Company Reports

The United States District Court of Nevada has granted Aristocrat a preliminary injunction against no-moat Light & Wonder’s Dragon Train game, prohibiting further sales in the US. The case centers around similarities between Light & Wonder’s game and narrow-moat Aristocrat’s highly successful Dragon Link series, including allegations of copyright infringement and misappropriation of trade secrets. Specifically, intellectual property and game mechanics, and the role former Aristocrat employees, now at Light & Wonder, had in its development. The court decision finds Aristocrat is “extremely likely to succeed” in demonstrating trade secrets were misappropriated in the development of Dragon Train.

Light & Wonder has significantly simplified its business by divesting noncore lottery and sports betting assets. It is now a more focused entity, cut in much the same image as dominant competitor Aristocrat, with operations across the social casino space, iGaming, and electronic gaming machines. Most of Light & Wonder's revenue—around two thirds in 2022—is derived from land-based gaming. Within this segment, revenue comes both from leased machines, which attract a fee-per-day or percentage of wagered amount, and outright sales. To maintain share over the long run in the fiercely competitive EGM market, manufacturers need to consistently deliver new, high-quality games that keep consumers engaged and maximize revenue for gaming venues. This requires continuous spending on research and development. Relative to Aristocrat, Light & Wonder spends a lower percentage of revenue on R&D. As a result, we expect it will be difficult to capture material, maintainable share in the EGM market. But we do not expect Light & Wonder to cede share to smaller players either, as its R&D spending is multiples of most of its smaller competitors.

We lift our fair value estimate for no-moat Light & Wonder by 7% to USD 104 (AUD 160) per share. The increase is in roughly equal parts due to an increase in our earnings forecasts and time value of money. Second-quarter fiscal 2024 underlying EBITDA rose 17% on the prior corresponding period, or PCP, to USD 330 million. The better-than-expected result was driven by strong performance in the core gaming market, the majority of Light & Wonder's earnings. We lift our full-year forecast by 3% to USD 1.2 billion—chiefly an upgrade to our estimate for the more durable installed base of leased machines. As leased machine revenue is relatively durable, we expect the higher installed base to also benefit later years. We lift our fiscal 2025 and 2026 EBITDA forecasts by 3% and 2%, respectively. Shares in Light & Wonder currently trade around fair value.

Light & Wonder continues to perform strongly. Underlying first-quarter EBITDA of USD 281 million was about 13% higher than the previous corresponding period. This broadly tracks our unchanged full-year forecast of USD 1.2 billion. This was primarily driven by the core gaming business, lifting underlying segment EBITDA 13% on the PCP to USD 232 million. We think much of this success comes down to the new Dragon Train game, which enjoys exceptional success in Australia.

We lift our fair value estimate for shares in no-moat Light & Wonder by 8% to USD 97/AUD 150 on the back of higher earnings forecasts for the core gaming business. Underlying 2023 EBITDA lifted 22% to USD 1.1 billion, about 3% ahead of our forecast. The firm enjoyed double-digit revenue and earnings growth across all segments by leveraging content research and development spending across gaming, SciPlay, and iGaming. R&D investment is necessary for a healthy pipeline of new products, software developments, and platform enhancements. However, we do not think Light & Wonder has carved an economic moat. While hit games can come down to chance, we do not believe Light & Wonder has garnered the appropriate intellectual property or brand assets to enjoy excess economic returns over the long run, particularly given stiff competition from market leader Aristocrat.

Light & Wonder has significantly simplified its business by divesting noncore lottery and sports betting assets. It is now a more focused entity, cut in much the same image as dominant competitor Aristocrat, with operations across the social casino space, iGaming, and electronic gaming machines. Most of Light & Wonder's revenue—around two thirds in 2022—is derived from land-based gaming. Within this segment, revenue comes both from leased machines, which attract a fee-per-day or percentage of wagered amount, and outright sales. To maintain share over the long run in the fiercely competitive EGM market, manufacturers need to consistently deliver new, high-quality games that keep consumers engaged and maximize revenue for gaming venues. This requires continuous spending on research and development. Relative to Aristocrat, Light & Wonder spends a lower percentage of revenue on R&D. As a result, we expect it will be difficult to capture material, maintainable share in the EGM market. However, we do not expect Light & Wonder will cede share to smaller players either, as its R&D spending is multiples of most of its smaller competitors.

Light & Wonder significantly simplified its business by divesting noncore lottery and sportsbetting assets. Light & Wonder is now a more focused entity, cut in much the same image as dominant competitor Aristocrat, with operations across the social casino space, iGaming, and electronic gaming machines. Most of Light & Wonder's revenue—around two thirds in 2022—is derived from land-based gaming. Within this segment, revenue comes both from leased machines, which attract a fee-per-day or percentage of wagered amount, and outright sales. To maintain share over the long run in the fiercely competitive EGM market, manufacturers need to consistently deliver new, high-quality games that keep consumers engaged and maximize revenue for gaming venues. This requires continuous spending on research and development. Relative to its main competitor Aristocrat, Light & Wonder spends a lower percentage of revenue on R&D. As a result, we expect it will be difficult to capture material, maintainable share in the EGM market. However, we do not expect Light & Wonder will cede share to smaller players either, as its R&D spending is multiples of most of its smaller competitors.

