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Morningstar | Fresh Leadership Could Help Improve Ainsworth's Fortunes as CEO Steps Down from Decade-Long Tenure

Ainsworth Game Technology has announced Danny Gladstone plans to step down from his position as CEO by the end of fiscal 2019. He will remain in the role until a replacement CEO is appointed, at which point he will stay with the company, albeit in a different capacity. Ainsworth's performance during Gladstone's decade-long tenure as CEO has been mixed. While we believe he is not solely responsible for the underperformance endured in recent years, we do believe fresh leadership could potentially help drive an earnings recovery. Ideally, we would like to see the new CEO invest heavily in design and development as a key priority, while pushing further into participation (leased machines) to help smooth out some of the earnings volatility in the same fashion as Aristocrat. Despite the pending change in leadership, we maintain our narrow moat rating, and our AUD 1.70 per share fair value estimate.

We continue to believe the stock is undervalued, notwithstanding the step up in competition during the past few years. Ainsworth remains one of the few companies in the world licensed to manufacture slot machines. These licences are Ainsworth's most important asset and a crucial component of its narrow moat rating. We also believe the outlook for Ainsworth is improving, and we expect earnings to commence a recovery in the near to medium term. Some positive signs we flagged in the most recent reporting period were a one percentage point increase in design and development expenditure to 13% of sales, a level which the company intends to maintain. This should help stabilise the domestic market and support a resumption of share gains in North America. The company also resumed paying dividends, albeit at a considerably lower level, which signals confidence in the firm's financial health.

We continue to project mid-single-digit revenue growth on average during the next five years, which assumes stabilisation of Australian market share, a resumption of growth in North American outright sales, albeit at a very modest pace, and increasing penetration of the Latin American participation market.

Gladstone's earlier years were positive, and he oversaw the international expansion, along with the push into recurring revenue, driving the group to peak earnings in fiscal 2014. Some of Ainsworth's key achievements under Gladstone's leadership were: (1) doubling Australian ship share between fiscal 2011 and 2014, reaching a peak of approximately 30%; (2) expanding into offshore markets, with over half of group revenue generated offshore by fiscal 2016, up from just over 10% in fiscal 2011, with the key driver the foray into North America where ship share rose from next to nothing to approximately 6% by fiscal 2016 and; (3) increased recurring revenue from nothing to 10% of group revenue by fiscal 2016.

Post fiscal 2014, the company's performance has been turbulent, with earnings halving by fiscal 2018. This mainly reflects delays in obtaining regulatory approvals, struggles getting new games to market, and a drop off in new game design and development (which fell from around 13%-15% of sales to around 10% of sales on average during 2014-2016). This drop off in game development left the door open for rival Aristocrat to ramp up efforts and steal considerable market share in the domestic market. Australian ship-share has since declined to approximately 10%. Most of this share was lost to rival Aristocrat, which now accounts for around 65% of the local market, although we believe this level is unsustainably high. North American outright sales and the number of leased machines have also both stalled post fiscal 2016, while all these earnings pressures led to a suspension of dividends in fiscal 2017.