TEXT-S&P rates Scientific Games proposed notes

Wed Aug 15, 2012 12:17pm EDT

Overview
     -- U.S. gaming services provider Scientific Games plans to issue
$250 million of senior subordinated notes due 2020.
     -- We are assigning the notes our 'BB-' issue-level rating, with a 
recovery rating of '5'.
     -- The stable rating outlook reflects our expectation that credit 
measures will remain at a level we believe is in line with the current rating.

Rating Action
On Aug. 15, 2012, Standard & Poor's Ratings Services assigned its issue-level 
and recovery ratings to Scientific Games International Inc.'s proposed $250 
million senior subordinated notes due 2020. The notes were rated 'BB-' (one 
notch lower than the 'BB' corporate credit rating on parent company Scientific 
Games Corp.) with a recovery rating of '5', indicating our expectation of 
modest (10% to 30%) recovery for lenders in the event of a payment default. 
Proceeds from the notes offering will be used to redeem or repurchase the $200 
million 7.875% senior subordinated notes (including accrued interest and the 
applicable redemption premium), and for general corporate purposes.

All existing ratings, including the 'BB' corporate credit rating on Scientific 
Games Corp., are unchanged. The rating outlook is stable.

Rationale
Our 'BB' corporate credit rating on Scientific Games reflects our assessment 
of the company's financial risk profile as "aggressive" and its business risk 
profile as "fair," according to our criteria. 

Our assessment of its financial risk profile as aggressive reflects our 
expectation that our measure of leverage will remain below 5x over the 
intermediate term. It also reflects the company's substantial acquisition 
activity and investments through joint ventures, its "adequate" liquidity 
profile, and our expectation for interest coverage to track around 3x over the 
near term.

Our assessment of Scientific Games' business risk profile as fair reflects 
competitive market conditions in the lottery industry for contract renewals 
and for new contracts, which often result in pricing pressure; the mature, 
capital-intense nature of the lottery systems industry; and the company's 
limited business diversity. Offsetting factors are Scientific Games' 
leadership position in the instant ticket lottery segment of the gaming 
industry, a diversified customer base, and substantial recurring revenue and 
cash flow, given long-term contracts with renewal options that are typically 
exercised.

Our rating factors in the expectation that Scientific Games' revenue and 
EBITDA will grow in the mid-single-digit percentage area in 2012. Our revenue 
assumption incorporates an expectation for continued weakness in instant 
ticket revenue, largely the result of a weak macroeconomic environment in 
Italy. We are currently incorporating an expectation that declines continue at 
the same level as the second quarter for the remainder of 2012. (Instant 
ticket revenue declined 8.3% in the second quarter.) Our expectations for the 
Italian instant ticket business are largely driven by our European economist's 
baseline forecast for a 2.1% decline in GDP in 2012 and 0.4% decline in 2013 
in Italy, and for unemployment to increase to 10% by the end of 2013. We are 
factoring in high-single-digit revenue growth across Scientific Games' service 
and sales revenue (excluding the acquisition of Barcrest). Our forecast also 
factors in a modest level of incremental revenue associated with the company's 
acquisition of Barcrest last year. Our performance expectations for the 
company's lottery business factor in our U.S. economist's forecast for modest 
consumer spending growth and changes in various lotteries, including the 
Powerball price increase and the ability to sell some lottery products through 
the Internet channel. We expect growth in the lottery segment in the remainder 
of the year to be more moderate than first-quarter sales levels, which were 
aided by strong jackpot activity. Additionally, we believe economic 
uncertainty in many European markets could dampen international growth. 

In addition to the revenue drivers above, our EBITDA forecast also factors in 
an expectation for about $55 million in cash distributions from joint ventures 
in 2012, slightly higher than distributions received in 2011. (We include 
return of capital payments in our measure of cash distributions.) Under our 
performance expectations, we believe leverage will remain in the high-4x area 
in 2012, and that the company will continue to improve leverage in 2013, 
building in additional cushion relative to the 5x maximum leverage threshold. 
We view some cushion relative to our threshold as necessary to provide 
Scientific Games with flexibility to pursue additional strategic growth 
opportunities without meaningfully impairing its financial risk profile.

