Written by: Jolyon Loo

Contact: loojolyon@gmail.com

Date: 31st May 2015

Summary

Everi Holdings Inc. (NYSE: EVRI) is an entity created by a merger of 2 seemingly disparate companies

in December 2013 in the gaming industry, Global Cash Access (GCA) and Multimedia Games (MGAM).

Post-acquisition, Everi Holdings now occupies a unique position as a service provider in the gaming

supply chain, offering both payment solutions and slot machines to casinos. The share price of Everi

Holdings has plummeted in the past year to current level of $1.50 following a transformation of its

business model to one that is more R&D intensive. Industry weakness, debt overhang and seemingly

secular shift in capital spending patterns seem to be threatening its business model.

However, a closer analysis of its transformation (or integration) with corroborating industry research

would perhaps suggest that Everi Holdings is normalizing its business model, with regards to its

Electronic Gaming Machines (EGM) segment, to that closer to other EGM providers. The operational

restructuring will help align Everi Holdings with casinos shifting preferences and capital spend habits.

More than that, the catch-up through boosting product library will allow it to claw away market share

in an industry where replacement cycle is lengthening and new casinos openings are muted.

One thing that the market fails to appreciate in Everi Holdings’ prospects is its new found exposure in

the Canadian market. With the Canadian licenses, Everi Holdings have found fresh sources to

ameliorate slowing slots demand in North America (Ex Canada). In particular, a potentially enormous

opportunity awaits Everi Holdings in Ontario as its gaming industry undergoes privatisation and

revitalization. Everi’s new competitive strategy makes much more sense when we put all these pieces

together - seeking growth in North America through cannibalizing market share away from the big 5

while upping the ante in new markets through better and more relevant offerings.

Given that it is priced close to bankruptcy, Everi behaves like an OTM option. However, a permeable

industry coupled with the introduction of future revenue upside volatility make the Everi bet a highly

asymmetric risk-reward scenario that should entice anyone willing to roll the dice.

Background

In December 2013, GCA took up $1.2bil of debt, to acquire MGAM in a deal which

a) expects $30 million of cost synergies as a combined entity

b) generate about $800 million in revenues and approximately $217 million in Adjusted EBITDA

c) accelerate growth opportunities of MGAM by cross-selling its product into GCA’s much larger

consumer base

Senior Secured Term Loan ($mil) 487.5 6.25% 2020

Senior Secured Note ($mil) 350 7.25% 2021

Senior Unsecured Note ($mil) 350 10% 2022

Total 1200

Yearly I/R expense in ($mil) 91.6

Indeed, many onlookers find this to be an odd deal. GCA earns money mainly by providing cash

services to the casino floor through its kiosks which is backed by a compliance infrastructure. Aside

from facilitating cash to the floor, its compliance expertise helps casinos globally to meet their Title

31 requirement (preventing fraudulent and illegal transactions in casinos) with the Financial Crimes

Enforcement Network (FinRec) and IRS. 3 years preceding the transaction, revenue is flat-line at

~585M with an EBITDA margin of ~11-13%. In short it is a cash cow. On the other hand, MGAM supplies

Class II and Class III EGM to casinos in North America, either through a revenue-sharing lease or an

outright sale. It also provides the central determinant system for the New York Lottery. Because of its

decision to focus on the native casinos from the 1990s, ~50% of its supplied EGM is concentrated in

the Oklahoma and Washington area with little diversification beyond the North America market.

Source: Everi Holding 2016 March Presentation

A series of unfortunate events precipitated throughout 2015 to 2016 that suggests even to the most

ignorant investor a structural weakness in Everi’s competitive position. In 2015 Q2, Everi Holdings

disappointedly revised its adjusted EBITDA downwards from $218mil - $228 mil to $200 to $205mil.

