Pacific Online Systems’ arrangement with PCSO entails a deep moat
Stock: Pacific Online Systems Corp (ticker LOTO)
Pacific Online Systems’ shares have been on its lowest point for the past year at 10.98 Php at the time of writing.
As gaming systems and equipment lessor provider to the Philippine Charity Sweepstakes Office (PCSO), Pacific Online Systems surely is worth a look.
**This article consists of the company’s operations and figures. For quicker reading jump ahead to the conclusion part.**
Pacific Online Systems
According to filings, Pacific Online Systems was founded in 1993. Pacific Online Systems’ has majority direct and indirect ownership in the following companies: Loto Pacific Leisure, Lucky Circle, Total Gaming Technologies, and Falcon Resources.
As of December 2016, Pacific has over 6,000 lottery terminals nationwide, and has 100% coverage of Visayas and Mindanao, while just 8% in Luzon.
In 1995, the company had an Equipment Lease Agreement (ELA) with the PCSO’s online lotto operations in the Visayas and Mindanao operations. Since then, the ELA has been amended in 2004, 2012, 2013, and 2015.
The ELA amendment in 2015 extended this agreement until 2018 along with a 5 million Php cash bond on Pacific to ensure liquidity in its operations until then.
According to its ELA, Pacific is to earn rental revenue per equipment at a fix 35,000 Php per terminal or whichever is higher, annually.
Total Gaming Technologies
Meanwhile, Pacific’s 98.92% ownership of Total Gaming Technologies, which does online keno (Lotto Express) operations nationwide for PCSO, makes it possible for Pacific to earn revenue at a fixed annual rate of 40,000 per terminal or whichever is higher, annually.
Total Gaming Technologies has an ELA agreement with PCSO that expires in 2020.
Pacific owns 97.64% of Lucky Circle. Lucky Circle is an authorized PCSO agent operating online betting stations that sell sweepstakes, lotto, keno and instant tickets in outlets located in major shopping malls like SM Supermall, Robinsons, and Gaisano nationwide. Lucky owns a certain percentage of the sales as commission income.
Interestingly, Falcon is 100% owned by Total Gaming Technologies. Falcon is engaged in consultancy services for Total Gaming Technologies and a sub-distributor of instant scratch tickets
50.1% of Pacific is owned by Premium Leisure Corporation (ticker PLC) and 8% owned by the company’s chairman, president, and director since July 1999, the 56-year-old Willy Ocier.
Premium Leisure defined itself as an investment holding company that participates in gaming-related businesses in the Philippines. Willy, on the other hand, is engaged in different chairman and chief executive positions in other companies such as Belle Corporation (ticker BEL), Premium Leisure, Tagaytay Midlands Golf Club, Philippine Global Communications, among others.
Pacific has two segments: Leasing activities and Distribution and retail activities.
In the first half that ended in June, revenue for Pacific’s leasing activities rose 18.9% year over year to 893 million Php or 85% of total revenue. The leasing business generated 35% income before tax margin compared to 32% a year earlier.
Distribution and retail activities
Revenue in the distribution and retail business grew 13.9% to 158.8 million Php (15% of revenue) and generated 35% in income before tax margin compared to 42% a year earlier.
First-half operations summary
In its latest six months operations, Pacific’s overall revenue increased by 12% compared to its year-ago period to 511.8 million Php. In contrast, profits fell by 18% to 109.1 million Php brought by higher costs and expenses.
Sales and profits
In the past three years, Pacific generated 4% revenue growth on average, 7% profit growth, and had a profit margin average of 20.75% (Morningstar).
Pacific trades at some discount in terms of earnings multiple having a 10.84 times price-earnings ratio vs. sector figure of 12.37 times, and a price-sales ratio of 2.35 times vs. 13.6 times. The company also has a trailing dividend yield of 2.73%.
The company has provided a meager 3.02% total returns so far this year compared to the iShares MSCI Philippines ETF (ticker EPHE) 15.45% (Morningstar).
I consider EPHE as a barometer of the overall Philippine Stock Market’s performance.
Cash, debt and book value (equity)
As of June, Pacific had 272 million Php in cash and cash equivalents, and 101.75 million Php in lease obligations with a leverage ratio of 0.05 compared to 0.04 a year earlier.
Overall obligations increased by 17.5 million Php while equity declined by 85.9 million Php year over year to 1.94 billion Php.
In the recent six months of operations, Pacific’s cash flow nearly doubled to 405 million Php brought by higher income before tax, and cash flow from retirement cost, unrealized foreign exchange activities, trade and other current liabilities among others.
Capital expenditures were 40 million Php leaving Pacific with 364 million in free cash flow compared to 203 million Php a year earlier.
In addition, Pacific’s dividend payouts in the period represented 70.6% of its free cash flow.
The cash flow summary
In the past three years, Pacific allocated 508 million Php in capital expenditures, raised 289 million Php in stock issuances, generated 641 million Php in free cash flow, and paid out 747 million Php in dividends and share repurchases at an average free cash flow payout ratio of 124%.
Looking at Pacific’s recent business operations that ended in June, the company surely has maintained healthy growth in its operations only hampered by increased in overall expenses resulting in lower profitability.
The company’s restricted entry in Luzon, which has generated about 63% of PCSO lotto sales nationwide, also is a weak spot or an opportunity for the company to pursue more business in the future.
Nonetheless, Pacific demonstrated healthy organic business growth as it discussed higher lottery sales resulting from higher jackpot prizes and additional draw for Lotto, increased Keno terminal rollouts and higher instant ticket sales resulting from increased public awareness—all as part of its recent performance.
Using historical price-sales average, 15% margin, with shares outstanding growing at the same rate as in 2016, would leave a price per share of 10.41 Php compared to 10.98 at the time of writing.
Watching from the sidelines and observing Pacific’s share to drop could be a long patient wait, but at the current price of 10.98 Php, Pacific is a hold.
Disclosure: I do not have shares of any of the companies mentioned.