MGT: Lawsuit Update Underscores Big Opportunity

Zacks Small Cap Research

By Marla Backer

Gaming Patent
Following a significant restructuring in 2011 that included cost cuts, divestiture of non-core assets and replacing management with a Wall Street savvy team, MGT Capital (MGT)shifted its strategy to focus on patents. This included the acquisition of patents, use for its own operations and the pursuit of patent enforcement. On May 11, 2012, MGT acquired Patent '088 from J&S Gaming for $200,000. Patent ‘088 addresses a gaming system in which at least two gaming machines are networked to one another and to an interactive sign, enabling a second bonusing game in which players compete against one another if the bonus is triggered.

Patent Infringement Lawsuit
With patent ‘088 in hand, MGT wasted no time and one month later retained a major law firm. On November 2, 2012, WMS launched an infringement lawsuit against WMS Gaming, Caesars Entertainment (CZR), MGM Resorts (MGM), Penn National Gaming (PENN) and Aruze Gaming America. WMS and Aruze manufacture gaming machines that MGT believes infringe its patents. The casino operators (Caesars, MGM and Penn National) offer the machines on their casino floors. The manufacturers are “direct” potential infringers, while the casino operators are “indirect” or peripheral. WMS, as one of the industry’s leading manufacturers, is probably the most important. In fact, according to Scientific Games (SGMS), which acquired WMS on October 18, 2013, WMS has the industry’s second largest market share.

Recent Court Ruling
Not surprisingly, the defendants filed a motion to, among other things, dismiss the case or change the venue from Mississippi where MGT had filed to Illinois, where WMS was headquartered, or Nevada, where Aruze is headquartered. On October 23, 2013, the Court ruled, stating that:

Court’s Decision                        

1)    Defendants’ motion to dismiss the case against the primary infringers is denied;

2)    The case against the casino defendants is stayed – or put on hold – pending the outcome of the litigation against the primary infringers, WMS and Aruze;

3)    WMS and Caesars and WMS and MGM will remain joined;

4)    Motions to transfer the case to another jurisdiction are denied.


The cases against WMS and Aruze will proceed, as they are the direct or primary infringers. Depending on the outcome of the cases against them, the court will determine whether MGT’s case against the casino operators will proceed.

Case Goes Forward in Mississippi
The ruling also means that the cases will be heard in what Forbes describes as “plaintiff-friendly” Mississippi, NOT in Illinois or Nevada. This is important, we believe, as it means the case is likely to proceed faster than if it had been moved to another jurisdiction and MGT had to wait for a new date for a Markman hearing. As it is, the Markman hearing remains scheduled for June 5, 2014 in Jackson, Mississippi.

How Many Machines Infringe?
Some of the games MGT cited in its complaint are WMS’ Pirate Battle, Reel ‘Em in Compete To Win, Great and Powerful Oz, Clue and Aruze’s Paradise Fishing. So how many machines potentially infringe the MGT patent? Among the exhibits filed by WMS, WMS Senior Director of Games Joel Jaffe asserted that “WMS has placed 405 of its accused gaming machines in 241 different casino properties in 26 different states, including in Illinois.” So WMS has 405 potentially infringing machines.

How Much Do They Generate?
How much gameplay do these machines generate? In its 2013 Annual report, WMS indicated that its average daily revenue per participation unit is $66. As these games are on a participation model with the casino, WMS and the casino share the revenue. We assume that the $66 noted above equates to average daily gameplay per machine of about $3,000, after factoring in the casino’s share and the slot hold or retention. The average slot hold is roughly 6.0% in Nevada, according to the UNLV Center for Gaming Research, and we assume that it is lower in non-destination gaming markets, for a nationwide average of about 4.5%-5.0%.

 

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Each Seat Generates Revenue Each machine has several seats, generally four to six. In fact, much of the excitement – and higher potential win – is derived from players playing against one another and being linked to the interactive sign. With 405 WMS infringing machines and 4-6 seats per machine, there are 1,620 (405 machines x 4 seats per machine) to 2,430 seats under consideration.

If each seat generates average daily gameplay of $3,000, per the analysis above, and we multiply that by 1,620 to 2,430 seats and by 365 days, then we estimate the total annual exposure for WMS and its parent Scientific Games at $1.77 billion to $2.66 billion. A similar analysis would apply for the Aruze infringing footprint, in our view.

What’s the Potential Award in a Court Victory?
MGT seeks “preliminary and permanent injunctions” and an award of damages including, “at a minimum, a reasonable royalty, trebled” for the defendants’ alleged infringement, as well as attorney fees and costs of the suit, pre- and post-judgment interest and “such other and further relief as the Court deems just and proper.”

If MGT prevails and is awarded 1% in damages, based on this analysis, the company would be entitled to $17.7 million to $26.6 million for each year that is covered by Patent ‘088’s nearly 11 years. That equates to a total potential win of $191 million to $286 million on the WMS/ Scientific Games case.

Moreover, we used $66 as the average daily revenue per participation machine for this analysis, but we would estimate that the machines in question generate higher levels of play than standalone machines. Surveying the casino floor anecdotally supports this view. The machines that are linked to one another and to an eye-catching interactive sign appear to be among the most popular. All else being equal, higher average gameplay – which presumably would be disclosed during discovery – likely would imply a greater potential monetary win for MGT, in our view.

Risks Include Jury Trial
If a settlement is not reached and the case goes to trial, we believe it is generally difficult to predict how a jury will decide. This is a risk that both sides face, but in our view the possible financial penalty imposes a greater risk – and incentive to settle – on the defendants. In addition, on September 9, 2013, MGT amended its original complaint to include the potential infringement of Patent ‘554, which implies that the infringing footprint could be larger than in our above analysis. According to MGT, games that infringe Patent 554 include Aruze’s Amazon Fishing and WMS’ Star Trek, Battle Stations, Monopoly Bigger Event and Castle King, among others. Other risks to MGT include that it could lose the case outright or the case could drag on longer than expected.

Impact on Shares
If MGT reached a settlement for let’s say $85 million, which is about 45% of the $191 million low end in our analysis, and kept about 38% after payments to its lawyers and the inventor of Patent ‘088, that represents roughly $33 million or $5.10 per share to MGT on 6.35 million shares outstanding as of August 2013. $5.10 per share is some 80% higher than the $2.83 latest closing price for MGT.

Option on Growth of Other Businesses
Moreover, the company also has about $1.00 per share in net cash and new businesses in mobile gaming and Fantasy sports that we believe have significant upside potential (see our June 25 2013 article). Net-net, we believe the lawsuit presents a sizable potential win for MGT and the shares also represent an option on the growth of the company’s operating businesses.

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