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Light & Wonder (NASDAQ:LNW) Reports Upbeat Q4


Full Report / February 27, 2024

Gaming products and services provider Light & Wonder (NASDAQ:LNW) reported Q4 FY2023 results topping analysts' expectations, with revenue up 12.9% year on year to $770 million. It made a GAAP profit of $0.73 per share, improving from its profit of $0.32 per share in the same quarter last year.

Light & Wonder (LNW) Q4 FY2023 Highlights:

  • Revenue: $770 million vs analyst estimates of $744.1 million (3.5% beat)
  • EPS: $0.73 vs analyst estimates of $0.41 (76.8% beat)
  • Free Cash Flow of $70 million, down 47.8% from the previous quarter
  • Gross Margin (GAAP): 69.5%, down from 84.5% in the same quarter last year
  • Market Capitalization: $8.54 billion

With names as crazy as Ultimate Fire Link Power 4 for its products, Light & Wonder (NASDAQ:LNW) is a gaming company supplying the casino industry with slot machines, table games, and digital games.

The company is known for its immersive slot machines with massive LED screens and vibrant colors. Combined with its other offerings, including mobile games developed by SciPlay (a company it acquired in 2023), Light & Wonder caters to both the physical and online gaming markets (iGaming).

Light & Wonder generates revenue through the one-off sales and leasing of gaming hardware to casinos, lottery services, and fees associated with its mobile gaming solutions. Its leased hardware products have a particularly unique business model, where it has revenue share agreements with casinos based on how much money a machine wins per day.

Generally, casino customers are free to place their leased machines wherever they'd like on the casino floor and can remove them if they underperform, meaning Light & Wonder would generate no revenue from its revenue share agreement. To mitigate this risk, the company will occasionally pay placement fees to casinos to guarantee a spot on the floor for a designated period, typically a few years.

Casinos and Gaming

Casino and gaming companies that offer slot machines, Texas Hold ‘Em, Blackjack and the like can enjoy limited competition because gambling is a highly regulated industry. These companies can also enjoy healthy margins and profits-have you ever heard the phrase ‘the house always wins’? Regulation cuts both ways, however, and casino and gaming companies may face stroke-of-the-pen risk that suddenly limits what they do or where they can do it. Furthermore, digitization is changing the game, pun intended. Whether it’s online poker or sports betting on your smartphone, innovation is forcing casino and gaming companies to adapt to keep up with changing consumer preferences such as being able to wager anywhere on demand.

Sales Growth

A company’s long-term performance can give signals about its business quality. Even a bad business can shine for one or two quarters, but a top-tier one may grow for years. Light & Wonder's revenue declined over the last five years, dropping 2.9% annually. Light & Wonder Total RevenueWithin consumer discretionary, product cycles are short and revenue can be hit-driven due to rapidly changing trends. That's why we also follow short-term performance. Light & Wonder's annualized revenue growth of 16.1% over the last two years is a reversal from its five-year trend, suggesting some bright spots.

We can better understand the company's revenue dynamics by analyzing its most important segment, Gaming. Over the last two years, Light & Wonder's Gaming revenue (slot machines, casino games) averaged 19.5% year-on-year growth. This segment has outperformed its total sales during the same period, lifting the company's performance.

This quarter, Light & Wonder reported robust year-on-year revenue growth of 12.9%, and its $770 million of revenue exceeded Wall Street's estimates by 3.5%. Looking ahead, Wall Street expects sales to grow 7% over the next 12 months, a deceleration from this quarter.

Operating Margin

Operating margin is a key measure of profitability. Think of it as net income–the bottom line–excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Light & Wonder has managed its expenses well over the last two years. It's demonstrated solid profitability for a consumer discretionary business, producing an average operating margin of 14.6%. Light & Wonder Operating Margin (GAAP)

This quarter, Light & Wonder generated an operating profit margin of 20.1%, up 5.6 percentage points year on year.

Over the next 12 months, Wall Street expects Light & Wonder to become more profitable. Analysts are expecting the company’s LTM operating margin of 17.8% to rise to 22.6%.

EPS

We track long-term historical earnings per share (EPS) growth for the same reason as long-term revenue growth. Compared to revenue, however, EPS highlights whether a company's growth was profitable. Light & Wonder EPS (GAAP)

Over the last five years, Light & Wonder cut its earnings losses and improved its EPS by 24% each year. This performance is materially higher than its 2.9% annualized revenue declines over the same period. There are a few reasons for this, and understanding why can shed light on its fundamentals.

A five-year view shows that Light & Wonder has repurchased its stock, shrinking its share count by 1.5%. This has led to higher per share earnings. Taxes and interest expenses can also affect EPS growth, but they don't tell us as much about a company's fundamentals.

In Q4, Light & Wonder reported EPS at $0.73, up from $0.32 in the same quarter a year ago. This print beat analysts' estimates by 76.8%. Over the next 12 months, Wall Street expects Light & Wonder to grow its earnings. Analysts are projecting its LTM EPS of $1.77 to climb by 104% to $3.59.

Cash Is King

Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.

While Light & Wonder posted positive free cash flow this quarter, the broader story hasn't been so clean. Over the last two years, Light & Wonder's demanding reinvestments to stay relevant with consumers have drained company resources. Its free cash flow margin has been among the worst in the consumer discretionary sector, averaging negative 5.3%.

Light & Wonder Free Cash Flow Margin

Light & Wonder's free cash flow came in at $70 million in Q4, equivalent to a 9.1% margin. This result was great for the business as it flipped from cash flow negative in the same quarter last year to cash flow positive this quarter.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money the business raised (debt and equity).

Light & Wonder's five-year average return on invested capital was 6.3%, somewhat low compared to the best consumer discretionary companies that pump out 25%+. Its returns suggest it historically did a subpar job investing in profitable business initiatives.

The trend in its ROIC, however, is often what surprises the market and drives the stock price. Over the last two years, Light & Wonder's ROIC averaged 5.4 percentage point increases each year. This is a good sign and we hope the company can continue to improving.

Key Takeaways from Light & Wonder's Q4 Results

We were impressed by how significantly Light & Wonder blew past analysts' EPS expectations this quarter. We were also excited its revenue outperformed Wall Street's estimates, driven by outperformance in its gaming segment ($496 million of revenue vs estimates of $470 million). On the other hand, its free cash flow fell short.

Light & Wonder noted its merger integration with SciPlay, an iGaming company it acquired in October 2023, is now complete. This is a good sign as it enables the company to achieve synergies faster. 

Overall, we think this was a decent quarter. The stock is flat after reporting and currently trades at $97.57 per share.

Is Now The Time?

Light & Wonder may have had a fine quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for all companies serving consumers, but in the case of Light & Wonder, we'll be cheering from the sidelines. Its revenue has declined over the last five years, but at least growth is expected to increase in the short term. And while its projected EPS for the next year implies the company's fundamentals will improve, the downside is its cash burn raises the question of whether it can sustainably maintain growth. On top of that, its relatively low ROIC suggests it has historically struggled to find compelling business opportunities.

Light & Wonder's price-to-earnings ratio based on the next 12 months is 26.8x. While the price is reasonable and there are some things to like about Light & Wonder, we think there are better opportunities elsewhere in the market right now.

Wall Street analysts covering the company had a one-year price target of $100.22 per share right before these results (compared to the current share price of $97.57).

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