R&D costs is expected to step-up to expand content development capacity from 8 to 16 studios along

with higher capex at $70mil related to placement of Core HDX cabinets and higher capitalized software

spend. More uncertainty ensues when a recurrent casino in Oklahoma did not renew placement of

500 class III machines although Everi Holdings has been a long-time supplier. There was another loss

of a major client in the payments section though the revenue loss was partially offset by acquisition

of ATM portfolio in Q4 2015. Furthermore, some signs of endemic profligacy within the company were

detected when Ex-CEO Ram Chary purchased a private jet for $6mil for the company despite the poor

financial position the company is in. Ram Chary was fired in February 2016. Last but not least, a

goodwill impairment of $75mil in Q4 2015 suggests that the prospects for the acquired MGAM would

weaken in the future and perhaps management has grossly overpaid for the acquisition.

NOTES Share outstanding (mil) 66.3

Current Price ($ USD) 1.50

Market capitalization ($mil) 99.6

Add Total Debt ($mil) 1138.9 Less Cash ($mil) 99.3

Add Warrants, Options ($mil)

3.4

EV ($mil) 1142.6 EBIT ($mil) 60.5 Payments Games

Adj. EBITDA ($mil) 196.0 75 121 EV/LTM EBIT 18.9X

EV/LTM EBITDA 5.8X

Its current market capitalization is ~$100mil and with a LTM adjusted EBITDA and EBIT of ~$196mil

and ~$60.5mil respectively, Everi trades at 5.8X EBITDA and 18.9X EBIT. However, one must remember

that the payments’ component of Everi is a highly consistent cash generator with a LTM adjusted

EBITDA of $75mil which trades historically at a 5 year LTM adjusted EBITDA average of 8.4X from 2010

to 2014. Assuming that the games component is valued at this multiple, which is a valid assumption

given its stability of the business, the implied market valuation for the games segment would then be

about 4.2X. This is much lower than any precedent transactions in the past few years.

Implied EV (in $bil) LTM adjusted EBITDA (in $mil) Implied EV/EBITDA

WMS 1.5 246 6.1X

IGT 6.4 736 8.7X

VGT 1.3 157 8.2X

BYT 5.1 496 10.3X

MEDIAN 8.6X

MEAN 8.3X

Why does this opportunity exist?

1) Softening EGM industry, with secular shift in capital spend habits and preferences which has

affected all boats in the EGM space, including Everi. However, Everi’s attempt to align its

business proposition with industry should allow it to navigate the headwinds and capture

share from the top five

2) Misunderstanding the increased R&D spend as a business weakness. However, this should be

viewed as a “restructuring” of its competitive strategy that will take advantage of a morphing

industry landscape. The new focus on superior product offering resembles Aristocrat’s (ASX:

ALL) successful entry into the North American market, suggesting a fat-tail upside to earnings

volatility.

3) Hidden top-line growth in EGM segment in the Canadian markets, acting as a positive catalyst.

Communication about its opportunities has been muted, probably to not inflate expectations

in a stock which has constantly disappoint. This further increases the upside volatility of

earnings

4) Onerous debt that seems bound to puncture the entire entity in times to come, depressing

equity value of the company. A clause would prevent the acceleration of debt even with the

step-down of Senior debt to EBITDA ratio in future years.

The above points will be discussed in depth in the next section.

Forces reshaping the North America Gaming Industry

Source Eilers-Fantini Quarterly Slot Survey 2013

In the North America market (Ex-Canada), there are approximately 880,000 EGMs, in which ~89% are

owned while about 11% are leased from the EGM manufacturers. As a flow basis, EGM manufacturers

can either acquire revenue from the sale of machines on a replacement or new shipment basis or

leasing games to the slot facilities in exchange for a daily fixed fee or a revenue sharing model.

Source: J.P. Morgan Slot Survey 2016

According to JP Morgan Slot Survey 2016, there seems to be a gradual compression in replacement

spent in the EGM market as less casinos are expanding their replacement budget relative to last year.

