International Game Technology Faces Strong Competition Despite Leadership Position

International Game Technology (IGT) holds a leadership position in slot machines. In January, the company reported adjusted earnings of 23 cents per share in the first quarter of 2010, beating the Zacks Consensus Estimate of 20 cents a share. This was due to increased cost cutting and higher sales of replacement slots.

The quarter benefited from increased North American replacement units compared to the prior-year quarter, large-scale deployment of the sbX platform and improvement in operating margin – the highest in the last six quarters. The results were also boosted by increased international growth, offset by a decrease in overall domestic placement levels, resulting in total sales decline.

However, revenue growth has suffered due to reduced demand for game play. Hence, IGT is focusing on reducing operational costs to improve earnings. While management remained cautious on casino budgets and spending plans for 2010, IGT reaffirmed its guidance.

IGT plans to remain focused on its core activities in 2010. Therefore, the company recently announced the closure of its operations in Japan due to ongoing difficult market conditions and lack of a strategic fit with its core business. The closure is expected to be completed by the third quarter of fiscal 2010. Thus the decision to close the Japanese operations will help IGT lower unnecessary costs and focus on core activities that could drive growth in fiscal 2010.

Ongoing cost-cutting initiatives, substantial free cash flow, increased international penetration, expansion of gaming operations into new U.S. jurisdictions and rapid replacement of new machines will drive growth. For the longer term, we remain positive on the company’s market leadership position in slot machines.

However, the highly leveraged balance sheet and strong competition are of concern. While spending appears to be rebounding, we have yet to see a recovery in the entire leisure and gaming industry.

Although IGT has a leadership position in the server-based gaming market, the emergence of a competitor with new technology or a new entrant into the market could hinder the company’s ability to retain market share. The company faces strong competition from Aristocrat Leisure Limited, Bally Technologies (BYI) and WMS Industries Inc. (WMS) in the U.S.

Thus, we maintain our Neutral rating on the stock.