“NYC Firm Lands 15-Year Contract to Run China’s Biggest Lottery Expansion”

By Travis Johnson, Stock Gumshoe, January 19, 2010

Todays tempting teaser travels toward the Thinkolator thanks to the Inside Strategist, the Stansberry newsletter, edited by Braden Copeland, that focuses on stocks that show patterns of insider buying.

As we’ve noted many times when looking at teasers from this and other insider-focused newsletters, there’s a good reason to track insider buying: on average, it works. Insiders can be stupid investors just like the rest of us, and insider selling rarely means anything actionable, but on average the C-suite insiders, if they’re buying and acting en masse (ie, buying by more than one person, like the CEO and the CFO, for example), tend to predict above average stock appreciation if you go out at least six months from their purchases.

So there are a lot of newsletters that use screens for insider buying patterns as one way of targeting stock picks — and this is one. But the breathless tease that gets us excited is all about China …

“Little-Known NYC Firm Lands 15-Year Contract To Run China’s Biggest Lottery Expansion

“‘When you add up all the new business [this company] has gained over the last few
weeks, you’d think it won the lottery.’ ~ Investor’s Business Daily ….”

“I’ve uncovered an opportunity that could begin your new year with a quick 100% gain.

“A few months ago – on July 1st, 2009 – the Chinese government approved a new gambling law, allowing lotteries to operate across the entire nation… expanding China’s gaming markets for the first time in decades.

“In a country that’s ‘home to the most fanatic gamblers,’ as the New York Times reports, that means just one thing:

“If you’re an early investor in the lottery business, you’re set to make a killing.

“According to Peking University researchers, China’s lottery is estimated to grow into a whopping $150 BILLION industry, thanks to this new law.

“That’s almost 3 TIMES the size of the U.S. lottery market, which is currently the world’s largest….

“But the most incredible part is, one little-known New York City company just won an exclusive 15-year contract with the Chinese government to run the biggest legalized lottery boom in history.”

Copeland then goes on to mention the massive wealth that was created in Macau, on the backs of those same Chinese gamblers, and several other examples, all focused on the fact that every time China or her neighbors has loosened gambling or lottery laws, specific companies have swooped in and made massive stock market gains as a result.

And then we get into some more specifics about this particular company … or as I like to call ’em, “clues:”

“Right now, one New York-based firm has the lead in capturing a big chunk of China’s legalized lottery market.

“This U.S.-listed company has secured a 15-year contract with the Chinese government to supply ‘instant-win’ lottery tickets in every region of the country.

“(These instant-win tickets are very similar to the scratch-off tickets you see in nearly every convenience store here in the States.)

“The firm has set up a state-of-the-art, multimillion-dollar facility – the first of its kind in China – to produce lottery tickets.

“And just to show you how much demand they anticipate, the facility is equipped to produce 4 billion instant tickets per year…

“And the company recently said in a press release that they anticipate ‘adding another four billion of ticket printing capacity [to] meet existing demand in the market.'”

So, this is a US scratch-off game maker, which cuts the list of possible stocks down to a very small size. Some more specifics?

“Although most people have probably never heard of it, the company produces instant scratch-off tickets and promotes new lottery games across almost every state in America.

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“For example, they recently created a very successful ‘scratch and sniff’ game for a famous candy company, to help increase Christmas sales.

“But its success in the U.S. is nothing compared to the possibilities for growth in China… which is just beginning to expand its lottery market.

“This New York company was smart. It moved into China in 2007, when almost no one was paying attention to the lottery industry.

“The company’s American executives gradually made important contacts in the Chinese government’s gaming commission… going so far as to start a 50% joint venture with a local government-backed gaming firm.

“Not surprisingly, in 2009, when the government issued a new gaming law – opening up China’s lottery market for the first time in decades – the firm was already poised to benefit.

“Thanks to its first-mover advantage, this New York company secured access to lottery ticket sales in 22 provinces across China.”

OK … so, this one must be …

Scientific Games (SGMS)

SGMS is indeed based in New York, and they have been expanding in China for a couple years now (and in other countries — they also have a fair amount of business in the UK, Mexico and Germany, and Italy, to name a few). They are best known as the developer of scratch-off instant lottery games, but they also run online lotteries and more standard lottery operations for some clients, and provide services to other gaming entities in areas like Off Track Betting, etc. They may be “little-known” in most circles, I suppose, but they’re one of the few investments in the lottery and gambling services space, and one of the larger companies with a market cap of $1.5 billion.

But the scratch-off is king for SGMS — and yes, they do have a 15 year deal with a joint venture partner in China to manufacture 4 billion instant lottery tickets a year. But the ad makes some timing implications that might be worth a thought — that 15-year deal with China started last January, and the enticing quote at the top of the ad from Investor’s Business Daily about all the new business they had gained recently? As far as I can tell, that article is six years old.

There was a spate of insider buying in SGMS shares last year — there is big insider ownership and has been for a while, most of it from founders or from very liberal stock options grants, but back in late October there was a round of actual open-market insider buying around $14 that stands out a bit, including several directors and officers. (Open market buying meaning that insiders actually went out and bought shares — they might have coordinated to get attention, but they paid the market price, presumably with their own money, which is far different than an options exercise or a stock grant).

The company is not huge, but it is certainly among the largest players in the industry — the main competitor is Lottomatica, which bought prior competitor Gtech, but in truth they also cooperate a lot, most lotteries are run as state monopolies and the two companies work together in consortiums at least some of the time. In some ways IGT, the big slot machine maker, competes with Scientific Games on a minor level too, but aside from some gambling service businesses they’re focused on very different markets. And there are other private companies, or consulting divisions of big IT companies that work on this stuff, too, but for the most part it’s SGMS and Lottomatica (which is not really traded here).

Right now, with Scientific Games now working through a joint venture in China, the revenue from China has actually been dropping a bit — that’s because before the joint venture they accounted for China earnings differently. But the various state lotteries in the US, with the myriad scratch-off opportunities you see when you fill th gas tank or pop into a 7-11, bring in the majority of the revenue. China may be one place where growth is expected (their deal gets them a cut of retail sales of the tickets), but it’s not yet a major part of their business.

So will this one double in the next six months?

Well, the forward PE ratio of about 17 is historically fairly low for SGMS — but they’re also coming off a pretty tough year, with more competition coming in here in the U.S. in particular as state lotteries look to scrape every penny they can from their deals. Scientific Games has been in cost-cutting mode over the last year or so, and has not won extensions of every contract as sometimes investors expect for a firm with such a near-monopoly market share (estimates that I’ve seen of their scratch-off market share in the US are about 80%). Still, they do have that strong market share, insiders did a bit of buying, and th