Slot-machine maker International Game Technology (NYSE: IGT - News) looks poised to jump on the bandwagon of companies that are increasing their stake in online gaming. The company plans to acquire Double Down Interactive, one of the biggest virtual casino operators on Facebook.
What's it all about?
Under this deal, IGT will pay $250 million in cash and $85 million in retention payments over the next two years. Additionally, IGT will pay up to $165 million to Double Down, depending on the latter's performance in the next three years.
All in all, this looks like a large amount to pay for a company the size of Double Down, but it's not as if IGT can't afford it. IGT generated over $400 million in free cash flow over the last year.
So is the cash worth it?
This deal will certainly broaden IGT's scope of operations. Already a seller of gaming equipment to casinos, it will now be able to sell virtual products to virtual casinos as well. Being the third-largest social gaming application, Double Down may well provide IGT with a valuable foothold in casino-style social gaming.
Double Down has significantly increased its user count, to 4.7 million now from 3.3 million in October last year, as it capitalizes on the rapidly growing online gaming industry. The industry in itself is expected to grow to $30 billion in 2012 from $20 billion in 2010. What I do like about the deal, however, is the exposure to a new and complementary set of gamers, which is sure to drive IGT's fiscal 2012 earnings. But there's another, larger aspect to it.
What's the catch?
The Double Down deal would mean that IGT is investing around $100 for each one of the former's roughly 5 million users. Now that's a lot of money, something that can be justified only if we consider the potential big bucks IGT can earn if online gambling is legalized. In fact, legalization of online poker would be a dream come true for the casino and gaming industries, something that may be fast becoming a reality as the Justice Department considers doing away with the ban on online gambling.
However, IGT isn't alone. Facebook game maker Zynga (Nasdaq: ZNGA - News) has about 30 million players for its online poker game and could be a great partner for a big branded casino. Industry titan MGM (NYSE: MGM - News) has already partnered with Bwin.Party, and Boyd Gaming and is likely putting pressure on other operators to get a foothold in the space while they still can. IGT could be in for a lot of trouble if an operator inks a deal with Zynga.
Stakes in online gambling will be lower than those at real casinos. Nevertheless, the company's exposure to a widespread online audience should create abundant volumes to push up revenue. Looking at it from that aspect, $500 million doesn't seem particularly extravagant to me, after all.
The Foolish bottom line
This deal could very well be IGT's royal flush. The company seems to be banking on potential revenue based on the expectations that online poker will be legalized. Till then, let's keep our fingers crossed on this one.
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Navjot Kaur does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of International Game Technology. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.