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Antitrust Probe For IGT, Anchor Deal Possible

10 July 2001

by David Strow

LAS VEGAS, Nevada – July 10, 2001 –In simple terms of market share, International Game Technology won't be getting much bigger after acquiring Anchor Gaming.

IGT is currently estimated to control about 70 percent of the North American slot machine market. Put in other terms, about 420,000 of the 600,000 slots in the United States and Canada were manufactured by IGT.

Anchor Gaming, by comparison, has a market share of about 18,000 machines; 15,000 of them owned by a joint venture between Anchor and IGT, and already typically included under IGT's market share umbrella. Outside of the joint venture, Anchor has about one-half of 1 percent of the U.S. slot market -- and that portion has been shrinking over the past year.

But there's a key reason IGT is willing to pay more than $1.3 billion for Anchor, as it announced Sunday it will do. Anchor produces roughly $200 million a year in annual cash flow, almost half the amount produced by IGT each year. That means the financially powerful IGT is about to get a lot stronger -- and make life potentially a lot tougher for its competitors.

"You're running out of entries (in the slot machine manufacturers' market)," said Dave Ehlers, chairman of Las Vegas Investment Advisors. "There's no question that such a deal is going to make IGT more powerful. I think they (IGT's competitors) have got their work cut out for them."

Whether that will be enough to prompt federal and state gaming officials to intervene isn't clear, though some in the gaming industry speculate privately that one or more of IGT's competitors might protest the deal on antitrust grounds.

"It's something we'll look at closely, because at some point, you have that million-dollar question of, 'When does it (IGT) become too big to be anti-competitive?"' said Dennis Neilander, chairman of the Nevada Gaming Control Board. "I would not be surprised if the feds take a look at this as well."

IGT is arguing the deal won't result in undue market concentration, as most of the Anchor machines on the market are already part of the Anchor-IGT partnership. Many believe it will be an effective argument.

"This isn't a merger of IGT and Aristocrat (Leisure Ltd.), Konami (Gaming Inc.) or Bally (Gaming & Systems, a division of Alliance Gaming Corp.)," said Shannon Bybee, executive director of UNLV's International Gaming Institute. "Those would raise more difficult issues at the federal level, I would think. Anchor wasn't a big player in the sale of machines. They were more of a subsector in the vendor market, as opposed to a general supplier of gaming machines."

In terms of market share, IGT's closest competitors are WMS Gaming, with 10 percent to 15 percent of the U.S. market; and Alliance Gaming Corp.'s Bally Gaming & Systems, estimated to have 8 percent to 12 percent of the market. Anchor, Mikohn Gaming Corp., Shuffle Master Inc. and Acres Gaming Inc. are all players in the slot market, but their share is well below the top three.

But IGT faces two new powerful competitors -- Aristocrat, an Australian-based slot maker, and Konami, whose parent company is based in Japan. Both companies recently received licenses to provide slot machines to Nevada casinos, and both are well-capitalized, capable competitors who have made strides in overseas markets. And Aristocrat stepped up its U.S. presence earlier this month by acquiring Casino Data Systems of Las Vegas for $180.5 million.

"What IGT has going for them is that strong entrants have been coming into the market, which shows the (slot machine) market isn't closed," Bybee said.

Neilander also noted that IGT has historical precedent on its side.

"Fifteen years ago, Bally had more than 90 percent of the market, and IGT ultimately wrestled it away from them," Neilander said. "I imagine IGT will say, 'Let the market work."'

But do the smaller slot makers need to consider their own mergers to defend their turf against a more powerful IGT? There's disagreement on Wall Street about whether that will happen.

"If you look at the position IGT is in now, there's a lot of potential benefit to acquisitions by some of these other companies," said Adam Steinberg, gaming analyst with CIBC World Markets. Steinberg sees Konami and Aristocrat as the most likely acquirers, and WMS and Alliance as companies that could be either buyers or sellers.

"IGT was so far ahead to begin with that I don't think this increment matters," said David Anders, gaming analyst with Merrill Lynch. "They should have been trying to catch up with IGT anyway. I don't think this announcement will be the catalyst."

Others believe even the smallest companies can still compete effectively.

