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Scientific Games: Lotto Winner

This lottery-equipment company has been on a roll and has the potential to further extend its gambling franchise abroad.

Scientific Games gets paid whether you win or lose. The company supplies equipment to run state lotteries and pari-mutuel betting at dog and horse race tracks. Lately, the New York City company has been on a roll, buying businesses that extend its gambling franchise to more countries. Citigroup analyst Geoffrey Davis rates the stock (symbol SGMS) a buy based on the potential for Scientific Games to use its size to win more business overseas, particularly in Germany.

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In 1974, Scientific Games produced the first scratch-off ticket for the Massachusetts lottery. Now the company makes 15 million scratch-off tickets per year, making it the dominant player in the instant-ticket business with a 65% share of the market.

Scientific Games is also involved in lotteries, such as Powerball, in which players buy a ticket and wait for a television drawing. In January, the company bought Stockholm, Sweden-based rival EssNet for $60 million. EssNet runs online lotteries in Australia and Europe, including those in 13 of 16 German states. "EssNet's online lottery relationships should help the company compete for new instant-ticket business in Germany," Davis says. In March, Scientific Games began operating two German instant-games contracts that Davis believes will add $8 million, or 9 cents a share, to yearly profits. Moreover, he says, the acquisition puts the company in position to vie for at least a dozen more deals in Germany.

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EssNet is only the start of Scientific Games' spending spree. Pending regulatory approvals, the company expects the $183 million purchase of Global Draw, a maker of sports-betting machines in the United Kingdom, to be completed by June. And on April 5, Scientific Games bought a Connecticut betting parlor for $12 million. Scientific Games runs nearly all the off-track betting facilities in Connecticut and operates all on-track and off-track pari-mutuel wagering in the Netherlands under a license that lasts until June 2008.

Despite the moves into other kinds of gambling, the bulk of Scientific Games business is lotteries, which offer a steady stream of recurring revenues. All told, the company generated revenues of $782 million last year, about 75% coming from its lottery operations. It earned $75 million, or 81 cents per share.

Shares of Scientific Games, at $35, are near their all-time high. The stock trades at 28 times the $1.27 per share that analysts, on average, expect the company to earn this year, according to Thomson First Call. Davis thinks the company's gamble on the international lottery market could boost 2006 profits to $1.32 per share. That and future overseas growth makes the stock worth $42.50 a share, he says.

--Thomas M. Anderson

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