Fitch Ratings has assigned a 'BB'/'RR4' rating to Light & Wonder, Inc.'s (LNW) proposed eight-year senior unsecured notes.

Proceeds will be used to refinance the existing 8.625% senior unsecured notes due 2025. LNW's Long-Term Issuer Default Rating is 'BB'. The Rating Outlook is Stable

LNW's rating reflects its conservative leverage profile and solid expected FCF margin for a gaming supplier and mobile developer. Fitch believes LNW's credit profile remains consistent with a rating 'BB', due to robust FCF generation, strong liquidity, and still conservative leverage. Fitch forecasts LNW's gross leverage will decline below 4.0x by 2023 through EBITDA growth.

Key Rating Drivers

Fitch forecasts LNW to reach 3.7x gross leverage for 2023 and decline further over the forecast horizon. The further recovery of LNW's gaming equipment and systems cash flows in 2023, coupled with stable digital cash flows, will allow LNW to achieve gross leverage metrics in 2023 and 2024 consistent with 'BB'. Notably, LNW's strong expected FCF generation (mid-teens margins forecast in 2023 and beyond) and strong liquidity remain consistent with the rating.

Growing Digital Presence: The company announced that it is acquiring the 17% remaining interest of SciPlay, a social gaming and casual mobile gaming operator, for approximately $500 million. The acquisition will be funded through cash on hand. Fitch believes the acquisition is a credit positive given the use of cash, the subsidiary becomes part of the restricted group, and enhanced balance sheet flexibility.

Monthly payer users have increased to 625,000 as of March 31, 2023 from 560,000 as of March 31, 2022. LNW's market share has grown to 10.2% in 2Q23 from 7.9% in 2019, aided by the performance of its Jackpot Party and Quick Hit products. The company's digital business faces strong competitive pressures , especially within social gaming. This is offset by the more stable FCF compared with the traditional slot business, as well as the increased product diversification and scale.

Diversified Product Mix: LNW is a diversified gaming supplier with exposure to traditional gaming (slots, tables, systems), iGaming, social gaming and casual mobile gaming. The company's digital adjacencies balance the traditional slot industry's high competitiveness, tepid replacement cycle, and unreliable new casino opening schedule. The company's leading slot systems business (approximately 10% of pro forma revenues) provides a relatively reliable cash stream and its table game business (approximately 8%) is shifting more toward a lease model with operators.

Leading Gaming Supplier: The company garners low-20% market share for both slot sales and installed base of premium slots in North America, which has come down considerably over the last decade as peers aggressively entered the market. With this share, the company comfortably remains a top-three supplier, and the company consistently rolls out attractive new content and cabinets that have helped maintain a leading competitive position.

There are signs of stabilizing market share shifts, with the company registering a relatively stable installed base in North America since 2020 of around 30,000 units (30,675 units as of March 31, 2023). The company's table game business is a differentiator relative to its peers, and also has a strong systems business.

Strong FCF Generation: Fitch expects the company's FCF generation and margin will approximate $275 million and 11%, respectively, in 2023 thanks to stronger EBITDA, reduced interest expense, and reduced capital intensity following lottery's divestiture. FCF is strong relative to the broader gaming industry and in line with other 'BB' and 'BBB' category suppliers. However, capital intensity is higher than casino operators given the company's premium slot business and royalty payments on licenses that are capitalized.

The company's FCF benefits from management's preference for share repurchases over dividends. Fitch expects a majority of FCF to be allocated toward repurchases ($437 million through May 4, 2023), tuck-in acquisitions to support its Digital segment and reinvestments within the business. Fitch does not anticipate any meaningful debt paydown beyond the current capital structure ($3.9 billion of debt). The company is expected to have high flexibility for restricted payments.

Parent Subsidiary Linkage: Fitch applied the strong subsidiary/weak parent approach under its Parent and Subsidiary Linkage Rating Criteria. Fitch views the linkage as strong across the company's entities given the openness of access and control by the parent and relative ease of cash movement throughout the structure. Fitch views the entities on a consolidated basis and the IDRs are linked.

Derivation Summary

Light & Wonder's rating reflects its conservative leverage profile and improved FCF generating ability pro forma for recapitalization and lottery and sports betting divestitures in 2022. LNW remains a diversified gaming supplier with strong market share, despite the sale of the less cyclical lottery business. The company's leading market position in the slot segment and greater diversification position it stronger than peer Everi Holdings (BB-/Stable), despite similar leverage levels.

The company has a similar business mix as peer Aristocrat Leisure (BBB-/Stable); however, Aristocrat has a long track record of managing gross leverage below 2.5x. International Game Technology (BB+/Stable) has a similar credit profile as the company, despite slightly higher leverage, thanks to meaningful lottery exposure, which can withstand higher leverage.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Company:

Fitch forecasts mid-single-digit growth for the Gaming segment in 2023 and low single-digit growth thereafter, supported by a stabilization in the company's overall installed base in the 58,000-59,000 range and healthy ADRPU;

SciPlay revenue growth of nearly 20% in 2023 and continues to grow in the high single-digits annually thereafter, supported by increased R&D and tuck-in acquisitions;

iGaming experiences mid- to high single-digit growth annually, supported by the rollout of LNW's Live Dealer platform and other online market advances;

EBITDA margins in the high 30% range. Fitch forecasts SciPlay to contribute $250 million in annual EBITDA by 2025;

Capex is approximately 8%-10% of revenues over the forecast horizon. This includes royalty payments on license obligations;

Total gross debt balance steady around $3.9 billion (modest annual term loan amortization);

Capital allocation is balanced between shareholder returns and tuck-in M&A in the digital space. Fitch assumes share repurchases are the primary avenue to return capital to shareholders.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Gross leverage sustaining below 3.0x;

Stable or growing slot share, particularly in North America;

Expanding footprint in casual gaming demonstrated by successful launch of new games and or an increase in user-based metrics (both paying and non-paying).

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Gross leverage sustaining above 4.0x;

Slots business suffering from market share loss or the deterioration of operating fundamentals;

Greater revenue concentration in the more cyclical and hit-driven casual mobile gaming business.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

The company has multiple sources of liquidity that will support its growth strategy and fund shareholder returns. The company had $909 million of cash as of June 30, 2023 and full availability under its $750 million revolver. Fitch forecasts the company to generate FCF of around $300 million-$500 million annually beginning FY 2023. This will fund continued tuck-in acquisitions in the mobile segment and an increase in shareholder returns primarily in the form of repurchases.

Capex is manageable in the context of the company's improved cash flow from operations, which should remain around 8%-10% of revenue. This includes 'payments on license obligations' that get reported in the company's cash flow from financing and are related to requirement payments on brand licenses that are akin to operating expenses.

Following the closing of the acquisition of the remaining equity interests in SciPlay, the subsidiary will become a restricted subsidiary of the company. The SciPlay $150 million untapped revolver is expected to be terminated sometime after closing. The full consolidation of SciPlay should provide for greater financial flexibility.

Issuer Profile

Light & Wonder, Inc. includes a cross-platform product portfolio that includes Gaming (casino products and services), Social Gaming (digital games on mobile and web platforms), and iGaming (digital gamin content and other iGaming content and services).

Date of Relevant Committee

02 December 2022

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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