before the purchase), and recent success implies that acquisition is contributing well. The Missouri facility should get back to normal at some point, allowing for a quick rebound in margins.
And Missouri aside, 2016 seems reasonably strong. EBIT, backing out a gain on sale in late 2015 and a $400,000 goodwill impairment in 2016, only declined about 7% year over year. Assuming that Missouri cost the company $2 million in Q4 (which still suggests margins would have compressed ~350 bps), EBIT would have been right around $10 million, and up 16% year over year. SG&A – again, adjusting out non-cash expenses – declined on an absolute basis year over year, with revenue increasing 5%.
There are some revenue concerns, though. Dolphin orders started shipping in Q4. Though the company didn’t break out its contribution, that business appears to have had a ~$13 million run rate under EGT ownership. The fact that revenue declined despite that contribution isn’t necessarily comforting. That said, a major RFID chip order hit in Q3, which made a tough comparison in that category for Q4. On an annual basis, Gaming Partners did have some success, notably in the long-targeted RFID space.
RFID chip revenue increased 25% for the year (possibly with some modest help from Dolphin) while RFID solutions sales rose 37%. Table layouts and accessories were weak, likely due to a rather modest opening slate worldwide this year – Gaming Partners appears not to have the major operators like Las Vegas Sands (NYSE:LVS) and Wynn Resorts (NASDAQ:WYNN) that had openings in Macau this year.
But aside from the production disruptions in Q4, there’s enough in GPIC’s 2016 to hold a reasonably optimistic view looking forward. Asia-Pacific revenue was flat and represented about 26% of overall sales; that region should have some drivers over the next few years, between additional openings in Macau and expansion in Vladivostok (Russia), the Philippines, and, eventually, Vietnam, Korea, and Japan.
Americas revenue increased 5%, and the small EMEA business rose 23%. Incentive compensation came down $700K, and may reverse next year, but there’s still room for GPIC to leverage low-to-mid single-digit growth on an organic basis. Adding in Dolphin should create double-digit reported growth on the top line, and that with modest margin expansion GPIC might get downright cheap.
The bull case for GPIC remains relatively the same coming out of Q4, even with the production issues. (The market probably isn’t paying enough attention to support the case for a short-term “buying opportunity.”) EPS in 2016, backing out ~$0.03 after-tax impact of the goodwill impairment charge, was $0.67. I had thought an optimistic case might support $100 million in 2017 revenue with Dolphin; that’s probably a bit too far, but Dolphin should be targeting $95 million or so.
Operating margin in the 10% range (up 30 bps year over year, as gross margin rebounds in the second half and SG&A deleverages modestly) at a 31% tax rate gets EPS to $0.80 or so, and the P/E to the 12-13x range. EBITDA is probably $13-$14 million, implying a 6x+ multiple at the moment. Capex is guided to $7.5 million this year against likely ~$4 million in D&A, but that figure is elevated a bit by further spend in Missouri; normalized maintenance spend seems likely to be closer to the D&A figure.
Basically, a decent 2017 means Gaming Partners is priced for zero growth – even though there should be additional gross margin improvement in 2018. GPIC has pretty solid market share (it’s #1 in currency, and one of three major providers in cards) and there’s still long-term room for both casino expansion and recurring revenue. And there’s a clear endgame here: Sell the company to Scientific Games (NASDAQ:SGMS). SciGames’ roll-up is based on being a ‘one-stop shop’ for casino operators.
It could pair the playing card business with its Shuffle Master unit, add GPIC’s table accessories and layouts to its branded games like Three Card Poker, and tie RFID into its Gaming Systems unit. SciGames can cut the nearly $10 million in cash G&A rather quickly, there are revenue synergies as well, and an 8x EBITDA multiple likely would be accretive for SciGames. There’s a pretty easy case for SGMS to pay $14-$15 for Gaming Partners in a deal that works out for both sides.
Of course, there’s also really no one else who makes a ton of sense at this point (Everi Holdings (NYSE:EVRI) would have regulatory problems, at least at the moment) – which limits GPIC’s negotiating power. Gaming Partners also has shown no interest in a sale, and a 51% controlling stake limits any activists or shareholder input on that front. In fact, GPIC wrote in the 10-K that it was considering additional acquisitions.
That’s not a terrible thing, if GPIC can add accretive businesses onto the current structure with little or no incremental cost. But it’s obviously a riskier strategy, and the illiquid nature of the stock makes it tougher for shareholders to exit if that strategy takes a perceived wrong turn. A margin rebound isn’t guaranteed, and GPIC could face some pressure on the top line this year given a rather slim crop of openings in the U.S., in particular.
In short, I like GPIC – but I don’t love it, and I don’t think the upside yet is compelling enough to take on some of the trading risk involved. But I do think it’s an interesting microcap play – and one for the watchlist. If margins rebound by Q2, valuation on 2017 metrics looks much stronger. If Gaming Partners can continue to drive growth in RFID, in particular, that could make the story more interesting to an acquirer (given that remains a large, if still mostly hypothetical, growth opportunity). All told, if GPIC executes, there’s probably room for upside from $10. And if investors are nimble enough to see that execution, there should be time to get into the stock at an attractive entry point.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.