Shuffle Master Is a Little Known Equity,

Shuffle master is a little known equity, as evidenced by the fact that it is 95% owned by institutional investors such as pension funds and mutual funds. It is what would be considered a small cap stock, with a capitalization of a mere 500 million dollars. The company is unique in that it maintains almost no debt and maintains no long-term debt. With a beta of.659, Shuffle Master has less than half the undifferentiable risk that its market peers do, but more than the industry average of.54. Shuffle Master's P/E is higher than average at slightly more than 32. The industry average is between 25 and 26. According to the most recent income statement, 12-month trailing revenue growth totals 17%. This is exceeded by earnings growth, which at 20.9% reflects both decreasing expenses and the non-existence of interest expenses.

Shuffle Master's profit margin, at 25.82%, is quite high, as is its operating margin of 38.64%. The company derives its profits from the sale and lease of gambling equipment. One of the reasons that Shuffle Master is unable to borrow is that many banks are unwilling to lend to the gambling industry. However, Shuffle Master is largely self-financed; it does not pay any dividends. With a market capitalization of 11.22 billion, International Game Technology is Shuffle Master's largest competitor.

Shuffle Master, Inc. develops, manufactures and markets automatic card shufflers that are used with card-based table games. As of the publication of the last 10-K SEC form at the end of last year, approximately 9,475 of its shufflers were installed in casinos and other gaming establishments, of which 3,237 units were leased and 6,238 units were sold. Shuffle Master also sells table games and licenses these products to casinos. Such games include the Let It Ride basic game, the Let It Ride Bonus game and the Three Card Poker game. As of October 31, 2002, 1,517 of Shuffle Master's table games were installed. Shuffle Master also develops and markets slot machines and slot game operating systems. The company licenses and sells slot machine games and sells them to casinos, of which 765 units were on lease and 147 were sold.

For the first three fiscal quarters of 2003, which ended on 7/31/03, revenues rose 18% to $47.9 million. Net income also rose, from 25% to $12 million. These revenues reflect an increase in the installed base of multi-deck shufflers. Higher production levels have lead to lower costs as a percentage of sales.

We maintained a conservative estimate of revenue growth, projecting that it will only increase at a rate of 17%, tapering off from its 20% level. Although we extended this estimate to all of Shuffle's revenue streams, it is notable that revenues from Table and Shuffle Sales have been gaining momentum while its leases and table royalties have been stable. Management indicates a warm reception for its slot machines and slot game operating systems. As of October 31, 2002, Shuffle Master was selling The Three Stooges, Let's Make A Deal, The Honeymooners, Press Your Luck, Hollywood, Spider-Man and Five Deck Pokergames. We expect these to experience stable growth.

Shuffle Maker's performance is largely inelastic to market performance as gambling fares well in good economic time as well as bad. This doesn't mean that differentiable risk is below average; as a small-cap corporation with three main types of income (card shufflers, card tables, and slot machines,) and a market share that is dwarfed by other commercial producers of gaming equipment, Shuffle Maker could see the market for its products evaporate if a competitor is able to rely on its production efficiencies to push Shuffle Maker out of the market. However, this is unlikely as Shuffle's debt obligations are nearly non-existent.

However, being small and possessing a well-received product has its benefits; a larger company could purchase Shuffle Maker. However, International Game Technology, Shuffle Maker's closest competitor, has a slightly lower P/E ratio, which may make Shuffle Maker seem expensive to a potential purchaser. A more likely option is that another company will attempt a take-over. This is because the company is virtually debt-free; such companies are the preferred targets of acquisitions specialists because such companies finance themselves. A company that wished to take over Shuffle Maker could easily borrow the money to do so. However, this ignores the nature of Shuffle Maker's ownership; institutional investors hold the company, which means that management answers to a relatively small number of people. Insiders, however, with less than 10% ownership of the company, could be easily muscled out if a faction fight was at stake.

Should Shuffle Maker borrow money for expansion? If revenues are indeed growing at 20% a year, this may not be necessary; it indicates that the company is mostly self-financed. Shuffle maker recently repurchased a million shares. A share repurchase seemed unnecessary; the only real reason for a share repurchase is to take away a number of stocks that seem to be depressing share value. However, this could have been a clever move suggested by the company's institutional shareholders; when a company repurchases stock and drives up share value, investors needn't pay taxes at a high rate on this increase as they would on a dividend. Even so, this could indicate that Shuffle Maker has hit a wall; that it cannot find new projects to invest its money in. This is evidenced by Shuffle's Cash flow statement: Shuffle spent more money on investments and stock repurchases than it did on operating costs.

This suggests that Shuffle needs new ways to spend its money, indicating that it isn't growing as fast as it could. Because it is such a small company, Shuffle can't take this extra cash and use it to acquire another company, as would suit another company with too much cash and not enough projects to invest in. Another option for spending this money could be overseas expansion. Shuffle currently caters to markets in the southwest, but could expand its operations in other gambling areas such as Indian Reservations, cruise ships, and close foreign cities such as Montreal.

Advocates of the efficient market hypothesis could argue that this company has already been 'discovered' by institutional value-seekers, which explains its price jump of approximately 50% over the course of the last year. Because institutional buyers maintain the closest relationships with management, they probably have the best indication of earnings estimates for the last quarter of 2003.

Management has indicated that expenses are stabilizing, and we tried to reflect this in our pro-forma statement. Only SG&A expenses and research expenses seem to be increasing at a rate that reflects revenue growth over the last few quarters. We expect this trend to continue going forward. Management believes that its sales expenses reflect the fact that they are capable of producing at a higher capacity than they have in the past, and that many of their expenses are fixed.