GPIC continues to dominate the casino chip market worldwide, and will benefit from the explosive growth in gambling in Asia.

The economics of this business are solid, as GPIC’s products are ‘sticky.’ Consider:

– all new casinos need chips

– casino chips must eventually be replaced

– most casinos will tend to stick with a sole supplier for their replacements.

This also allows for cross-sell opportunities among the company’s other product segments.

While the business will generally be variable due to the timing of new casino openings, GPIC has maintained profitability and just reported much improved results for the fourth quarter and 2010 fiscal year.

Financial Information

For the fourth quarter of fiscal 2010, revenues increased 5% to $16.6m compared to $15.8m in 2009. Net income for the quarter came in at $1m or $0.12 per share, compared to $1.7m or $0.21 per share in the previous year.

Full-year revenues jumped 20.9% to $59.9m, driven primarily by the record-breaking third quarter, which coincided with several major casino openings in the U.S. market.

The company benefited from improved gross margin, increasing from 32.1% to 36.2%, as the company’s product mix shifted towards higher-margin Paulson chips and plaques/jetons (which carry a much higher price point: $3 – $20 for these European-style chips compared to $1 – $5 range for normal chips).

With this momentum, reported EBIT was $6.4m, up significantly from the 2009 figure of $1.2m, a number which was negatively affected by a $1.5m goodwill impairment charge.

Net income for the full year was $4.4m, translating into EPS of $0.54.

Balance Sheet

While company appears undervalued on an earnings basis, the balance sheet is a key part of the investment thesis.

Book value has increased every year since 2006, and the company now sits on $29.7m in cash and marketable securities. Of this amount, $18.1m is held overseas by GPI SAS, with the balance of $11.7m at GPI USA.

Even if the $18.1m overseas cannot be returned to the U.S. because of tax implications, there still remains significant excess cash in the U.S. operations, while still allowing the company to reinvest money back into the business on the international side (where much of the growth is coming from).

The company has paid dividends in 3 out of the last 5 years, with the most recent announcement in Dec 2010 for a special dividend of $1.5m, or $0.1825 per share.

In an unusual transaction, the company actually borrowed the money in order to pay this dividend, with the loan secured by certificates of deposit due later in the year. The details:

“In December 2010, GPI SAS borrowed 5.0 million euros (approximately $6.7 million in December 2010) to be repaid by July 2011 without prepayment penalty and at an interest rate equal to 50 basis points over the three-month Euro Interbank Offered Rate (EURIBOR). We incurred this debt to fund the payment of the $6.6 million dividend to GPIC in order to avoid liquidating higher yielding marketable securities.”

I applaud this move as a creative way to return cash to shareholders in 2010 without prematurely sacrificing returns on existing investments.

Growth Opportunities

If you’ve read my background, you might be able to guess that I’m very bullish on the prospects for casinos and gambling in general. China’s middle class is exploding – with tens of millions of people with newfound wealth, with gambling just one of the possible (but proven) outlets.

In December 2010, the company announced the creation of GPI Asia, in order to market existing product lines in this white-hot market.

Meanwhile, many states in the U.S. are stuck with gigantic budget deficits and are increasingly turning towards gambling as a way to raise additional tax money.

A few examples:

• States Continue to Feel Recession’s Impact
• A new proposal could bring five mega casinos to Florida
• Casino Gambling Mulled to Help Close Texas State Budget Gap

As the number one player in the casino chip market – and with an exclusive license in the U.S. for RFID technology for at least the next few years – GPIC is uniquely positioned to capitalize on this growth.

Valuation

Recent results do not materially change my original valuation estimate, as the stock still appears undervalued based on current and future earnings.

Even with the most conservative assumptions for DCF and EPV, I find it hard to come up with a value less than $8-9 per share.

At current prices, the stock is trading at with an EV/EBIT multiple of 5.3x and EV/FCF of 6.5x.

Compare 2010 financial results to 2006:

2010 financials are roughly 20% lower than 2006’s record year, yet the company’s current enterprise value is 75% lower than in 2006, when the stock price was almost $18 per share.

Conclusion

2010 was definitely a great year, arguably the second-best in the company’s history, and yet the stock trades at one of the lowest multiples in its history.

This is despite the fact that the business is earning double digit returns on equity, to go along with average ROIC and CROIC of 17.7% and 24.4% respectively (the business is cyclical however, so short-term results can swing wildly).

The company has grown book value by 11% annually for the last ten years, and now sits on a significant cash balance that can fund additional growth or used to reward shareholders in the form of dividends or buybacks.

Going forward, I see two positive outcomes:

– Mr. Market reawakens and values GPIC at a more appropriate multiple

– The company returns some of the excess cash to shareholders if management cannot find a way to reinvest it at a satisfactory rate of return

The recent purchase of GPIC’s injection mold supplier – while not material – seems to be a good move to consolidate the supply chain and shows that management is looking for ways to utilize this excess cash.

