Light & Wonder: How Far Can The Growth Momentum Last?

seekingalpha08-20

Light & Wonder's growth momentum has continued across the company's segments.The land-based gaming segment's growth momentum looks to slow down with the industry's traffic stabilization and with ...

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John Rensten/DigitalVision via Getty ImagesLight & Wonder, Inc. (NASDAQ:LNW) has continued its great growth momentum even above previously anticipated levels, again exceeding revenue expectations with the recently reported Q2 financials. The reported revenues of $818 million beat Wall Street’s estimates by $20.7 million, but the EPS of $0.90 missed by $0.14 despite consistent continued momentum. I believe that there needs to be some caution in extrapolating the growth much further, though. In my previous article on the stock, “Light & Wonder: Valuation Leaves Me Wondering”, I initiated Light & Wonder at a Sell rating due to the stock’s valuation. The stock’s return of 44% has outpaced S&P 500’s return of 32% since the article was published on the 1st of November in 2023.   My Rating History on LNW (Seeking Alpha)Land-Based Gaming Momentum Looks to Slow Down Light & Wonder’s land-based gaming solutions, including slot machines and other gambling systems, have continued having great growth momentum – in Q2, the segment’s revenues grew by 14% into $539 million led by great machine and system sales. The land-based gaming segment had 5% growth in gaming operations revenues from the already installed base’s recurring revenues, with machine sales growth of 32% driving the overall growth performance. While the growth in the land-based gaming segment has been great in recent years, the segment’s recurring growth is starting to slow down – the Covid pandemic disturbed casino traffic from 2020 forward, creating space for extraordinarily high growth afterwards as customers have now returned to land-based casinos. For example, Caesars Entertainment’s (CZR) revenues show stabilization into pre-pandemic levels in 2023, and MGM Resorts’ (MGM) and Wynn Resorts’ (WYNN) revenues show quite a similar trend with constant growth back into slow pre-pandemic momentum. The slowing growth ultimately creates less momentum for Light & Wonder’s recurring revenues' growth. The great machine sales momentum at a 32% growth year-on-year should slow down quite significantly as well after the current casinos' maintenance & replacement CapEx slows down - capital expenditures for the land-based casino industry's largest companies suggest high investing activity for the time being, boosting the segment for now. Caesars, Boyd Gaming (BYD) and PENN Entertainment (PENN) are currently investing at record rates (cash flow statements: CZR, BYD, PENN), and MGM Resorts has pushed CapEx higher than the 2019 pre-pandemic level. On the other hand, Bally’s Corporation (BALY) has recently started to already slow down CapEx and Wynn Resorts has remained with low CapEx even after the pandemic, but the overall investing activity has been higher than normal. The Q2 growth was achieved through replacement units, as expansion unit sales decreased quite dramatically.   LNW 2024 AGE Investor PresentationWhile the ongoing high machine investments in casinos should drive Light & Wonder’s recurring revenue base, I believe that the land-based gaming momentum is due to slow down considerably depending on the industry’s investment and traffic stabilization trends as discussed. In Q2, the installed base in the US is up 7% year-on-year but down 13% in international locations, and in total, the installed base already decreased -2.4% year-on-year from 55879 to 54563. With growth in average revenue per unit likely to slow down from stabilizing traffic, and with likely slowing mid-term machine sales momentum, the growth outlook isn’t as great going forward. SciPlay Monetization Is Pushing Earnings Up Well, But Is Disturbing User Growth The SciPlay segment is growing revenues very impressively with $205 million of revenues in Q2, up 8% year-on-year – the segment is still performing well as the segment continues grabbing estimated market share.   LNW 2024 AGE Investor PresentationThe recent growth in SciPlay still comes with a caveat. Light & Wonder seems to be monetizing the SciPlay apps aggressively, potentially acting as a threat for growth over the long term. Revenues in Q2 grew incredibly well driven by a 12% growth in average revenue per daily active user [ARPDAU], but daily active users [DAU] is already experiencing pushback at a -5% decline in Q2 with users seemingly dissatisfied about monetization changes including overwhelmingly negative reviews of the MONOPOLY Slots app. Deteriorating DAU could start to push back on SciPlay’s total growth in the mid-term as SciPlay's ARPDAU can’t be expanded as well over the longer term – I suggest to look at the segment’s DAU closely going forward, as without a stabilizing and growing user count, the