While revenue growth has somewhat exceeded our expectations in the first half 
of the year, EBITDA has performed in line with our expectations. In the six 
months ended June 30, 2012, Scientific Games' revenue increased 11%. EBITDA 
(which we adjust to include cash distributions and return of capital payments 
from joint ventures) increased about 6%. At June 30, 2012, leverage and 
coverage were 4.8x and 2.9x, respectively. 

Scientific Games is a leading integrated supplier of instant tickets, lottery 
gaming systems and services, and server-based interactive gaming terminals and 
systems to lottery and gaming organizations worldwide. While the company 
remains a distant second in the lottery systems segment, behind industry 
leader Lottomatica SpA, Scientific Games is the leader in the instant ticket 
segment of the lottery industry, which has grown more rapidly in recent years.

Liquidity
Based on the company's likely sources and uses of cash over the next 12 to 18 
months and incorporating our performance expectations, Scientific Games has an 
adequate liquidity profile, according to our criteria. Relevant factors in our 
assessment of Scientific Games' liquidity profile include the following:
     -- We expect the company's sources of liquidity over this period to 
exceed its uses by 1.2x or more.
     -- We expect that net sources of liquidity would be positive, even if 
forecasted EBITDA declined 15%.
     -- We believe that Scientific Games has sufficient covenant headroom, 
such that a 15% decline in forecasted EBITDA would not result in a breach of 
financial covenants.  
     -- We believe Scientific Games has a sound relationship with lenders and 
a satisfactory standing in credit markets.

Liquidity sources include a $250 million revolving credit facility, a moderate 
cash balance, and internally generated cash. As of June 30, 2012, the company 
had approximately $212 million in availability under its revolving credit 
facility (after accounting for letters of credit outstanding) and a cash 
balance of $112 million.

In the 12 months ended June 30, 2012, Scientific Games generated about $157 
million in cash flow from operations and spent about $98 million on capital 
expenditures. We expect that operating cash flow generation in 2012 will be 
sufficient to cover our expectations for around $150 million in capital 
expenditures and that the company will generate a modest amount of free 
operating cash flow (FOCF) that it could use for debt repayment, modest-sized 
acquisitions, or possible additional strategic growth opportunities.

The company's credit facility includes several financial maintenance 
covenants. The total leverage covenant is set at 5.75x through Dec. 31, 2013, 
5.50x for all of 2014, and 5.25x thereafter. The senior leverage covenant is 
set at 2.75x, and the interest coverage covenant is at 2.25x. Under our 
forecast assumptions, the company maintains adequate cushion with respect to 
these financial maintenance covenants. 

The proposed $250 million senior subordinated notes offering, which will 
refinance the company's $200 million senior subordinated notes due 2016, 
improves Scientific Games' already strong debt maturity profile. Over the next 
few years, debt maturities consist primarily of amortization payments under 
the term loan until the company's term loan and revolver mature in June 2015. 

Scientific Games has a $200 million share repurchase authorization in place 
through the end of 2012, with roughly $172 million remaining as of June 30, 
2012. While the company has built in some flexibility to complete a modest 
level of share repurchases, we generally expect the company will use its 
resources for growth opportunities as they arise and have not incorporated any 
meaningful share repurchase activity.

Outlook
Our rating outlook on Scientific Games is stable, reflecting our expectation 
that credit measures will remain at a level we believe is in line with the 
current rating. Furthermore, we expect the company will continue to gradually 
improve its leverage profile over the next two years. This should allow 
Scientific Games to build in some cushion relative to our 5x maximum leverage 
threshold, which would provide it flexibility to make additional strategic 
investments without meaningfully impairing its financial risk profile. For 
2012, we have factored into our rating a mid-single-digit revenue and EBITDA 
increase. Under our performance expectations, we expect leverage to be in the 
high-4x area at the end of 2012 and EBITDA coverage of interest around 3x.

We could lower our rating if the company does not demonstrate organic growth 
in its existing businesses or if the company embarks on larger-than-expected 
investments for acquisitions or other strategic growth opportunities, such 
that we no longer believe the company has the ability to maintain leverage 
below 5x. A higher rating is unlikely over the next two years, given our 
expectation that Scientific Games will pursue investment opportunities and 
that leverage will remain in the mid- to high-4x area, on average.
Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Scientific Games Corp.
 Corporate Credit Rating                BB/Stable/--

New Ratings

Scientific Games International
 Subordinated
  $250 mil sr sub notes due 2020        BB-
   Recovery Rating                      5
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