***Upfront note- investing in bankrupt equities is very risky. There is a significant risk of losing all of your money. Please do your own research. ***
I first mentioned Gametech (GMTCQ) a few weeks ago. Since that time, the stock has been a rollercoaster, nearly doubling a few week ago before declining back to the price I originally wrote it up at. But despite the rollercoaster stock price, I think there’s been significant progress made that indicates significant potential for upside recovery for the equity.
I also wanted to go into a bit more detail than I did in the first post, so let’s do a recap of the situation and then try to figure out why I think there’s a good bit of upside from today’s prices.
In many ways, Gametech reminds me of Arctic Glacier (AGUNF) and Cagle’s (CAGAQ), two other bankrupt equities I invested in pre-auction that enjoyed significant upside in the form of huge bids resulting in big equity recoveries.
Before we do that, there are three key documents that you’ll want access to that I’ve used as the basis for this write up. They are
- The original motion for bankruptcy
- Kinetics’ valuation of Gametech as of August 1st
- The motion that gave “the Trust” the DIP loan, made them stalking horse, and started the auction process.
So with that, let’s get into Gametech.
Gametech is the leader in electronic bingo systems, controlling between 40-60% of the market (depending on whose estimates you rely on). In 2006, the company took on a significant amount of leverage to make a huge acquisition of a video lottery machine company.
The video lottery division (VLT) was a somewhat related market that was supposed to offer huge growth and significant synergies. However, as happens with so many acquisitions in tangentially related markets, the synergies never panned out, and the debt load crippled the company as the economic crisis caused a huge drop in the bingo and VLT markets.
The company responded to the crisis the way most overleveraged companies do: by cutting all investment and focusing exclusively on paying down debt. And while this allowed them to stay in business and pay down huge amounts of debt, the company argued that it also lead to further deterioration in their business as they had to forgo several investments in equipment and inventory that would have increased sales.
This strategy worked relatively well for several years, as the company managed to continue paying down debt and extending their loans. However, as their loan reached maturity on June 30 this year, their bank sold their loan at a slight discount to par to a competitor, Yuri Itkis Gaming Trust (the Trust), on June 27th.
After buying Gametech’s loan, the Trust immediately told Gametech that they would not extend the loan and handed Gametech a 38 page merger proposal. Gametech rejected the merger proposal, noting that the merger could not be completed in the form presented and that they believed more value could be realized by seeking a merger with other parties, and requested a thirty day extension of the loan.
The Trust rejected the extension, and Gametech filed for bankruptcy, unable to pay down the loan.
Gametech filed for bankruptcy on July 2nd. The bankruptcy filing is quite interesting, but the nugget that really stands out comes from page 10.
“The Debtors have identified a number of operational initiatives that they believe will substantially improve their business operations and have considered a variety of strategic transactions that could result in substantial value for the Debtors’ estate. In fact, the Debtors are in discussions with another company about a transaction that would create more value than the Proposed Merger Agreement.”
After filing, Gametech and the Trust shifted into a war over Gametech’s DIP loan and the terms of a potential stalking horse bid / auction for Gametech. Gamtech argued that the Trust’s bids placed zero value on the VLT business and made it difficult for potential acquirers to buy the two businesses separately, while the Trust argued Gametech’s bankruptcy proceedings were creating unnecessary fees and extracting value from the estate when Gametech would most likely end up merging with the Trust anyway.
On August 10, Gametech and the Trust finally reached an agreement on a DIP loan and stalking horse big. The major terms of the loan were as follows
1) The value of the Trust’s bid equals the full value of the bank loan the Trust purchased, plus $2.5m, minus the value of the DIP draw.
2) The bid is for a full sale and transfer of all of the company’s assets and liabilities, and will also pay for any potential sales taxes. Thus, anything above the debt will go straight to the equity.
3) In the event the Trust does not win the auction, the Trust will be reimbursed fees and expenses of $540k.
4) Perhaps most importantly, the auction allows for separate bids for the VLT and bingo business
Gametech has consistently accused the Trust of valuing only the bingo business, and the Trust has relatively freely admitted that they are only interested in the bingo business. So the ability to separately bid for the two businesses is huge and should allow for maximum recovery to the equity.
The company had $16.5m in bank loan outstanding at their last balance sheet, and the company is currently projecting for a full draw on the DIP loan. Thus, the bid values the company at an EV of $19m w/ no current recovery for the equity.
However, there’s reason to believe there is significant potential upside in the auction.
First, Kinetic advisors has estimated an EV for the company at between $24-29m as of August 1st. Assuming a full draw on the DIP facility and net of the bank loan, these would result in a recovery for equity of $5-10m. With a bit less than 11.85m shares outstanding, this would result in a recovery between $0.42-0.85 per share, or 2.4-5x today’s share price.
