Gtech Unfairly Stung by British Libel Ruling, Analysts Say

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The chairman just resigned after being convicted of libel.

The company is on the verge of losing its most profitable contract.

What better time to buy the stock?

That, at least, is the opinion offered by several sell-side analysts and money managers who follow

Gtech

(GTK)

, the Rhode Island-based company that runs dozens of state and national lotteries.

The bad headlines that hit Gtech last week after an English jury ruled that Chairman Guy Snowden lied when he denied trying to bribe British entrepreneur Richard Branson can't obscure the company's solid earnings and enormous cash flow, the bulls say. And they hope that Snowden's resignation may at last allow Gtech to shed its reputation for pushing the limits of the law to win contracts in the politically charged business of administering lotteries.

"I love the story. The fundamentals are unbelievable. The valuation is even better," says Paul Meeks, the head of research at

Jurika & Voyles

, a California money manager with about $7 billion in assets that is Gtech's second-largest shareholder. "They haven't missed a quarterly estimate for years. They generate huge cash flow."

Gtech posted $5.90 per share in cash flow -- or earnings before interest, taxes and noncash depreciation charges -- in 1997. In 1998, cash flow should be about $6.50 per share, according to

Merrill Lynch

analyst Naomi Talish, who rates the company a long-term buy. Merrill Lynch has participated in Gtech underwritings in the last three years. She notes that Gtech, which closed Monday at 27 9/16, down 13/16, is trading at about four times its 1998 cash flow, less than one-third the average valuation for companies in the

S&P 500

.

Of course, Gtech's business is unusually capital-intensive. Its contracts with state lotteries usually run five to seven years, occasionally with a couple of one-year extensions, and Gtech usually installs a new set of lottery terminals each time it wins a new contract. The company must then depreciate the cost of the terminals over the relatively short life of its contracts. So higher-than-normal depreciation charges take a bite out of Gtech's earnings.

Still, Gtech is hardly expensive on a price-to-earnings basis. The company will earn around $86 million, or $2.10 per share, in its 1998 fiscal year, which ends at the end of this month. For the 1999 fiscal year, it's expected to earn $2.47, according to

First Call

. By that standard, Gtech is trading at a bare 11 times forward earnings, about half that of the average company.

But those earnings come with a big asterisk, says

Gerard Klauer Mattison

analyst William Schmitt. The Texas Lottery, which is Gtech's largest and most profitable account, contributing about 15% of the company's revenues and about 40 cents per share in earnings, has been feuding with the company for months. In August 1997, Texas asked for new bids for its lottery contract, and Gtech, believing that the terms that the lottery sought were unfair, declined to bid.

Now, although Gtech argues in

Securities and Exchange Commission

filings that "it is party to a valid contract with the (Texas Lottery) Commission through August 2002," Schmitt says the company may well lose its contract before then.

"I don't even have Texas in the numbers anymore. I assume that it goes away in September '99," Schmitt says. Even so, he thinks Gtech's earnings will rise to $2.70 in the fiscal year ending in February 2000, as growth in other jurisdictions makes up for the loss. He rates the company a buy.

Not everyone is so sanguine.

Salomon Smith Barney

analyst Bruce Turner cut his rating on Gtech from outperform to hold after the libel verdict.

"While government contracting of any type generally involves warlike bidding, politicians generally react harshly to issues, or even perceptions of issues, regarding attempts to unethically buy political favor or otherwise influence the structured bid process ... The jury has spoken, and a dark cloud will hang over Gtech."

Schmitt says the real risk for Gtech is that states other than Texas will try to rebid or revoke their contracts with the company because of the unsavory actions of Snowden, its former chairman. Branson, Britain's most popular businessman, said that Snowden tried to bribe him in 1993 to ensure that a group that included Gtech would be the only bidder on the British national lottery. (Snowden's exact words, according to Branson: "I don't know how to phrase this, Richard. There is always a bottom line. Let me get to the point. In what way can we help you, Richard?") Snowden denied the charge, but a jury agreed with Branson, ordering Snowden to pay Branson 100,000 pounds.

Despite the ugly headlines the verdict generated, Schmitt says Snowden's resignation may help Gtech. "What we have today is really a new regime that I don't think people can look on as being associated with the past problems with the company," he says. Indeed, several states have already said they remain committed to using Gtech to run their lotteries.