Roland George Investment Program
Shuffle Master, Inc.
Alexandria Vita
Company
Ticker
Sector
Industry
Market Cap
Recent Price
Shuffle Master, Inc.
$965.58 Million
27.64
P/E
SHFL P/B
Consumer Discretionary 52 Week Hi/Lo
Gaming and Casinos Inst. Ownership
Average Volume
Fair Price
34.6
31.8
22.49 – 40.75
99%
760,280
32.53
I.
Market Analysis:
2006 has been quite the active year for the stock market, starting off the year strong as
2005 ended with an increasing Consumer Confidence Index despite the threat of rising energy prices on holiday spending. By May the market saw a decline as energy prices continued to increase causing consumers and investors to act more cautiously. However,
September’s decrease in oil prices raised consumer confidence and resulted in greater discretionary spending. This confidence was further assured when the Fed made the decision to maintain the overnight rate at 5.25%, a welcomed break after the recent rate hikes.
In the past month the Dow Jones Industrial Average has hit an all-time high and continues to impress investors. The S&P, NASDAQ, and Russell 2000, although not record breaking, continue to increase as the market improves from the summer months.
The Consumer Confidence Index has dropped slightly in October from 105.9 to 105.4, but remains well above the index from a year ago of 85.2. There is some concern in regards to the job market, but according to the latest figures released with the Consumer
Confidence Index more people feel that conditions are “good” and will continue to expand. 1 In fact, just recently the unemployment rate decreased as more jobs opened in
October.
II.
Industry Analysis
Shuffle Master Inc. belongs to the consumer discretionary sector under the casinos and gaming industry. This $14 billion industry covers not only casino facilities and resorts, but online gambling sites, other gambling entrainment companies (e.g. racetracks) and companies similar to SHFL who develop service and utility products for the companies within the industry.
1 http://www.conference-board.org/economics/ConsumerConfidence.cfm

The industry has a 12% 5-year historical growth and a long-term future growth rate of
15% with earnings for 2006 expected to increase at 8% from 2005 and 16% for 2007.
The industry is a strong performer in the sector and in fact is out performing the sector as well as the market.
There has been legislation recently in effect that is adversely affected the industry; however the effect was on online gaming companies, which despite revenue loss continue to remain resilient and are seeking new methods of marketing and partnership to combat the negative repercussions.
2
In a more positive light, other aspects of the industry continue to grow. In South Florida a continued push for expansion is in the works. With such areas expanding, SHFL can remain hopeful that companies will continue to seek services and products.
III.
Company Analysis: a.
Background Information:
Shuffle Master Inc. (SHFL) was founded in 1983 by truck driver, John Breeding who developed the idea of an automatic card shuffler after reading an article about frustrations of card players in Atlantic City. The company was first listed on the NASDAQ in 1992.
The fist product was a simple card shuffler to be used in between games with the purpose of providing efficiency and preventing card counting during blackjack games. Since this first product the company has expanded and developed three different generations of shufflers and has added to its product portfolio other specialty games such as slot machines and more recently wireless electronic card games.
Today the company’s principle activities include the development, manufacturing and marketing of technology-based products for the gaming industry within two product segments: utility products and entertainment products. Although now based out of Las
Vegas Nevada, Shuffle Master provides products and services to Canada, Europe, South
America, Africa, and Australia; a tremendous amount of growth from its original licensing agreement in Nevada.
3 b.
Product Portfolio : i.
Entertainment Products
Entertainment products were added to the company’s portfolio in 1996 and have quadrupled in the past ten years. This segment includes live games, electronic wagering tables, game tournaments, and merchandising opportunities. Currently the entertainment product segment includes 4 of the top 5 titles in the industry.
Revenue opportunity from this segment comes from collecting royalties from intellectual property as well as the sale of the products themselves. In 2006 (as of July) over 4,000 games have been installed in casinos compared to the 3,681 total from 2005.
2 http://www.nytimes.com/2006/11/01/business/01gamble.html?ref=business
3 www.shuffleMaster.com

