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Analysts Bullish on IGT, WMS

17 July 2001

by David Strow

LAS VEGAS, Nevada – July 17, 2001 --Deutsche Banc Alex. Brown gaming analyst Mark Mutkoski has initiated coverage of International Game Technology and WMS Industries Inc., assigning the two slot machine manufacturers a buy rating.

Mutkoski noted that demand for new slots should begin to slow in 2002 because of a lack of new casinos, but said IGT and WMS were best positioned to ride through this period because of their reliance on "revenue-participation" slots, which produce recurring revenues. Both companies produce 40 percent to 60 percent of their revenues from such machines, giving IGT and WMS much more stable earnings, Mutkoski said.

Mutkoski estimated IGT will produce $421 million in cash flow in 2001, rising to $462 million in 2002. He set a 12-month target of $68 -- a 16.6 percent premium over current levels -- based on the stock trading at 21 times its 2002 earnings estimate of $3.25 per share.

Though noting that manufacturers' stock prices should begin to peak in coming months, Mutkoski said IGT's plans to acquire Anchor Gaming Inc. for $1.37 billion prompted him to be more bullish on the stock. With Anchor's cash flows, IGT should be able to maintain earnings growth of more than 20 percent through 2002, and possibly in 2003, Mutkoski wrote. IGT should also benefit from the expansion of California gaming, cashless slot machines, strong management, favorable joint ventures and a strong balance sheet, he said.

"We believe IGT's healthy, near investment-grade balance sheet will allow the company to consider acquisition opportunities over the next few years beyond its pending acquisition of Anchor Gaming," Mutkoski wrote.

A potential risk is growing competition in the slot manufacturing industry, particularly from WMS, Alliance Gaming Corp. and Aristocrat Leisure, Mutkoski said. However, the company has the deepest pipeline of future products in its history going forward, he said.

At WMS, Mutkoski is projecting 2001 cash flow of $100 million, rising to $116 million in 2002. He set a 12-month price target of $33, a 31 percent premium over current levels, based on the stock trading at 17 times its 2002 earnings estimate of $1.93 per share.

Mutkoski based his buy rating on WMS's growing market share, its strong line of video slot machines, the strong performance of WMS' "Monopoly" product line, and the attractive valuation of its stock compared to other slot manufacturers. Earnings growth should be driven by increased sales, particularly in California, and the placement of new participation slots.

"We believe that the recently announced merger between IGT and Anchor Gaming may lead WMS to make an acquisition sooner than later," Mutkoski wrote. "The combined IGT-Anchor entity will have an even strong (research) team and product portfolio, which we believe may place some added pressure on WMS."

However, Mutkoski said WMS may wait to strike a deal until smaller manufacturer stocks have declined somewhat from the historic highs they reached in recent months.

Separately, gaming analyst Damon Brundage of Raymond James has re-initiated coverage of Station Casinos Inc., assigning a "market perform" rating to the Las Vegas company's stock.

Brundage set no price target for Station, but projected cash flow of $250 million in 2001 and $270 million in 2002. He set earnings estimates of 85 cents in 2001 and $1.05 in 2002 -- equal to $49 million in 2001 net income and $60.6 million in 2002. The stock currently trades at a multiple of 7.5 times 2001 cash flow, a fair valuation when compared to other gaming companies, he said.

Brundage called Station a "play on the health of the Las Vegas locals market," noting that the company now controls 50 percent of the locals market. However, "the near-term economic outlook for Las Vegas and, hence, for levels of play by Las Vegas locals, is not clear," Brundage wrote.

"With U.S. economic growth slowing, unemployment rising and consumer confidence waning, we would not be surprised if economic growth slowed and unemployment rose in Clark County during the next six to 12 months," Brundage wrote.

This could lead Station's customers to reduce their visits and their bets, and could also force Station to become more aggressive in its promotional offers. "Neither of these developments would necessarily bode well for profitability," Brundage said.

In another ratings action, Merrill Lynch gaming analyst David Anders upgraded Phoenix-based Aztar Corp. from neutral to accumulate, following stronger-than-expected earnings for the second quarter of 2001. Anders set a $15 price target, a 15 percent premium over current levels.

Anders said "outstanding expense control" at Aztar made him more confident in future earnings estimates, and noted the company had "an attractive long-term growth opportunity" with its expansion of the Atlantic City Tropicana. Aztar is building a $225 million, 500-room hotel tower there, with a spring 2003 completion date.

Further, Anders noted, Aztar "is getting virtually no credit for its outstanding real estate position on the Las Vegas Strip." Aztar owns and operates the Las Vegas Tropicana.

The company's 2001 earnings estimate was raised from $1.18 to $1.26 per share ($49 million in net income) and from $1.36 to $1.39 per share ($54 million in net income) in 2002.

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