Crikey hates the pokies but they sure are delivering handsome profits for the world’s second biggest manufacturer of the mindless machines.

Aristocracy n; the highest class in certain societies, typically comprising people of noble birth holding hereditary titles and offices.

Leisure use of free time for enjoyment.

[The New Oxford Dictionary of English, 2001, Oxford University Press]

Lest you be deceived by this company’s name, we’ll note from the outset that this mob arguably isn’t in the “leisure” industry, as one might generally understand it. And certainly, the vast majority of this company’s clientele are not members of the aristocracy.

For those who didn’t know, Aristocrat Leisure is a pokie manufacturer.

But putting it that simply is not something that Aristocrat Leisure does when referring to their principal activities. Chairman John Ducker in his report to shareholders refers to the company being a leading “global entertainment group”. CEO Des Randall refers to the company as being a “leading global provider of gaming solutions”.

Cut the spin, fellas you’re in the pokie caper!

Another example of the company’s curious take on their place in the world was Bwuvver Ducker’s description of the company’s “harm minimisation” work. At one point in his address he said “we are very aware that a small number of people encounter problems in relation to their use of gaming machines”.

A small number of people?!

I don’t propose to sermonise about the evils of gaming, but Bwuvver Ducker’s whistling Dixie if he thinks that only a “small” number of people are problem gamblers.

Try telling that to the people who clean up after you.

This correspondent doesn’t like pokies, would love to see fewer pokies and more bandstands in pubs, and believes that there are plenty of people out there who need to be protected from themselves when it comes to pokies. But he also believes that so long as they’re legal, there’s no point bashing a company just because it makes its money out of pokies.

If they’re exploiting the vulnerable, then it’s up to the government and regulators to step in.

Instead, this spray will be a study on why a company’s share price goes south when all the noises emanating from the company seem to be positive.

Former pollie and union man Bwuvver Ducker and Double-or-nothing Des Randall talked up the company’s considerable financial achievements during the year and they were impressive at first blush.

But ASA representative John Wilson pointed out that, despite all the good news, the company’s share price has slumped from around $6.50 last year to $5.56 today (May 21). Wilson’s suspicion was that the market wasn’t so keen on the company’s US acquisition, Casino Data System, for which Aristocrat had forked out $348 million, with $253 million of this being goodwill.

Of the assets acquired, $63 million was trade debtors. While there isn’t much in the way of tangible assets in CDS, its importance to Aristocrat is in the valuable customer lists it brings, so there’s probably not much point in reading a lot into the substantial goodwill that has been booked. And with $947 million in total assets and $350 million in net assets, it isn’t as if Aristocrat have taken a reckless punt and thrown their lot in with CDS entirely.

Bwuvver Ducker was at pains to point out the successful acquisition and integration of CDS, which had posted a “record first quarter result, contrary to market expectations”.

Double-or-nothing Des also made a very stinging point of saying that their market penetration data had been audited by the industry regulators “to counter many claims made by our competitors”!

It sounds like there is no love lost in the pokie caper.

Indeed, the chairman spends a great deal of his report to shareholders setting out the favourable reviews that Aristocrat received from management consultants AT Kearney and LEK Consulting and various finance journos. He noted that “the achievements of the Company in terms of enhancing shareholder value were recognised by many commentators during the year”.

Except, of course, the one that matters most to shareholders the share market.

So why has the market gone cold on Aristocrat, despite its operating profit after tax being up from $64 million in 2000 to $82 million? Further reason for promise is that the company now gets half of its contribution to profit from its overseas activities, so its expansion plans appear well grounded.

Certainly, there was market skepticism about the CDS acquisition. Aristocrat’s bid amounted to US$9.25 a share at a time when CDS was trading on NASDAQ at around US$7 per share.

And although Aristocrat’s 2001 result fell slightly short of some analysts’ estimates, it was described by many as a strong result, noting that the company expanded their base in the USA and clung to market share despite stiff competition in Australia.

