Intralot

The world's #2 lottery company knows how to hedge its bets. Intralot S.A.
(second only to Italy's Lottomatica) designs and develops hardware and
software for lottery gaming systems around the world. It also operates the
lotteries, including managing the games, printing tickets, handling
advertising and marketing, and controlling payments and payouts. Intralot
offers more than 400 games, including sports betting, fixed odds betting,
pari-mutuel wagering, video lottery, instant games, and online betting.
The company has operations in more than 50 countries, and in the US it
manages the lotteries for 11 states. Intralot was founded in 1992 by
chairman and majority shareholder Socrates Kokkalis.

The company’s main segments are:

• Hardware and software (gaming machines, central computer
systems, gaming software, communication systems)
• Technical services (technical support)
• Gaming management (design, organization and management of
games, advertising, marketing, risk management, sales network
etc.)
• Game operation (installation, payment management etc.)

The company has made substantial investments over the past 5 years,
totaling over €600 million. They’ve rapidly expanded into both emerging
and developed markets, and have drastically improved and diversified
their operations. Much of their business involves signing licenses, with
varying durations. Although the startup costs are often quite high, the
returns to be earned afterwards are also quite high. So whilst the past two
to three years have seen lower bottom line, both as a result of the
economic environment and the massive investments made (including
write downs etc.), these investment will be attractive, and should allow the
company to earn high returns on capital going forward. Management has
expressed a desire to streamline operations and cut non-performing
operations, which should help improve efficiency and move margins back
up.

How to identify good companies? Does the company have a moat? The
first thing to do is look for evidence of a moat; companies with moats are
often able to earn excessive returns on capital for sustained periods.
Although Intralot’s returns of equity have declined over the past few years
for various reasons, they remain above 15%, which is high in both
absolute terms, and relative to competitors. So in this regard the company
would appear to have a competitive advantage. What is the competitive
advantage, and why is it able to persist?

Companies need to know-how, expertise and research and development

capabilities to develop the wide array of games etc. Even once this
technological and software barrier has been overcome, the competitor
would then have to obtain regulator licensing in the relevant market,
which is also a substantial hurdle. For this reason, Intralot and the industry
have high barriers to entry.

Diversity and range of offerings is a competitive advantage. Huge library.

Intralot's games library includes a variety of games such as numerical
games, TV lottery games, sports lotteries, fixed odds betting, instant
lotteries, pari-mutuel, video lottery and monitor games

Reasons for revenue decline or decline in EBITDA or margin compression:

• Negative impact of the economic turmoil

• Currency devaluations in many countries
• Burdened with significant start up expenses due to a number of new
projects that it had undertaken internationally (acquisitions and new
terminals)
• Fees from its contract in Turkey have been lower since March 2009,
after the renewal of the contract for the next 10 years
• Write-downs and provisions
• Extraordinary taxes imposed to 2009 results

From the 2009 Annual Report: Negative impact of the economic turmoil in
its operations, it was also influenced from the currency devaluations in
many countries, where it has presence, it was burdened with significant
start up expenses due to a number of new projects that it had undertaken
internationally, while the fees from its contract in Turkey have been lower
since March 2009, after the renewal of the contract for the next 10 years.
In this respect, INTRALOT’s consolidated revenues in 2009 decreased by
16,1% to €903,6 mil. and the consolidated net income after taxes & after
minorities reached €49,8 mil. in 2009 from €50,1 mil. in 2008. If we take
into consideration the write-downs and provisions, as well as the
extraordinary taxes imposed to 2009 results, consolidated net income
after taxes & after minorities reached €73,9 mil. decreased by 18,7%
compared to 2008. Concerning Parent company results, revenues were
€151,6 mil in 2009, while net income after taxes reached €2,7 mil. The
Group return on equity in 2009 was shaped at 23,37%.

None of the developments that have caused the declining margins and
returns on capital are long-term. Most of these are short-term
problems/situations that do not materially affect the elements that
contribute to the company’s competitive advantage. They still have
superior technology and a wide and diverse range of games, and still
provide an attractive overall product/services. In fact, during the period,
they have the company has undertaken the improvement of the offering
products and services and the development of new technologies. In
addition, the company has expanded into a large number of markets with
various different game/lottery types, and as such has greatly diversified
operations.

The company has been making substantial efforts to expand and continue
growing by acquiring other companies and increasing their ownership
stakes in existing companies. Previously, many of the gaming markets
were regulated, and Intralot was one of the main suppliers of games etc.
to the government led industry; now with liberalization (or voting in
parliament), many of these markets will be opened, but not completely. In
various countries, only a limited number of licenses will be offered, so
competition will still be reduced…there is more opportunity for volume,
but probably at lower margins.

SWOT

Strengths:
• Large variety of games (over 400)
• Large diversity in types of games/solutions (sports betting, poker,
lottery)
• Diverse product offering, including platform, software, support,
management
• Complex technical expertise and reliability means the company is
more likely to get licenses etc.

