Fitch Ratings has assigned a final Issuer Default Rating (IDR) of 'BB' to Light & Wonder, Inc. and Scientific Games International, Inc. (collectively, LNW).

Fitch has also assigned final ratings of 'BBB-'/'RR1' to LNW's senior secured credit facility and 'BB'/'RR4' to LNW's senior unsecured notes due 2028 and 2029. Fitch assigned a 'BB'/'RR4' rating to LNW's senior unsecured notes due 2025. 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. Gross leverage is declining slower than anticipated at the time of the April 2022 initiation due to less debt paydown, stemming from the reduced asset sale proceeds from OpenBet ($400MM less). Despite this, Fitch believes LNW's credit profile remains consistent with 'BB', due to robust free cash flow generation, strong liquidity, and still conservative leverage. Fitch forecasts LNW's gross leverage will decline below 4.0x by 2023 through EBITDA growth (3.8x), though Fitch previously expected LNW to reach mid-3x by YE 2022.

Key Rating Drivers

Stable Outlook Despite Steeper Leverage Trajectory: Fitch forecasts LNW to reach 4.2x and 3.8x gross leverage for 2022 and 2023, respectively, compared to 3.4x and 3.3x at initiation in April 2022. The difference is driven by the $550 million in 2025 notes remaining outstanding and higher cash balances (about $500 million more than Fitch's initial forecast) as the company has already achieved its net leverage target of '2.5x-3.5x' (3.2x as of Sept. 30, 2022).

The further recovery of LNW's gaming equipment and systems cash flows in 2023, coupled with an anticipated pull back in gaming operations cash flows and stable digital cash flows, will still allow LNW to achieve gross leverage metrics in 2023 consistent with 'BB'. Notably, LNW's strong expected FCF generation (mid-teens margins forecasted in 2023 and beyond) and strong liquidity remain consistent with the rating.

Good Mix ex-Lottery: Pro forma for the lottery and sports betting dispositions, LNW is still a diversified gaming supplier with exposure to traditional gaming (slots, tables, systems), iGaming, social gaming and casual mobile gaming. The divestiture of lottery removed a stable and diversifying cash flow stream with healthy long-term growth rates, although the debt paydown from sale proceeds was viewed positively.

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 (~10% of pro forma revenues) provides a relatively reliable cash stream and its table game business (~9%) is shifting more toward a lease model with operators.

A 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 has helped maintain a leading competitive position.

There are signs of stabilizing market share shifts, with the company registering relatively stable installed base in North America since 2020 of around 30,000 units (30,536 units as of Sept. 30, 2022). The company's table game business is a differentiator relative to its peers, and also has a strong systems business.

Growing Digital Presence: The company operates social gaming and casual mobile gaming through its unrestricted subsidiary, SciPlay, of which it owns 81% economic interest and controls over 90% of voting power. The social gaming business has grown materially over the last seven years, with quarterly EBITDA approaching $50 million in 2021, up from $10 million in 2015.

While daily active users have been volatile, monthly payer users have been stable around 500k the last three years with an 8% CAGR in monetization (600k as of Sept. 30, 2022). There is meaningful title concentration, with Jackpot Party Casino generating roughly 50% of total SciPlay revenue.

The company's digital business tends to be hit driven and competitive, especially within social gaming. The business also requires considerable R&D investment and customer acquisition costs. These factors may cause operating cashflows to be more volatile than the traditional slot business; however, digital provides the company increased product diversification and scale.

Fitch expects the company to pursue more casual mobile gaming development as an avenue for revenue growth, which could lead to increased R&D and tuck-in acquisitions for talent or proven game titles. The casual mobile gaming industry is more competitive than traditional slots given low barriers to entry and more formidable publishing peers like Electronic Arts (A-/Stable).

Significantly Reduced Leverage: Fitch estimates gross leverage to be 4.2x by YE 2022 and will improve toward the high-3.0x in fiscal 2023 as the gaming segment's EBITDA fully recovers (specifically equipment and systems adjacencies). This is a significant improvement from the 6x-8x level the legacy business was rangebound within during 2015-2019.

The exit of a controlling shareholder, new board and management were the catalysts for rapid de-levering through asset sales totaling roughly $6 billion. This level of leverage is more in line with the company's 'BB' category supplier peers and will support the company's ambitions to grow its digital segment, particularly casual mobile gaming. LNW will have less leverage headroom at the 'BB' level relative to Fitch's 4.0x downgrade sensitivity than initially forecasted, given lower levels of debt paydown from this year's asset sales.

Strong FCF Generation: Fitch expects the company's FCF generation and margin will reach around $450 million and 15%, respectively, by 2023 thanks to fully recovered 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, 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 (NR) has a similar credit profile as the company, despite slightly higher leverage, thanks to meaningful lottery exposure, which can withstand higher leverage.

In addition, Fitch views the company's credit profile as stronger than Playtika Holdings (NR), a pure-play digital peer that does not have exposure to the traditional slots, table games, or systems businesses. LNW's divested lottery business, Scientific Games Holdings LP (B/Stable), maintains meaningfully higher leverage in the 7x range, which offsets its lower cash flow cyclicality.

Key Assumptions

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

Gaming segment revenue growth around 20% in 2022 as the slot sale, systems, and table games verticals recover toward pre-pandemic levels. Fitch forecasts mid-single-digit growth 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 2022 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, and Fitch does not assume any incremental jurisdictions legalizing (seven U.S. states currently);

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

Capex is 10% of revenues in 2022 but declines to around 8% annually thereafter given the divestiture of lottery. 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 $1.3 billion of cash as of Sept. 30, 2022 ($299 million of which is at SciPlay) and full availability under its $750 million revolver. SciPlay also benefits from a $150 million untapped revolver. Fitch forecasts the company to generate FCF of around $450 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% of revenue. This includes 'payments on license obligations' that get reported in the company's cash flow from financing and is related to requirement payments on brand licenses that are akin to operating expenses.

SciPlay is an unrestricted subsidiary of the company and has no outstanding debt given its revolver remains untapped. SciPlay is subject to a 2.5x total leverage and 4.0x fixed charge coverage financial covenant. Fitch expects SciPlay to retain its cash flow to pursue growth but its credit agreement does provide flexibility for cash movement up to the company via its restricted payments carveouts (e.g. unlimited if total leverage is less than 1.5x).

Issuer Profile

Light & Wonder, Inc. is a gaming equipment supplier and digital gaming company. The company is a leader in slot systems & table games, while also among leaders in slot shipments/premium slot leases. LNW also provides products and services for online gaming, sports betting and social gaming.

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

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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