Perhaps it has been a case of “guilt by association” for Aristocrat. In February, around the time of its profit announcement, its share price hovered around $6.15, but it slumped in mid-May to a low of $5.34 after one of its US competitors, WMS Industries Inc, released poor profit results.

Any concerns of the company having paid too much for CDS should have been laid to rest by now, as it has commenced contributing to profit and has been bedded down in the company’s operations long enough for any concerns.

So really, it is hard to fathom the slump in the company’s share price. There don’t appear to be any news releases after the February profit announcement that would explain the company’s share price fall, which at one stage was about 20% for the year.

Unless there’s some accounting chicanery that’s passed me by, I’m stumped as to why this mob is travelling poorly on the market when all the vital signs are positive.

Sole subscriber Tom Elliott points out:

There is a relatively simple explanation for the drop in Aristocrat’s share price. Over the past couple of months, many so called “growth” stocks on high P/Es have been caned by the market when they released profit downgrades. Prominent examples include Coles Myer, Mayne and Computershare. Becasue of this, the market has become nervous about all high P/E stocks, irrespective of whether they’ve issued profit downgrades or not. As Aristocrat is on a trailing P/E of about 29, and a forward one of 20 (depending whose forecasts you believe), it definitely falls into this growth category about which investors are nervous.

Remember Occam’s Razor – the simplest explanation is usually the most correct!”

The ASA’s John Wilson was the only one to get up and ask questions during the meeting. In a moment of light relief from a none too arduous AGM, during general business and a final reluctant question from Mr Wilson the chairman suggested “we owe a debt to Mr Wilson for the contribution he has made to the meeting”. The meeting broke out into a generous round of applause – how civilised!

During questions on the accounts, Wilson first asked why the share price had collapsed. The chairman, obviously reading from a prepared statement, mentioned that we were living with a very “nervous investment market” and wondered what sense we could make from the market at times. He mentioned several technology-based competitors who had suffered share price slumps in recent times, including Computershare and Cochlear, but really they aren’t comparable to Aristocrat.

Wilson buttered up and noted that there was a subtle difference between “being good” and “appearing to be good” as a way of alleging a lack of independence between the company and its auditors, as well as implying that the company’s audit committee was not independent.

The chairman refuted this suggestion and I tend to agree that it was probably a bit of a fishing expedition.

The re-election of three directors went through without question or dissent, except for the re-election of lawyer and former Weston’s MD, John Pascoe. For some reason Wilson voted against Pascoe. Must have been something in his Chocolate Wheatons.

The options package awarded to Double-or-nothing Des attracted some strong criticism from the ASA’s indomitable Mr Wilson, of course and it looks like once again this has been framed pretty generously.

Des gets 800,000 options a year for the next three years (according to Mr Wilson, although this seems to be off the Richter Scale, but it wasn’t corrected by the chairman) so long as the company outperforms the ASX all industrials accumulation index by 10% each year. As Wilson said, if the index goes up 10%, then the CEO gets his options if the company’s share price goes up 11%.

Not much of a performance hurdle for a company that really is milking a cash cow.

Wilson’s other gripe was that if Double-or-nothing Des gets his options, they are assessed on the average share price over 5 days in early July. Given that the price is a dollar below what it was last year, that’s a pretty generous deal for the CEO.

Still, the package got voted up, with only about 10 shareholders in the 100-plus meeting voting against it.

The chairman even said that Merrill Lynch had “fully supported” the resolution and said the CEO’s package was the “best model for good corporate practice”.

Perhaps Merrills might want to have a chat to the chaps at Corporate Governance International, who like to see option strike prices set about 20% above market price as a general rule of thumb, just to give some sort of performance hurdle.

Unfortunately I didn’t have a proxy to this meeting so I had to sit silently as Mr Wilson valiantly carried the can for the ASA.

The fairly subdued tone of the meeting was reflective of a company that’s doing pretty well aside from its share price. A little sad then, but not at all incongruous, that one of the few Australian companies that should be doing well in the export market is making its dough out of the one-armed bandits. We’ll see if its share price sorts itself out or if the market really has picked this one correctly.