Weaknesses:
• Bargaining power of buyers (government lottery monopoly)

Growth Opportunity:

• The company is focused on becoming a large player in:

o Emerging markets
o Liberalized developed markets
• The company is also focused on developing its presence in the
internet gaming market, and therefore launched Intralot Interactive,
and also acquired stakes in interactive gaming platform providers
such as CyberArts

Opportunities:
• Online Gaming Market
• Emerging Markets
• Outsourcing of US and other developed market Lottery Services
• Legalizing of now mostly illegal gambling/lottery markets in Asia
(Vietnam Example)

New Markets/projects:
• Italy (video lottery through joint venture with Cogotech)
• Morocco (management of two state lotteries)
 • Brazil (state lottery in Mina gerais)
• Azerbaijan (sports betting games)
• USA (Vermont, new Hampshire etc. state lotteries)
• Caribbean (SVL etc.)
• Netherlands
• France (liberalization of internet gaming, acquired license)
• Croatia (state lottery)

Threats:
• Increased/higher gaming taxation
• Currency Weakness

In order to become a service provider and solutions manager, companies

must receive accreditation, which is a long and difficult process.

INTRALOT has become the first international lottery vendor certified with
the World Lottery Association (WLA) Security Control Standard Certification
along with ISO/IEC 27001:2005 certification.

INTRALOT has been ISO 9001:2000 certified. This certification guarantees

that the products, systems and services provided to INTRALOT’s
international clients comply with the highest quality standards.

INTRALOT S.A. has been also certified for its Information Security
Management System (ISMS) against the requirements of the international
standard ISO27001:2005.

In most markets, including Australia etc. limited licensing to operate

lottery machines have been provided, and Intralot is consistently one of
the only companies that have been awarded the licenses, which makes
high barriers to entry for other companies (high margins). In the
liberated/non-regulated market, still limited licenses are being offered (5
to 10), and because of the experience and variety of games, Intralot is
likely to develop a first mover advantage in those markets as well.

INTRALOT, as a provider of technological solutions and services to lotteries

has limited global competition and there are strong barriers for new
players to enter. Moreover, there are substantial growth opportunities
from the liberalization of gaming markets and particularly the rapidly
increasing licensed Internet market, the lottery privatizations and the
legalization of lottery games. All these opportunities arise from the need of
the governments to maximize their lottery revenues, especially during
difficult economic periods with increasing budget deficits, such as the
current one.

The company runs stand alone gambling operations, but also licensing
software to monopoly providers (government run operations). As such,
many of the company’s main clients are monopoly operations, and have
very stringent/substantial requirements.

The results of the Group in 2011 will depend, among others, on the course
of the new markets where it has established its presence and the projects
that 2011 will be their first full year of operations, such as: Italy, where
INTRALOT has entered the newly established Italian video lottery (VLT)
market through a joint venture with Cogetech S.p.A., a leading licensed
VLT operator in Italy. The operation of the VLTs started at the end of 2010,
while the establishment of the network of 1.500 VLTs is expected to
complete by the end of the first semester of 2011. Morocco, where
INTRALOT after an international tender undertook the management of the
two state lotteries in the country. The project started during August 2010.
Brazil, where INTRALOT, following an international tender, undertook the
operation of the lottery games in the state of Minas Gerais. The project
started in September 2010. INTRALOT S.A.

• Azerbaijan, where INTRALOT in the beginning of 2010 undertook the

management and the development of the sports betting games in
the country. The project started in the beginning of 2011.
• USA, where three new lottery contracts of INTRALOT, in Louisiana,
New Hampshire and Vermont, commenced in July 2010, while in
December 2010 started the new project of the Company with the
State Lottery of Washington D.C.
• The Caribbean and specifically in Jamaica, where INTRALOT has
increased its participation in Supreme Ventures Limited (SVL).
• Netherlands, where the significant project of INTRALOT with both the
leading lotteries of the country started during the second quarter of
2010.
• France, where after the liberalization of the Internet gaming market,
INTRLALOT in
October 2010 awarded a license for Internet sports betting.

Company’s financial situation

Loan Α: On December 20, 2006, Intralot Luxembourg (“Issuer”) issued a

convertible bond with a face value of € 200 million maturing on December
20, 2013, at which point the holder, in case the right to convert was not
exercised in 2013, may opt for repayment of € 230.076.637,6 (nominal
value increased by 15,04%) or conversion into 13.289.036 common shares
of Intralot S.A.. Interest is payable semi-annually in arrears at a nominal
interest rate of 2,25% per annum. The loan is listed at the Luxembourg
Stock Exchange.
• Loan B: On July 2006 the parent company decided to borrow through a
bond issue of 70 million EURO. The financing bears floating interest 3M
Euribor plus 0,85% spread. The bonds mature in July 2011. The company
holds the right to repay the face value of the bond under certain
conditions. The terms of the bond issue contain events of default
including, among other usual terms for such a loan the following: to file
audited financial statements and offer the bond holders any relevant
information for its financial position, to have secured its assets, not to
move its base outside Greece, to reveal any denunciation, to pay in due
course amount owed to the public, to inform the trustee about any legal
issues remaining affecting its financial performance.

• Loan C: On December 2007 a foreign subsidiary entered in a syndicated

revolving credit facility agreement for 500 million EUR for 5 years, of
which 200 million were utilized.

This industry could quite readily be compared to the pharmaceutical

industry, in the sense that major investments must be made in order to
acquire, and set up new deals/territories, but the licenses often last 5 to 7
years, and during those periods ROE is abnormally high as the company
benefits from strong barriers to entry. At this point, the company has
made substantial investment to establish themselves in developing
markets, and has signed various multi-year licenses. Acquiring the patent
is expensive, and returns on equity are lower during phases in which
heavy costs are taken, however, once the patent is given, the company
benefits from a margin of safety that allows for superior returns on capital.
Intralot has made substantial investments to update their
products/improve their offerings, and has acquired new licenses in
multiple countries, either as the sole lottery licensee or one of two or
three, and therefore returns on