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Is Scientific Games taking on too much Debt?

Scientific Games (SGMS) is trading near 52 week highs and in the last 5 trading sessions has traded as high as $43.90. Much of the company growth has occurred through leveraged buy outs in a hope to gain market dominance in the gaming industry. Some of these acquisitions include Williams Gaming (WMS), Bally Technologies (BYI), and newly announced NYX Gaming (NYX:CA).

Scientific Games currently has $8.1 billion in debt on their balance sheet and with the proposed takeover of NYX Gaming more debt could be coming. Look no further than the pharmaceutical industry and investors can be reminded of the problems some companies face when aggressive acquisitions are funded using debt. Concordia International (CXRX) and Valeant Pharmaceutical (VRX) are two companies who come to mind which have fallen victim. Could Scientific Games share the same faith as these once highly sought after stocks?

It appears Scientific Games is having difficulty generating net income with the current debt load. As a result shareholder equity has been decreasing but the stock has continued to surge higher in recent months. Now the company will have to find an additional C $775 million to fund the NYX Gaming acquisition. NYX Gaming remains unprofitable but the growth prospects for the online digital gaming space look promising. In my opinion Scientific Games is getting a favorable deal for NYX Gaming as the company is small and still growing, but they already have enough debt.

One option Scientific Games may benefit from is the recent increase to share price which may lead to a share offering in the near future. If this happens we could see the share price shoot lower as investors become diluted. This would provide an opportunity for the company to reduce some of the debt on their balance sheet.

Looking ahead I don’t see significant upside potential for Scientific Games in the near future as it needs to find a way to deal with their debt. For these reasons my 3-6 month target for the company is $35.00. For someone looking for a little more protection in case the company continues to increase I believe writing April call options at a $43-44 strike and premium between 15-20% may be an effective strategy.

At the time of writing this article I currently have no open position in Scientific Games but plan to open one in the next 3 trading days. I am long NYX Gaming stock and still hold a long position in CXRX.

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