Global Cash Access(GCA) Plunge Overdone

It’s 2AM.  Your stubble-covered face glows in dim light of the casino floor.  Lights flash, bells ring. You’re about to get lucky. And you run out of cash.

Enter Global Cash Access(GCA).  GCA has contracts with many of the nation’s largest casinos to provide ATM services on their floors. GCA provides other cash services as well, and the nation’s only gaming-focused credit bureau. If you’ve ever paid the fee on one of these ATMs, you know this is a lucrative business.

Going into trading on July 21, GCA was at nearly $7, down from a high of $9.26 in April. It was expected to earn between $.75 and $.78 in 2010, for a fairly attractive valuation. Then, yesterday morning, the company filed an 8-K revealing that Harrah’s, its largest customer, would not be renewing its contract which expires at the end of November.

The market reacted swiftly and violently to this news. Almost immediately, the stock plunged over 40%, and it has continued to fall today, July 22, 2010.  Management, clearly stunned by the magnitude of the decline, hastily scheduled a conference call, where they were unable to present many new details.  From the data available to us, the stock’s move seems like an overreaction.

While Harrah’s has been the company’s largest customer, it has dropped from 19.3% of revenue in 2007 to 14.1% in 2009, and 13.8% in Q1 2010.  The company informed us that this deal did not have better than average margins, that they would be able to reduce SG&A somewhat, and that it would be immaterial to their 2010 projections, despite the deal being missing for the last month of the year. This implies growth in non-Harrah’s customers over the balance of the year.

The company’s revenues from Harrah’s were $94MM last year.  If that revenue were 100% margin, the company would swing to a loss. A more likely margin is 25%, which I arrived at by looking at cost of revenue as a percentage of revenue. By this measure, operating income would decrease by about $23.5MM.  Assuming that decrease carries straight through to net income, and a $.75 per share earnings number for 2010, 2011 earnings should, conservatively, be somewhere around $.40 per share, leaving the company trading somewhere near 9 times forward earnings at its recent price of $3.60. Perhaps this is a reasonable multiple given the risk of margin compression and additional customer defection(though on average only 1/3 of the customers have expiring contracts in any given year).  There are certainly big questions about why Harrah’s decided not renew and what their plans are.  To my mind though, this is an attractive multiple for a profitable business with a temporary setback, and worth a small stake.

Disclosure: I own shares in GCA