This corroborates management’s guidance in the conference call as they expect in ”the next few years

where machines and casino floors as the cycle has gotten stressed out for replacement from five to

six years now to 10 to 12 years.” (Q2 2015 Everi Holding’s Conference call). The lack of new casinos

opening in North America certainly did not help to fill the purchasing vacuum. Assuming about 52000

replacement units, Everi’s Holding ship share was ~5.4% in 2015.

Source Eilers-Fantini Quarterly slot Survey 2013

Although the replacement market remains a shrinking pie, the market share is highly fragile as

established players continue losing share in the market. In particular, Aristocrat Gaming was able to

increase its market share in a highly concentrated EGM industry from 15% (2013) to 19% in 2015.

Source: J.P. Morgan Slot Survey 2016

Another trend is the growing weakness in demand for established market players in the EGM industry.

In particular, IGT and WMS’s popularity with casino owners have been shrinking overtime while Bally’s

and Konami’s remain relatively stagnant in the industry. In particular, the weakening appeal of big

players will likely continue the redistribution of market share to alternative EGM suppliers.

Thus, market share in the EGM replacement market is highly porous where market share is

reshuffled to whoever is able to provide the best products. This is integral in the investment thesis

which is predicated on top-line revenue expansion in a stagnant/flat market, creating the possibility

of abnormal growth if Everi delivers. This will be further examined as we see a parallel between Everi’s

new narrative and Aristocrat Gaming’s history.

Normalizing Business Operations

The adjusted EBITDA downwards revision signals to many, probably including management

themselves, that GCA probably didn’t know what they were doing when they acquired MGAM. What

happened was probably an overestimation of the attractiveness of multimedia current product

offerings, which include the Award Winning Tourevent. And the unsuccessful continued placement of

500 third-party class III machines in Oklahoma is a poignant reminder to management that they can

no longer hope to retain customers on the basis of “customer relationships”.

2

Source: Author’s Own Work

“Extrapolation is not a good practice” is a maxim most acquirers should take heed of. Following an

uninterrupted ascent from FY2011 to FY2013, installed participation base reached a plateau from

FY2014 onwards. This could be due to several reasons. In the preceding period from the 2000s to

FY2013, MGAM released multiple new cabinets and acquired large quantities of third-party class III

games which coincided with its entry into many new markets in North America. The inorganic growth

of its game library prop up its diversity of offerings to compete closely with the incumbents in the

market. This move allowed it to gain share in a recovering gaming market (post great recession) where

gross gaming revenue is picking up and new casinos are being erected around the country. At the

same time, the marketing hype from its Tourevent Tours around different casinos broadcasted its

penetration into the new jurisdictions which led to a louder presence in the market.

“To accelerate their participation in this shift to Class III games, the mid-to-late 2000’s, Multimedia

committed to purchasing large quantities of third-party Class III games. Many of these games while

aging is still on casino floors today. Our customers who allowed us to place these third-party games

on their casino floors and expectation that Multimedia would develop their own proprietary Class III

products and better Class II games to replace these third-party games when the placement

agreements expire.”

- Michael Rumbolz in Q4 2015 Everi Holding Conference Call

However, this strategy, though adequate to kick start entry into new markets, would be perilous to a

continual take down or even the maintenance of market share overtime. Firstly, the external

developers of third-party games tend to have very little incentives to improve the game once the sale

is made, leading to marginal improvement in game quality over time. This would signal to casino

operators that the quality of the games will likely stagnate overtime, discouraging them from offering

longer term contracts or conversion of placed consoles. This is crucial to new capital habits as casino

shifts to employ conversion as a more efficient way to renew their base.

8683

12957

6000

8000

10000

12000

14000

Installed Participation Base

Secondly, Everi effectively loses control on the pace of developing new games as content acquisition

is outsourced. In a consolidating market, it will be difficult to keep up with gaming giants like IGT

(merged with GTECH), SGMS (who acquired WMS and BYT) and ALL (who acquired VGT) whose

internal R&D capacity is constantly expanding with their bigger scale. Moreover, the can is kicked

down the road as expectedly outdated third-party games causes Everi Holdings to fail to continue

placements of its third-party games. Further on in 2016, as management has guided, many old

contracts with the placement of third-party games will likely not be renewed.

