Frank Voisin is a value investor and independent analyst whose site, Frankly Speaking, contains Frank’s investment theses as well as educational material to help investors avoid value traps. Subscribe to Frank’s feed here.
International Lottery & Totalizator Systems (OTC:ITSI) is a Vista, California based company that supplies and services computized wagering systems for the online lottery and parimutuel racing industries and, through its wholly owned subsidiary, Unisyn Voting Solutions Inc., supplies and services electronic voting machines. The company trades with a market capitalization of just $2.59 million. With no debt or preferred stock and substantial cash, the company’s enterprise value is around negative $1.5 million. The company has NCAV of $0.35 per share, which is 75% higher than its current stock price of $0.20.
I first came across this company in a regular screen for companies undervalued relative to NCAV. Few companies that meet this criteria are profitable and this year I resolved to stay away from persistently unprofitable NCAVs. Though ITSI has a mixed operating history with profitability over the last ten years just 50% of the time, it is currently profitable and has a P/E of 4.4x. The company has low capital expenditure requirements, indicated by the fact that it has had positive free cash flows over the last ten years 80% of the time. Additionally, the company states that it expects low research and development costs going forward:
For the three and six months ended October 31, 2010, we did not incur any R&D expenses, compared to $391,000 and $868,000 in the same periods in 2009. We attribute the significant decreases to the completion of the development of new voting system products. While we continue to enhance our products, we anticipate that R&D expenses will be very minimal, if any, in the remaining quarters of fiscal 2011 as we focus and dedicate our efforts on the marketing and sale of the new voting system.
With low capital expenditure requirements and low R&D demands, (and $53.3 million of loss carryforwards to offset future taxes) the company should continue to generate strong positive cash flow. With no debt or preferred shares, this will accrue to the benefit of common shareholders, who can now buy in at a 43% discount to current NCAV! As for corporate governance, I was happy to see that top management earns combined total compensation of just $400,000 per year and that there are no options outstanding.
I should note that the voting machine business is currently unprofitable. but this appears to be the logical result of the fact that this line of business operates along the American election cycle. There appeared to be a substantial refresh in 2007-2008 leading up to the previous Presidential election. The company licenses its products to Election Systems & Software Inc., a private company which is the largest voting machine company in the United States.
My biggest worries about this company arose when I noticed that, over the last decade, anywhere from 60 – 90% of sales have been to just a few customers. With much larger competitors like Scientific Games Corp (NASDAQ:SGMS) or Italy’s Lottomatica Group vying for sales, the loss of just one customer would be difficult to overcome. I soon found out that investors need not worry – the bulk of these sales are to related entities! 71.3% of the company is owned by Berjaya Lottery Management (H.K.) Ltd. (“BLM”) That probably doesn’t ring a bell for most of my readers, but viewers from Malaysia are smiling in recognition – BLM is a wholly owned subsidiary of Berjaya Sports Toto Berhad which is itself the wholly owned gaming subsidiary of the Berjaya Group, a massive Malaysian conglomerate with interests in, to name just a few, Financial Services, Hotels, Resorts, Real Estate, Food & Beverage, Education, and Media (See the full list here). Berjaya Group is run by Vincent Tan, a well-connected industrialist who is now the ninth wealthiest Malaysian. More importantly for our discussion is the fact that, in addition to BLM, Berjaya Sports Toto Berhad owns Sports Toto Malaysia Sdn Bhd and Prime Gaming Philippines, Inc. which play large roles in the gambling industries in the Philippines and Malaysia (and BLM in Hong Kong). How does this relate to ITSI? The 60 – 90% of sales it makes each year to a select group of customers are actually these companies, related entities which have a vested interest in seeing ITSI succeed. ITSI is thus not likely to lose these customers to its much larger competitors anytime soon.
Two drawbacks to ITSI exist. First, the company trades in the OTC market, which doesn’t have the same level of oversight as the regular market. This leads some to worry about the company’s disclosures. Second, ITSI has very low average volume of just 2100 shares, or around $400/day, so a meaningful position can take a while to build.
Though not a factor of my analysis, I was interested to see the company’s ties to my current location, Hong Kong. ITSI’s parent company is located in Wanchai (the area in which I lived temporarily when we moved here) and the company has supplies the storied Hong Kong Jockey Club (located within spitting distance from my apartment in Happy Valley) with more than 6500 Datamark terminals.
Author Disclosure: No Position.