We lift our fair value estimate for shares in no-moat Light & Wonder by 3% to USD 90 (AUD 140) following the release of third-quarter 2023 results. Revenue and profitability are tracking ahead of our previous forecasts for the first 9 months of fiscal 2023, with underlying EBITDA up 26% on the previous corresponding period to USD 815 million. We raise our 2023 underlying EBITDA forecast by 6% to USD 1.1 billion—a 19% increase on 2022. The increase in our estimates, together with the time value of money, lifts our valuation.

We initiate on Light & Wonder with a USD 87 (AUD 135) per share fair value estimate, a Morningstar Uncertainty Rating of High, and a Capital Allocation Rating of Standard. We do not think Light & Wonder benefits from an economic moat. While stringent regulatory licensing requirements in major markets create barriers to entry for new players, the market is already highly competitive, and we do not believe Light & Wonder has garnered the appropriate intellectual property or brand assets to enjoy excess economic returns. Our valuation implies a fiscal 2023 price/earnings ratio of 36 and an enterprise value/EBITDA of 11. Our discounted cash flow model uses a 7.8% weighted average cost of capital.

Light & Wonder significantly simplified its business by divesting noncore lottery and sportsbetting assets. Light & Wonder is now a more focused entity, cut in much the same image as dominant competitor Aristocrat, with operations across the social casino space, iGaming, and electronic gaming machines. Most of Light & Wonder's revenue—around two thirds in 2022—is derived from land-based gaming. Within this segment, revenue comes both from leased machines, which attract a fee-per-day or percentage of wagered amount, and outright sales. To maintain share over the long run in the fiercely competitive EGM market, manufacturers need to consistently deliver new, high-quality games that keep consumers engaged and maximize revenue for gaming venues. This requires continuous spending on research and development. Relative to its main competitor Aristocrat, Light & Wonder spends a lower percentage of revenue on R&D. As a result, we expect it will be difficult to capture material, maintainable share in the EGM market. However, we do not expect Light & Wonder will cede share to smaller players either, as its R&D spending is multiples of most of its smaller competitors.

We are no longer providing equity research on Scientific Games Corporation SGMS. We provide broad coverage of more than 1,700 companies across more than 140 industries, and adjust our coverage as necessary based on client demand and investor interest.

We believe Scientific Games has temporarily lost its focus, and recent competition has put pressure on the firm's economic moat, causing us to downgrade it to none from narrow.

We believe Scientific Games has temporarily lost its focus, and recent competition has put pressure on the firm's economic moat, causing us to downgrade it to none from narrow.

Scientific Games SGMS reported fourth-quarter results that did not impress, as consolidated revenue declined 9% to $212 million and net income declined 75% to a net loss of $158 million. The decline in revenue was primarily related to the firm's sale of its racing business in the year-ago quarter. Excluding the results of the racing business, revenue increased 2% to $211 million. The increase in adjusted revenue came from the core instant ticket business, which increased sales 7% to $124 million as U.S. retail ticket sales grew 5% from the year-ago quarter. Scientific reported an operating income loss of $11 million this quarter, besting the $70 million loss in the prior-year quarter. This quarter's loss included a host of noncash charges for underperforming lottery system contacts, obsolete equipment, and accelerated depreciation on equipment.

We believe Scientific Games has temporarily lost its focus, and recent competition has put pressure on this narrow-moat firm.

Scientific Games SGMS reported dismal third-quarter results as all three of the firm's major business lines declined in revenue. Consolidated revenue declined 8% to $221 million compared to the year-ago quarter. Revenue in the printed products group declined 3% to $117 million due to weak instant ticket and phone card sales globally. Sales in the lottery systems group suffered the worst, as revenue declined 19% to $53 million versus the prior-year quarter due to lower hardware and software sales, less favorable pricing terms, and contract losses in New Hampshire, Vermont, and South Dakota. More surprising was a 5% decline in retail sales in China where the firm is facing stronger competition from the China Welfare Lottery. Revenue in the diversified gaming group fell more modestly to $51 million, a 3% decline, due to lower service revenue. Operating margins declined almost 300 basis points to 10% due primarily to unfavorable operating leverage as revenue declined, coupled with a mix shift toward less profitable business lines.

We believe Scientific Games has temporarily lost its focus, and recent competition has put pressure on this narrow-moat firm.

Morningstar is initiating credit coverage of Scientific Games SGMS with an issuer rating of BB-, which reflects the benefits of the firm's long-term business contracts as well as its recent operational struggles and inflated debt burden.