Source: Author’s own work

Likewise, the saturation of its flagship product, Tourevent, seems to be imminent in the North

American market. From 2014 to 2015, there is a palpable fatigue in Tourevent unit sales as numbers

continue to trend down both as a proportion of sale and on an absolute basis. The thing about

Tourevent is that it operates more like a “trojan horse” per management’s opinion which means it

facilitates an initial sale rather than a continual sale. With most American jurisdictions having been

marketed to, there are little uncharted territory where Tourevent can make an invasion.

Transitioning

As management becomes cognizant of these transformations, the decision to redirect almost all game

development internally is a wise move to reposition itself for market share capture. As part of the

transition, management will increase its capital expenditure for 2016 - 2017 for games development

as they expand from 8 to 16 studios. At the same time, capital expenditure will inch up further as Everi

Holdings roll out more Core HDX cabinets. For an LTM adjusted EBITDA of ~$200M, a new capex rate

of ~$80mil is obviously does not bode well for its financial structure, especially when it expects 2016

interest expense to be at ~$101mil. Its recurrent income comes with a huge caveat of larger capital

spend. However, to fully appreciate the impact of this new normal, we will have to factor in a defensive

impact on its installed base, a prospective gain of market shares for the replacement market and

model in a higher win rate.

Source: J.P. Morgan Slot Survey 2016

From the chart, there is a consistent preference for video reel EGM if not a heightened interest in

2016. This is a precise fit to the competitive strategy management is shifting towards; new video reel

cabinets supplemented by a step-up in content development capacity. As aforementioned in the

industry trends, we witness a constant reshuffling of market share to the most competitive products.

This raises the possibility that Everi could snatch away market share from the big players, if it positions

itself correctly in the market.

Source: J.P. Morgan Slot Survey 2016

Another data to support Everi’s prospective market take would be the growing receptivity of operators

to allocate floor space to other suppliers. As much as this is an open gate, the entire market share

capture theory is predicated on the right positioning of its offerings, which Everi is leaning towards

with its increased spend in developing better games and cabinets.

Lastly, the increased focus in developing game content should lengthen the longevity of its installed

base. Unlike the third-party games, churning out licensed games will refresh the relevance of its

cabinets and retain renewal contracts. On a long term perspective, this should allow Everi to renew

the placement of its units and prevent an erosion of installed base, like Oklahoma, overtime.

Everi’s current competitive strategy resemble closely to Aristocrat’s in its initial years of entry into the

North American market. To take advantage of the growing preference towards video reel machines,

Aristocrat competes almost exclusively in the video reel EGM segment. It takes full control of its

innovation, devoting 15.5% (5 years average from 2010 to 2014) of revenue to Design and

development and throughout the years, was constantly churning out licensed games with themes

popular with operators. As a result, it grew its installed unit base from 5670 units in FY10 to 9071 units

FY14 despite a flat gaming market coupled with an 19.4% of daily revenue per machine from 2010 to

2014. At the same time, its ship share in the outright sale segment continues to increase, taking away

market share from the incumbents. Aristocrat continues to dominate the list of preferred EGM

suppliers.

Then, a fresh look at Everi’s new spending habits could indicate that it is following in Aristocrat’s

footsteps. 5-year average R&D as a % of sale pre-merger is ~9.4% and after including software

expenditure which is capitalized, total historical annual design and development cost is ~11%. Clearly,

with a step-up of development and design capacity in 2015, its business model is tending towards one

that is poised for organic growth through future replacement cycles. Assuming a replacement demand

of ~52000 units in 2017, we should expect its ship share to increase, average sale price to tick upwards

as its HDX core cabinets get picked up by the market, daily revenue per slot to increase incrementally

with better games.

