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Scientific Games an Instant Winner in China

With its entrance into the Chinese market, this gaming stock is poised to outperform the rest of the sector.

The quick-thrill "scratch and win" lottery tickets seem to be in every corner store and gas station across America, with snazzy and playful names such as "Bada Bling" or "Cashtastic."

However, in China, the novelty of the ubiquitous convenience-store game is young and fresh. And most important, it is finding an eager consumer.

This is a huge opportunity for

Scientific Games

(SGMS) - Get Scientific Games Corporation Report

, which has recently entered the huge Chinese market. The instant-lottery business is lucrative here stateside, where the company distributed 31.5 billion instant tickets in 2007. Can you imagine the potential for business in China, where the population is more than four times ours and games of chance could almost be considered the national pastime?

On June 20, Morgan Stanley upgraded shares of Scientific Games, citing China as the primary growth driver. After meeting with several industry leaders, it sees the rapid adoption of the instant lottery games by the Chinese consumer and sees motivated partners in the China lottery industry "driving an unprecedented nation-wide rollout of distribution points."

Further, Morgan Stanley states that current demand exceeds supply. It believes that instant game sales will exceed $5.8 billion in 2009 and could reach as high as $11.7 billion. Morgan Stanley's analyst set a new price target of $42, up from the previous $28.

Earnings estimates are rising but still don't reflect the upside potential of entry in the China market. Currently, SGMS trades with a P/E ratio of about 19 on its forward 2009 earnings estimates, with a long-term growth rate of 18%. I see significant upward estimate revisions coming in the near future as the rest of the sell-side analysts catch on to the China potential.

The stock of Scientific Games has performed well over the past few months and is particularly impressive given the dismal state of the overall gaming sector. With the weak domestic environment, most gaming stocks in the group are hitting new lows and look to continue their downward path.

Shares of Scientific Games hit a near-term low of $17.03 on March 11 and have run 70% since. This compares with abysmal returns during the same time frame of

Las Vegas Sands

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(LVS) - Get Las Vegas Sands Corp. Report

, down 40%;

MGM Mirage

(MGM) - Get MGM Resorts International Report

, down 43%;

International Game Technology

(IGT) - Get International Game Technology PLC Report

, down 45%; and

Boyd Gaming

(BYD) - Get Boyd Gaming Corporation Report

, down 35%.

So next time you see these instant lottery games at your local deli, instead of buying tickets to "scratch and lose" your money, consider buying a few shares of Scientific Games to profit.

Patrick Schultz is a research associate at He has previously obtained securities licenses under the NASD's Series 7, Series 24, Series 52 and Series 63 exams and has worked in the financial markets on various trading desks in addition to trading for his own account. Schultz holds a bachelor's degree in applied economics from Cornell University.