Meanwhile, the appetite for casino gambling will only grow – and the market for casino chips along with it.

Check out my original post on Gaming Partners International (GPIC.OB), as it contains much of the background information on the company.

Disclosure

Long GPIC

It is taken for granted in today’s world, but back in the early to mid 1980’s, I’m sure the idea of wireless modems was truly revolutionary.

Tom Kirchner, the founder and still-CEO of Electronic Systems Technology (ELST.OB) saw the future of telephone modems and struck out on his own.

Kirchner set up shop with 2 colleagues (Kirchner was the only full-time employee at the start), and joined with a local manufacturer who offered the group free office space.

As with all start-ups, the new company eventually needed more capital to test their prototypes:

“So they had office space and a manufacturer, but they still lacked the capital they needed to test their prototypes as they went through development, which is not inexpensive, Kirchner said.

In addition, at the time Hanford was shuttering N-Reactor, people were being laid off and the outlook in the Tri-Cities was not rosy. That’s when Kelso Gillenwater, who was the Tri-City Herald publisher at the time, contacted the men. Kirchner said Gillenwater was looking for positive stories for the newspaper, and felt that three men striking out on their own fit the bill.

Kirchner said the stories the newspaper did on the trio helped the men attract the attention of a group that would ultimately help them raise the money to make a go of it. The people in charge of the Spokane Stock Exchange, which at the time focused mainly on mining stocks, were looking to diversify their offerings and felt the wireless modem was a good fit.

The two-year-old company went public and was able to raise nearly $1 million through their investors. That money was instantly put into buying test equipment and helped pay for the creation of the company’s prototypes, which took about a year.”

After four long years, in 1986 the company launched their first offering, a wireless modem that retailed for $1,100, a serious chunk of money back in the late 1980s.

Eventually, ELST found a niche market selling to certain large companies, municipalities, and government agencies who need to create their own wireless networks, and continues to offer the ESTeem wireless modem product lines direct from the Kennewick facility.

A great story – read the rest of the article.

Disclosure

Long ELST

As usual, a few of the best value investing links from the past two weeks:

Alpha Pro-Tech (APT)

Alpha Pro-Tech (APT) stock has been on a tough run over the past several weeks as reported earnings continue to be rough.

These results were somewhat expected, as the company benefited from a one-time spike in revenue in 2009 that was unlikely to be repeated – Mr. Market often overreacts in such situations.

APT’s sales mix has shifted towards the lower-margin Building Supply segment, but as Barel writes, sales in this division have quadrupled since 2007, and management seems bullish on new product lines and future growth.

Assign a 10x multiple to this segment alone (and add back the net cash balance), and the stock price appears to be throwing in the other two high-margin divisions for free!

USA Mobility (USMO)

USMO is a stock that seems to appear on many of quantitative value investing screens – and has for many months – as the stock appears to be cheap based on most valuation metrics.

USMO sells pagers and the market doesn’t seem very keen on the business’s future prospects (hard to blame the market – it’s amazing that a profitable business still exists in this market with all of the other technology available).

Yet this dynamic may provide an opportunity, as the company continues to throw off impressive amounts of cash despite the decline in sales.

However, the recently announced $160m acquisition of Amcon Software completely changes the game, as USMO will lose much of the downside protection built into a solid balance sheet.

Arden Group (ARDNA)

Arden operates a number of Gelson’s supermarkets, a high-end full-service grocery store chain, throughout Southern California.

The business has produced steady profits in the past seven years, and the business model produces extremely high profit margins (ARDNA’s net margins are around 5%, compared to a company like Whole Foods at only 2%).

On the negative side, management has no plans to expand the current store base – meaning the potential for growth is extremely limited – and eventually competition seems poised to put pressure on margins.

Read the comments for a further quality discussion.

CSS Industries (CSS)

An impressive value investing blog that I’ve been following for a few months, Tenoeight makes a case for CSS Industries, a small-cap manufacturer of gift wrap, cards, and other seasonal items.

The stock trades right around net asset value despite earning positive free cash flow in each of the past ten years. At current prices, the average free cash flow per share works out to a FCF yield of more than 20%.

Management seems to be making the right moves in closing down its U.S. manufacturing plants and sourcing many of their products overseas, but the industry is very competitive and two retailers account for 36% of sales.

However, the stock pays a nice dividend and management has shown that it’s willing to repurchase shares, making for an interesting play.

Suggestions

If you have suggestions for detailed analysis examples from other value investors, please drop me a line using the Contact Form.

I’m always open to ideas from other investors, especially for a thoughtful and well-researched investment articles.

Disclosure

No positions.