Thus, as much as it is increasing its operating leverage, Everi is also introducing larger upside volatility

to its enterprise value. As a distressed firm that is priced for bankruptcy, the equity in fact behaves

like an option, with the strike price being the face value of the debt. Higher volatility in its enterprise

value will increase the value of an OTM option since now it has a higher chance to not become

bankrupt. Contrary to that, market is marking down the value of the equity in response to the business

changes.

The Big Gamble in Ontario

The gaming industry in Ontario is undergoing a major transformation. Gaming profits in the region

have declined from $800mil in 2001 to $100mil to 2011 following strong competition from US casinos.

In response to that, the Ontario Gaming and Lottery Corporation (OGL) passed a Modernization deal

with regard to its gaming industry in 2012. This includes shifting the day-to-day management of the

gaming facilities to private hands, hoping to revitalize the entire gaming industry and encourage

private investment in the region. At the same time, OGL is planning to open up new casinos in the

region. As part of the procurement process, they carved up Ontario into during geographical segments,

labeling the gaming bundles as East, North, South-west and GTA.

Source: OLG website The entire EGM count in Ontario is 22282 according to the publication and out of this 22282 slot machines, there will probably be a huge chunk of it which are likely to be old, obsolete machines that are in need of replacement. For instance, a check on the Blue Heron Casino would reveal the presence of archaic slot machines like “Double Diamond Deluxe Slot” and “Rich Girl”. Deducing this should be quite straightforward given the lacklustre language employed in the marketing of the deal. Likely in

2017 when the finalization of the operators is done, there would be a huge acceleration of replacement demand as the OGL seeks to revitalize their slots offering in lieu with modernization.

Source: OGL website For instance, in gaming bundle North, the number of gaming machines in N1, N2 and N3 are still a notch away from the maximum number of EGM permitted while N4 and N5 have virtually 0 gaming machines. An examination of other regions reveals similar figures. This represents another huge opportunity for Everi Holdings who happened to just acquired the license to sell EGM in Ontario. As aforementioned, there would likely be substantial Tourevent sale into the Ontario market from its “Trojan horse” effect. Concurrently, the shifting demographic of Ontario would imply that the OGL will probably renew its outdated slot base to video-reel machines. This is exactly the value proposition that Everi is shifting towards.

Last but not least, the Canadian market is far less competitive than the North American market.

Source: Eilers-Fantini Quarterly Slot Survey 2013 Probably due to its more stringent licensing process, there are far less EGM suppliers in the gaming space in Canada. This is a good sign for an upcoming entrant, Everi Holdings, as it tries to expand into the market. Noteworthy to the discussion, Spielo, a Canada based EGM supplier, despite occupying a relative low market share in the North American market, has a large market share of 29% in Canada. This should not be a surprise as the heavily regulated gaming industry in Canada has always praised the economics benefits of the gaming industry to local communities which obviously points to a disproportional share of capital to a local firm. However, the modernization would reduce the degree of politicization in capital allocation decisions, and probably create a window of opportunity for Everi to break into the Ontario market. Despite the significant potential market in Ontario, management’s guidance for Ontario is a minimalistic “we have opportunities to further expand our presence in Ontario” which is vague to say the least. Thus I believe that potential large sale into Ontario reinforces the asymmetric risk reward profile of the trade. Large quantity of successful EGMs placement in the Ontario market would be a substantive catalyst in 2017 that will cause a revaluation of the equity. Debt Woes? At its current valuation, the market is pricing the equity as if it is worthless relative to its debt.

Source: Company’s Presentation March 2016 Although Everi’s Holding has large quantities of cash and equivalents in its latest filing, i.e. ~$99mil, its effective cash is only ~$17.3mil after accounting for receivables and liability settlements, and current portion of debt.