"The reality of the slot manufacturing industry is that if you have a hot game, you can be successful," said Steven Kent, gaming analyst with Goldman Sachs. "I'm not sure it makes that much sense for consolidation in that group ... (because) one hot theme can really turn things around."

For Anchor and IGT, that theme had been "Wheel of Fortune." As of March 31, the Anchor-IGT joint venture had 11,550 Wheel of Fortune machines installed across North America, and an additional 1,300 "I Dream of Jeannie" slots. In total, the joint venture had 15,400 slot machines installed as of March 31, a 50 percent increase in one year.

The venture is quite profitable as well -- over the nine months ending March 31, the joint venture produced $196.5 million in net income on $341.1 million in revenues. Revenues rose 41 percent, while net income rose 50 percent.

But Anchor indicated in financial reports that, outside of its venture with IGT, the number of gaming machines it has installed across the U.S. has been on the wane.

Despite a 120 percent run-up in Anchor's stock price in the past year, it's been a bumpy year financially for Anchor outside of the joint venture. Over the nine months ending March 31, the company posted a net loss of $70.3 million, compared to net income of $47.1 million in the year-ago period. Revenues edged up 3 percent to $389.9 million, thanks to strong sales through the joint venture.

While gaming machine revenues rose 22 percent to $138.5 million over the nine month period, gaming operation revenues -- that is, revenues from Anchor's Colorado casinos and the newly opened Pala Casino near San Diego, which Anchor manages -- fell 10 percent to $124.4 million. Gaming system (lottery equipment) revenues were essentially flat at $128.7 million.

The heavy loss was primarily the result of a $111 million non-cash "impairment charge" taken during the March 31 quarter, as Anchor restructured and reduced the book value of its lottery equipment subsidiary, AWI. Two issues prompted the move -- one, a decision that AWI would not be awarded two European contracts the company previously thought it would receive; and two, a February ruling that AWI's contract with the Florida Lottery was null and void.

Anchor acquired its online lottery operations when it bought Powerhouse Technologies Inc. of Atlanta in 1999 for $280 million. Most of the impairment charge came from writing down goodwill associated with the Powerhouse purchase. Another $7.9 million charge was taken to reduce the value of its Montana slot route, which Anchor has been trying to sell.

Still, some believe those business lines will get a big boost under IGT.

"With potential new international lotteries and contracts coming up for renewal, with IGT's stronger balance sheet, there's a stronger possibility of IGT getting those (contracts) now," Steinberg said.

Anchor's debt load also increased substantially over the last 12 months. The company had $222.8 million in debt as of March 31, 2000 -- one year later, that debt had risen to $429.7 million.

Prior to the announcement, Moody's Investors Service had a Ba3 issuer rating assigned to Anchor -- a rating class defined as providing creditors "questionable financial security" -- while Standard & Poor's has a similar "BB-minus" corporate credit rating assigned to the company. With news of the IGT buyout, Moody's and Standard & Poor's immediately placed Anchor on review for a possible credit upgrade.

But while IGT has a stronger credit rating, it isn't that much stronger -- Moody's has IGT rated at Ba1, and confirmed these ratings Monday. S&P placed IGT's "BB-plus" corporate credit rating on review for possible upgrade.

"Anchor Gaming under Stan Fulton (its retired chairman) always eschewed debt and held onto as much cash as possible," Ehlers said. "Since the Powerhouse transaction, things changed substantially. There have been significant impairment losses, and a substantial incurment of debt."

Much of that debt, however, was incurred when Fulton retired from the company in September 2000. When Fulton retired, Anchor acquired the Fulton family's 4.6 million shares -- about 39 percent of its outstanding stock -- for $306 million.

To fund the transaction, Anchor issued $250 million in bonds last October, and increased its credit line from $300 million to $325 million. Fulton also received $66 million in promissory notes from Anchor, but these were cancelled when Fulton acquired Anchor's 25 percent stake in the Sunland Park Racetrack and Casino in New Mexico.

And Fulton's departure, some observers say, was the event that finally opened the door for an Anchor-IGT marriage after years of courtship.

"Once Stan Fulton sold his interest in the company, the door was open for senior management to negotiate with IGT," said Deutsche Banc Alex. Brown gaming analyst Andrew Zarnett. "Then it was only a matter of time before a deal was consummated."

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