This segment offers a tremendous opportunity for revenue growth as the demand for such games increases. ii.
Utility Products
Utility products were among the first developed by Shuffle Master. Since the first automatic shuffler hit the scene in 1992, Shuffle Master has produced three generations starting with the mechanical shufflers of 1992 to the now used computer controlled shufflers. Besides shufflers, the utility product portfolio includes roulette chip sorters and intelligent table system.
As of July 2006, over 21,000 shufflers have been installed this year alone. That is a little under 200 more than 2005 as a whole. The company’s roulette section is relatively new, since May 2004 and has so far proven to be successful with a market of over 8,000 tables worldwide. c.
Business Plan
Shuffle Master is dedicated to providing their customers with profitability, productivity and security. By continuing research and development, the company is able to constantly improve their equipment and replace older, out-dated machines.
4 i.
Strategic Alliances
In order to prepare for the future and continue to grow and expand, Shuffle Master has entered into several partnerships with similar companies. One of the bigger of these is the company’s partnership with Progressive Gaming International and International
Game Technology to develop a better roulette sorter. By utilizing specialized capabilities from each company, Shuffle Master was able to expand this product line. Such alliance have enable the company to go beyond their capacity has a company and at the same time keep cost relatively low. ii.
M&A
Shuffle Master has been involved in several mergers and acquisitions since the start of the company. Most recently, Shuffle Master acquired Stargames, a Sydney-based manufacturer of electronic entertainment equipment, which added three new products to the company’s portfolio and increased revenue in the third quarter by $8.7M.
The acquisition was partially paid for through a cash reserve and a loan of $115M scheduled to be paid off by the end of the year. As of July 31 statements, the loan balance was $80M, which in this quarter has already dropped to $70M. iii.
Other Developments
In addition the recent acquisition of Stargames, Shuffle Master has experience other developments in the past year that position the company for future growth. Last month the company signed a contract with the Delaware State Lottery to install 54 units of Table
4 www.yahoo/finance.com

Master, an electronic table game platform. According to CEO, Mark Yoseloff, this is the
“single largest placement of this type.” 5
Earlier in the month, Shuffle Master completed a patent-licensing agreement with
Progressive Gaming International. Under this agreement Shuffle Master has the right to use over forty patents licensed by Progressive Gaming in their own games. This agreement is exclusive and can not be offered to any other producer of such products.
Shuffle Master has agreed to a one-time payment in stead of regularly paid royalty fees.
This agreement not only allows Shuffle Master to extend their portfolio, but through the help of a competitor has put themselves in a position higher than others.
6
More recently, Delaware casinos were given legal permission to use Shuffle Master’s electronic blackjack games. This is a huge advancement for the company. Delaware has outlawed casino-style black-jack, but has stated that Shuffle Master’s virtual games do not violate laws against “table games.” With so much controversy around gambling and casinos, Shuffle Master is showing resilience and the ability to adapt to such changes. 7 d.
Risk Analysis
There are risks involved with investing in SHFL. These risks as stated in SHFL quarterly filings are summarized below.

Consumer preference . As with any product based company, SHFL must consider the growing and changing needs of customers. So far SHFL has been able to accommodate those needs with an ever growing product line.

Competition . SHFL must compete with other producers for limited casino floor space. By partnering with the competition, SHFL has been able to stay a strong force in the industry.

Higher than expected costs . This was a factor this past year with the unexpected costs related to Stargames (quarter 2). In the past SHFL has held a reserve for such instances and future acquisitions.

Legislation against gambling and casinos . Being a part of the gaming industry, SHFL faces this inherent risk. The company is constantly updating their product line to ensure compliance with such regulations. e.
Pro Forma Statements and Estimates
Earnings for SHFL are expected to decrease from last year. This is mostly due to the loan associated with the acquisition of Stargames as well as a one time R&D expense also associated with Stargames. As the company enters 2007, however, earnings are expected to increase by 25% and continue to increase through the 15 month work out period.
5 “Shuffle Master, Inc Announces Update on Delaware State Lottery Contract” www.biz.yahoo.com
.
6 “Shuffle Master, Inc. Announces Completion of Patent Licensing Agreement with Progressive Gaming
International.” www.biz.yahoo.com
.
7 “Casinos deal blackjack by another name.” www.delawareonline.com
.

The following pro forma income statement was produced by the researcher (Alexandria
Vita) and is based off analysts’ estimates as well as company outlook and future statements.
Shuffle Master Inc.
Pro Forma Income Statement
In Millions of Dollars
Revenue 1
COGS 2
Gross Profit
Operational Expenses
R & D 3
G & A 4
Operating Income
Other Income (Expense)
EBIT
Income Tax Expense
5
Net Income
2007
Q1
(EST)
48.67
Q4 (EST)
44.65
16.0611 14.73
32.61 29.92
1.96
18.01
1.96
16.52
12.64
0.05
12.59
3.94
11.44
0.24
11.20
3.94
8.65 7.26
0.25 0.21
2006
Q3
40.73
13.34
27.39
(0.80)
14.85
13.34
2.00
11.34
3.90
7.44
0.21
Q2
43.30
14.44
28.86
22.33
13.36
(6.83)
2.48
(9.31)
3.24
(12.55)
(0.36)
Q1
33.32
9.92
23.40
Q4
34.00
9.00
25.00
1.96
10.00
2.00
9.00
14.00 11.44
0.49
10.95
3.73
7.22
-
14.00
3.83
10.17
0.21 0.22
Q3
27.27
6.99
20.28
1.79
6.47
12.02
0.29
11.73
3.66
8.07
0.23
2005
EPS
Assumptions
1
Assuming targeted sales of $162 million based on company history and estimates.
2 COG is approximately 33% of sales based on trend data and gross profit margin.
3 Assuming no unusual R&D expense.
4 Assuming continued 37% of sales.
5 Assuming 34.4% tax bracket. f.
Technical Analysis
The following graph, from Baseline, shows the percentage change in price for SHFL, the
Gaming and Casino Industry, as well as the S&P 500 over the past year.
Notice the large price increase in February and March and sudden dip in June as EPS missed analyst estimates. This is largely due to a one-time, unexpected cost in the second quarter and an amendment to a loan agreement associated with Stargames
Q2
27.13
6.71
20.42
2.10
7.90
10.42
(0.14)
10.56
3.73
6.83
0.19
Q1
25.37
5.92
19.45
1.86
7.88
9.71
0.34
9.37
3.27
6.10
0.17