In thousands

Cash And Cash Equivalent 99334

Settlement Receivables 28321

Settlement Liabilities 110361

Effective Cash 17294 Source: Everi’s Holding Q2 2016 Financial Report They are technically not the company’s cash. However, the cash reduction to net debt does not care about the source of the cash, and this clause is significantly helpful in reducing the covenant restrictions. Following the reduction, there is really little chance that a technical breach of the covenants would occur; Adj. EBITDA for 2015 is at ~$200mil, much higher than 2016’s limit. Modelling wise, this would imply that the life of the option would likely be at least until 2020 when the first bulk of the debt matures. Instead, what is worrying is the onerous interest payment of ~$91mil each year, cutting off almost 45% of its Adj. EBITDA. The problem is further compounded by the recurring issue of higher design and development spend that could impair the company’s financials. Let’s be honest, this is theoretical financial risk in its superlative form. Its Debt to tangible equity ratio is ~11.5X. Its future interest payments are funded by incoming cash flows when current ratio is <1. Thus a substantial risk obviously exists for anyone looking to purchase equity from a distressed company. The debt will continue to be onerous and probably have to be refinanced down the road. However, the way to think about this equity-as-an-OTM-option trade is since the company is priced for bankruptcy anyway, downside risk is just the time decay of the option value while there is an open ended upside risk from the aforementioned analysis. A probabilistic viewpoint must be taken to justify the trade. And If EVRI indeed delivers huge top-line growth, captures market shares and renews its prospects, it will be able to approach the capital markets with a stronger balance sheet and proof of robust cash flows, Refinancing would not be an issue. Again, from an option perspective, this will prolong the expiry date and boost the price of the equity. Valuation Since this is a distressed option, I will attempt to illustrate the upside given a successful turnaround of the business. Assuming a ~55% EBITDA margin for the incremental ~2% market share in 2017, translating to 1040 additional units at a slighter higher average sale price of 17500, there would be incremental adj. EBITDA of $10mil from the North American market. Assuming that it sells ~200 Tourevent (roughly 19k each) into Ontario, plus replacing 2% of the total machines in Ontario, representing ~450 units, the incremental gains to Adj. EBITDA would be ~$6.4mil, representing an increase of ~$16.4mil of Adj EBITDA. This excludes new sale from other markets like Missouri, increased penetration rate in existing markets, an increase in daily revenue per unit from better games and growth from the GCA section from its new compliant infrastructure which should provide a cushion of error for the estimated increase in adj. EBITDA if the scenario plays out. Also, if Everi Holdings manage to claw away market share in the North America market and gains big contracts in Ontario, there should be an upwards revaluation of its EBITDA multiple, closer to industry

level. Thus, applying a multiple of 6X adj. EBITDA to the games segment, 8.4X adj. EBITDA to the payment segment, we will arrive at an estimated intrinsic value of ~$1.45bil, translating to an implied market value of equity of $411.6mil or a 313% upside to the current price.

Source: Author’s own work Alternatively, a DCF analysis assuming growth in most operating metrics in Canada and NA, decaying replacement market, constant minimal growth of payments segment plus tax exemption for the next 5 years and arrive at a value of ~$335mil, a more conservative estimate. This is could be seen as the base case for the thesis though I must admit the values will likely vary widely due to large upside uncertainty introduced by the transition. Bear Case On the other hand, if Everi fails, the downside is capped to the time decay of the option since the equity can be presumed to have no premium at current going rate. The way I would structure the investment is to exit by 2017 end if a) market share fails to pick up b) Ontario’s penetration is overestimated. Thus, assuming the equity loses 1/3 of its value, we will exit the position with ~33% loss. Head, you win 313%, tail, you lose 33%. The reward to risk ratio stands at 9.5 to 1 which should make this an opportunistic trade to whoever takes up a probabilistic view of the company. Conclusion Everi Holdings is an equity stub that is undergoing a restructuring, creating a fat-tail event while increasing the upside potential. Coupled with a huge sell-down, balance sheet opacity from the merger and ongoing industry weakness, there is a huge dislocation in intrinsic value and current share price. Yet, the transition story is a compelling one given the extensive slot survey and a precedent to base our analysis on. Positive catalysts include successful Canadian entry and reported market ship share in the next 2 years. With a 9.5 to 1 odds, this is an actuarially favorable trade.