growth could even halt. I don't think the DAU decrease is a very bad sign yet, but if the KPI continues decreasing, the segment's future growth outlook becomes worrying. iGaming Should Continue Growing With the online gaming industry growing very rapidly in the US, Light & Wonder’s iGaming revenues are growing. In Q2, revenues grew by 6% into $74 million, driven by continued North American momentum. The growth is fair, but not exceptionally good when compared to peers. GAN Limited’s (GAN) B2B offering managed to grow at a 39.7% rate in gross operator revenues in Q2 with its primarily US-based operations, at a noticeably higher rate than Light & Wonder’s 25% North American OGS gross gaming revenue growth. The growth still does outpace Bragg’s (BRAG) total 0.5% revenue growth in Q2 by around 5 percentage points, in part as Bragg’s quarter compares to an all-time high performance. While not a best-in-class growth rate, Light & Wonder's iGaming segment still has solid momentum. I believe that with DraftKings (DKNG) and Flutter Entertainment's (FLUT) FanDuel representing the US market’s growth potential well, Light & Wonder’s iGaming offering should continue to grow increasingly well while not growing exceptionally well compared to peers. After Q2, the segment has 85 partner studios and 570 brands under the segment as told in the Q2 earnings call, providing a foundation to leverage in the future. The segment is still small for Light & Wonder for the time being, though. Light & Wonder's Profitability Increased Well in Q2 With still ongoing revenue growth momentum in all of Light & Wonder’s segments, profitability improved well year-on-year in Q2. The land-based gaming segment had constant segment profitability, but the SciPlay monetization pushed the segment’s profitability up considerably. The iGaming segment had stagnating profitability with increased investments to new content launches. The increased overall revenues provided operating leverage into a 39% adjusted EBITDA margin, up 1 percentage point year-on-year when combined with great SciPlay segment profitability scaling – as expected, the growth story streamlines Light & Wonder’s earnings capabilities. Updated Valuation I updated my discounted cash flow [DCF] model. I now estimate a revenue CAGR of 6.1% from 2023 to 2033, compared to an implied 5.6% CAGR previously in the same period. The ongoing land-based casino momentum and SciPlay monetization have driven up the estimates slightly, but the future outlook is still cloudy regarding land-based casino industry’s stabilization and SciPlay’s DAU, requiring some caution. With the greater growth estimates, I now estimate the operating leverage to push the EBIT margin into 24.5% eventually, compared to 24.0% estimated previously. Due to increasing capital expenditures, I have taken down my cash flow conversion estimate a notch, but I still estimate a good cash flow conversion due to high amortization.   DCF Model (Author's Calculation)The estimates put Light & Wonder’s fair value estimate at $74.81, 29% below the stock price at the time of writing – I still believe that the stock is too tightly valued despite good, continued growth momentum. The outlined risks in the land-based casino segment and SciPlay segment also pose further risks to the valuation. The fair value estimate is up from $47.42 previously, primarily due to a lower used WACC. CAPM A weighted average cost of capital of 10.37% is used in the DCF model, down from 13.16% previously. The used WACC is derived from a capital asset pricing model:   CAPM (Author's Calculation)In Q2, Light & Wonder had $75 million in interest expenses, making the company’s interest rate 7.75% with the current amount of interest-bearing debt. I now estimate a slightly lower 35% long-term debt-to-equity, down from 40% previously. To estimate the cost of equity, I use the 10-year bond yield of 3.89% as the risk-free rate. The equity risk premium of 4.11% is Professor Aswath Damodaran’s estimate for the US, updated in July. I have updated the beta to Seeking Alpha’s current estimate of 1.54. With an ESG add-on of 1.5% and a liquidity premium of 0.25%, the cost of equity stands at 11.97% and the WACC at 10.37%. Takeaway Light & Wonder has shown greatly continued growth momentum. Yet, with the casino industry’s high current investment level and traffic stabilization, the land-based casino segment’s growth looks to slow down considerably in the midterm. The SciPlay showed great momentum as well, but the aggressive monetization efforts could turn away customers, as shown by the Q2 decrease in DAU. The company’s total earnings growth outlook still stands good, including the iGaming segment’s continued content releases and US growth momentum.  I still believe that the stock’s valuation is too tight despite likely continued overall growth, and as such, I remain with a Sell rating for Light & Wonder.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2460515017"}