.
IV.
Valuation Analysis a.
Pure Short Term Earnings
P*
SHFL
= Normalized P/E*FY 2007 EPS
P*
SHFL
= 35.08*.96
P*
SHFL
= 33.68
The Pure Short Term Earnings Model was used, multiplying the normalized P/E
(calculated using future and historical estimates) and the EPS for 2007 as determined by the researcher through Pro Forma Statements. b.
Holts Model
The industry as well as two competitors were used to calculate the Holt’s Model in order to account for the variety in the industry itself. Notice the variation between the Casino and Gaming industry and the two competitors.

Casino & Gaming Gaming Partners International WMS Industries
Pessimistic Scenario
SHFL earning grow at 20%
Pessimistic Scenario
SHFL earning grow at 20%
Pessimistic Scenario
SHFL earning grow at 20%
PE
SHFL
= (
1+.20+0.00
) 2 = 1.07015
PE
USPH
= (
1+.20+0.00
) 2 = 1
PE
SHFL
PE
WMS
= (
1+.20+0.00
) 2 = 0.8928
PE
CSINO
1+.16+0.00
SHFL Fair P/E = (1.07015)(25)=26.753
SHFL FY 2007 EPS = $.96
Fair Value = $25.68
Moderate Scenario
SHFL earning grow at 25%
PE
GPIC
1+.20+0.00
SHFL Fair P/E = (1)(32)=32
SHFL FY 2007 EPS = $.96
Fair Value = $30.72
Moderate Scenario
SHFL earning grow at 25%
1+.27+0.00
SHFL Fair P/E = (.8928)(34.7)=30.98
SHFL FY 2007 EPS = $.96
Fair Value = $29.74
Moderate Scenario
SHFL earning grow at 25%
PE
SHFL
= (
1+.25+0.00
) 2 = 1.1612
PE
CSINO
1+.16+0.00
SHFL Fair P/E = (1.1612)(25)=29.03
SHFL FY 2007 EPS = $.96
Fair Value = $27.87
PE
USPH
= (
1+.25+0.00
) 2 = 1.08506
PE
GPIC
1+.20+0.00
SHFL Fair P/E = (1.08506)(32)=34.72
SHFL FY 2007 EPS = $.96
Fair Value = $33.33
PE
SHFL
PE
WMS
= (
1+.25+0.00
) 2 = 0.96875
1+.27+0.00
SHFL Fair P/E = (.96875)(34.7)=33.62
SHFL FY 2007 EPS = $.96
Fair Value = $32.27
PE
SHFL
Optimistic Scenario
SHFL earning grow at 40%
= (
1+.40+0.00
) 2 = 1.4566
PE
CSINO
1+.16+0.00
SHFL Fair P/E = (1.4566)(25)=36.42
SHFL FY 2007 EPS = $.96
PE
USPH
Optimistic Scenario
SHFL earning grow at 40%
= (
1+.40+0.00
) 2 = 1.36111
PE
GPIC
1+.20+0.00
SHFL Fair P/E = (1.36111)(32)=43.56
SHFL FY 2007 EPS = $.96
Optimistic Scenario
SHFL earning grow at 40%
PE
SHFL
PE
WMS
= (
1+.40+0.00
) 2 = 1.2152
1+.27+0.00
SHFL Fair P/E = (1.2152)(34.7)=42.167
SHFL FY 2007 EPS = $.96
Fair Value = $34.95 Fair Value = $41.81 Fair Value = $40.48
Weighted average fair value according to the Holt’s Model: 32.53
According to these valuation models, SHFL is 17.69% undervalued.
V.
Recommendation
Despite two rough quarters, SHFL is back on track and holds a promising future with new partnerships and contracts in the fourth quarter. With the repayment of the Bridge
Loan (Stargames) the company will substantially reduce costs associated with interest and amortization of debt. Revenues are also expected to increase into the next fiscal year and as a result increase earnings for the 15 week holding period. While the price is still low, I would recommend to the Roland George Investments Program the purchase of
:
1800 shares of SHFL .