The Gaming Operations Market

Last month I discussed the competitive world of gaming equipment suppliers and how volatile both the size of the outright sales market and the size of each supplier’s respective share have been over the last decade. There is, of course, another major segment most gaming suppliers compete in. In many respects, the rewards for successfully competing in this segment are huge. But get it wrong, and it can be very costly. This segment is commonly referred to by equipment suppliers as “gaming operations.”

The gaming operations segment is entered when the equipment supplier retains ownership of the machine and “leases” the product to casinos instead of selling it. Pricing models vary, but suppliers normally charge a percentage of net win, or in some cases, a fixed fee per day. This is typically the casino operators’ least favored model for slot machine acquisition. Casino operators prefer to purchase machines and depreciate them over a multi-year period, as opposed to indefinitely having to share revenue with suppliers.

There are, however, obvious advantages of this model for casinos. In the current economy, where casino capital expenditure budgets are very tight (or even non-existent), this model allows operators to offer the latest premium games to players without having to stump up a large amount of capital. There is also another important benefit, and that is guaranteed game performance. If the product works, it stays on the floor. If it doesn’t, the casino operator only needs to make a phone call to request that machine be removed or replaced.

The Gaming Operations Market
The gaming operations market for suppliers is complex and comprises not only traditional casino slots, but also lottery and centrally determined products. Not all companies provide detailed breakdowns of their installed base, making meaningful comparisons challenging. However, this is what we do know: the top three U.S. suppliers (IGT, WMS and Bally) have all been very focused on this segment within their businesses. This business segment represents a significant, and in many cases growing, portion of their total revenues. This is demonstrated in Chart 1, which shows that gaming operations, expressed as a percentage of total revenue, have been increasing since 2007. Today, gaming operations represents just under half of the total combined revenues of the top three equipment suppliers, up from 45 percent in 2007, as demonstrated in Chart 2.

Chart 1: Gaming Operations as a Percentage of Total Revenue
Chart 1: Gaming Operations as a Percentage of Total Revenue

Chart 2: Top Three Suppliers’ Gaming Operations as a Percentage of Total Revenue
Chart 2: Top Three Suppliers’ Gaming Operations as a Percentage of Total Revenue

Despite gaming operations revenue now representing a higher proportion of total supplier revenue, the total amount of revenue derived from this segment has actually been on the decline since 2008. (See Chart 3.) This decline is the result of a number of factors, including casino players spending less of gaming given the current economic crisis, competitive pressure driving down prices charged by suppliers, and a concerted effort by casino operators to reduce their gaming operations footprint as well as lower their revenue share costs.
Chart 3: Total Gaming Operations Revenue
Chart 3: Total Gaming Operations Revenue

The total number of machines in North America reported as “gaming operations” by equipment suppliers as of June 2012 was approximately 140,000. This is an increase of 7.5 percent from the estimated number of gaming operation machines reported in 2007. This low growth rate is concerning, especially when you consider all the new casinos that have opened between 2007 and today. I estimate that between 2007 and June 2012, approximately (and coincidentally) 140,000 new machines were installed in new or expanded venues. Given the absence of reported data, we cannot be certain how many of those new machines were sold versus leased, but the trend does suggest that either the legacy (existing) base of gaming operations machines has steadily declined over that five-year period or the number of gaming operation products being placed on new casino floors is significantly lower than historical rates. The most likely scenario is a combination of both.

The small growth in the gaming operations installed base does strike down one possibility that suppliers were hoping would turn into reality: that the economic crisis would encourage operators to be more accepting of the gaming operations model and therefore increase their overall gaming operations representation on the casino floor. It has not happened, and in fact, it appears that had it not been for new casino openings, the gaming operations installed base would have declined.

Revenues from gaming operations are considered by many to be higher quality earnings. This revenue stream is certainly much less volatile and is not subjected to the wild quarterly sales movements associated with outright unit sales. The model is attractive to suppliers, as revenue is recurring as long as the product performs. However, the costs associated with this model are also high. A significant portion of suppliers’ R&D budgets are associated with the development of premium gaming operations products. In addition to R&D expenditure, there are also costs relating to large (and sometimes complex) signage packages, high-end premium chairs, license fees associated with branded or themed games, ongoing servicing, jackpot funding, and of course, the cost of the machine itself.

In summary, this particular business segment has become more challenging for suppliers. It is highly competitive and capital intensive, and it consumes a significant portion of suppliers’ R&D budgets. The last five years of data also suggest that although the installed base of gaming operations products grew slightly over that period, the total revenue size of this market has actually declined. Nevertheless, this segment remains more than ever a critical one for suppliers, as it now represents close to 50 percent of their total combined industry revenues, and as it is a segment that Wall Street puts a premium on.

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