Perelman’s Interactive Gaming-Unit Shuffle Rattles Bondholders

(Bloomberg) -- Scientific Games Corp. shareholders loved the slot machine and lottery company’s decision to consider an initial public offering of its fast-growing interactive-gaming unit. Bondholders, not so much.

Shares of Scientific Games jumped almost 17 percent after the Las Vegas-based company said on Sept. 7 it would consider joint ventures, an IPO and other options for the business, which makes casino-style games for mobile devices. The bonds fell and remain lower a week after Scientific Games designated the business an unrestricted subsidiary, raising concerns among bondholders about how any proceeds may be used. Scientific Games, 40 percent-owned by New York billionaire Ronald Perelman, had $8.07 billion in long-term debt as of June 30.

Perelman’s Interactive Gaming-Unit Shuffle Rattles Bondholders

“They’re moving value away from bondholders to the equity holders,” said John DeCree, an analyst with Union Gaming in Las Vegas. “That’s why we’ve seen the divergent trade.”

Since the announcement, Scientific Games has reached out to debt investors, telling them the interactive business is still a subsidiary of the parent and that cash generated by the business will be available for debt reduction.

“Designating our social-gaming entities as unrestricted subsidiaries allows Scientific Games to pursue a wide range of options to generate greater value for our company and our investors, including our debt holders,” Chief Financial Officer Michael Quartieri said in a statement to Bloomberg News. “Following the unrestricted designation, the social-gaming entities are wholly owned by Scientific Games and continue to support the growth of our company and our goal of delevering the business.”

Lottery Roots

Although Scientific Games traces its roots to lottery products developed in the early 1970s, the company has ballooned in size recently through acquisitions that included the purchases of slot-machine makers WMS Industries in 2013 and Bally Technologies the following year for a total of more than $6.5 billion.

Casino-style games are among the top-grossing apps in the U.S., according to App Annie, a research site. They’re typically free to start but require money if you want to keep playing.

Traditional Slots

The top titles include Big Fish Casino, owned by Churchill Downs Inc., and Slotomania, from Caesars Entertainment Corp. Caesars agreed last month to sell its interactive business for $4.4 billion to a Chinese consortium. Online players gravitate to brands they know from the casinos, according to Melissa Price, a senior vice president at Caesars.

“The traditional slot player, they play traditional slot content online,” she said.

Scientific Games’ Jackpot Party Free Casino Slots app offers mobile versions of the company’s slot machines, such as Super Monopoly Money and Michael Jackson Smooth Criminal. Revenue at the interactive unit jumped 62 percent to $83.4 million in the second quarter. Adjusted earnings before interest, taxes, depreciation and amortization rose 37 percent to $18.2 million.

The interactive business could be valued at 15 times Ebitda or more in an IPO, almost twice the eight-times multiple Scientific Games trades at now, according to Larry Haverty, a fund manager at Gamco Investors Inc. in Rye, New York, which owns 626,000 Scientific Games shares. A deal that highlights the value could lift the stock price, he said.

‘Opportunistic Use’

The view is different for bondholders, according to Barbara Cappaert, an analyst with KDP Investment Advisors Inc. Putting the interactive business in an unrestricted subsidiary means that cash may not be available to pay interest or reinvest in the company’s other businesses, she said. Funds could be used to buy back stock or declare a dividend.

The company’s largest debt issue, $2.2 billion in 10 percent notes maturing in 2022, fell 2 cents on the dollar when plans for the interactive unit were announced. They were trading Wednesday at 89.125 cents, down 3.6 cents from the day preceding the announcement. The shares have risen 17 percent to $10.28.

The interactive business could be worth $875 million to $1 billion, or $10 to $11.50 per Scientific Games share, according to Union Gaming’s DeCree. The sale of a minority stake could generate proceeds to pay down debt, such as the $250 million in 8.125 percent notes due in 2018, he said. That would save as much as $20 million a year in interest.

“Given what has happened with other issuers due to the opportunistic use of unrestricted subsidiaries, bondholders are right to be concerned,” said Anthony Canale, head of high-yield research at Covenant Review, a research firm that analyzes credit agreements. He cited Caesars, which sold some of its hotels to an affiliate and then put its most heavily-indebted unit in bankruptcy. “Bondholders are skittish about this because the company now has a freer hand with those assets.”