Second, there appear to be multiple parties interested in acquiring Gametech’s assets. Outside of the party Gametech mentions in their initial filing as offering a superior merger agreement, there were multiple parties interested in providing Gametech with a DIP loan, and the ability to bid separately for the two lines of businesses will allow competitors to bid for the parts of Gametech that they covet most (and thus assign the highest multiple).
Speaking of competitors bidding, there appears to be significant synergies possible between Gametech’s business and a competitor in a merger. SG&A costs run over 40% of sales, and Gametech has the largest distribution system in the bingo market and an extensive distribution system in the southeast in the VLT market. Both business likely offer high synergy potential in a merger, as a competitor could both cut out costs and increase sales by pushing their products through the distribution network.
To put it in perspective, assuming a competitor could cut out 10% of SG&A in a merger, that would result in $1.4m in increased EBIT. At a 10x multiple, the value of that synergy alone is almost worth the full of the bank loan.
Finally, an analysis of past acquisition multiples suggests significant upside. Gametech acquired the VLT business for ~1.6x trailing sales in 2006, and the Trust acquired Fortunet, another bingo equipment company, for 1.55x sales in 2009.
It is true that Fortunet was in a stronger financial position than Gametech, but that appears to be countered by the fact that the Trust already controlled a majority position in Fortunet and thus was the most likely buyer for the business (and didn’t have to engage in an auction) and that 2009 was a much rougher economy than today’s. Gametech’s distribution and competitive positioning is also much stronger than Fortunet, again suggesting that Gametech should command at least a similar multiple.
Trailing twelve months sales for Gametech come in at ~$30m, and the company is projecting similar sales for the next twelve months before rapidly growing revenue after that. Assuming a potential bid of 1-1.5x sales would give an implied EV of ~$30-45m, which would result in a recovery of $11m, or almost $1.00 per share, on the low end.
The potential for these high bids is backed up by one more thing: significant upside potential from the business recovering.
Again, Gametech believes their sales rebound has been hindered by an inability to invest in assets due to their high debt load. Gametechs bingo business alone did $50m in sales both 2005-2006, and $7m in EBIT in 2006. The combined VLT/bingo business did almost $60m in sales and $9m in EBIT in 2007. If having a clean balance sheet allows a potential acquirer to achieve anything close to that level of profitability, the acquisition would look like a steal even without potential synergies.
The other thing that argues for a decent recovery and strong auction process is the timeline. Gametech’s financial advisor has already been contacting potential interested parties for a month, and the stalking horse bid provides potential bidders till September 7th to submit their qualified bids. After that, the auction will happen on September 19th. Given how long the gap is between the bankruptcy filing, the announcement of the stalking horse, the qualified bid, and the auction, it appears the courts are gearing up for multiple parties to participate in the auction and providing themselves with enough time to sort through everything.
With multiple parties interested in bidding, it doesn’t take much of an increase to result in significant recovery for the equity. Again, the current stalking horse bid results in all debt being paid down but basically nothing for the equity. However, any increases over the stalking horse go straight to equity, and Gametech’s significant leverage means even small changes in the bid level would result in recovery substantially higher than today’s prices.
The Trust appears to have prepared for substantial interest in Gametech’s assets as well. Their breakup fee + expenses of $560k is pretty significant relative to an implied EV <$20m. However, it appears that the break-up fee will not apply if the Trust wins Gametech’s bingo business and someone else wins the VLT business. Thus, the Trust has stacked the odds in their favor on the bingo business, but we could see very active bidding on the VLT business.
Given the Trust has stated that they are only interested in the bingo business, and Gametech believes the Trust’s bid only values the bingo business, it seems most likely that the Trust applies the full value of the DIP loan + bank loan to the bingo business bid, and then uses the break-up fee to try ward off potential competitors. Competitors can compete freely over the VLT business, and any bids would flow straight through to equity. If the VLT business is valued at just 1x sales, that would result in recovery of ~$5m, which fits nicely with several of the early recovery estimates and would result in $0.42 per share.
There should be even further upside from there, as the Trust would acquire the Bingo segment at ~0.75x sales in this scenario, and such a low multiple should attract competing bids despite the high break up fee.
Obviously, this is a risky situation, and there is a chance of no bidders emerging. But there are plenty of indications that there will be an active bidding process, and the substantial upside of the equity from a potential bidding war more than outweighs the downside.Given the tight time frame and substantial upside make, Gametech is a very attractive offering at today’s price.
Disclosure- Long GMTCQ, AGUNF, CAGAQ
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