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Class II slots eyed as next big boom

Mar 16, 2004 5:24 AM

(Editor’s note: This is the first in a three-part series on the Class II slot market.)

Class II gaming has always been viewed as a kind-of second-class citizen in the gaming community. But recent legal and economic developments have pushed Class II to the head of the class. In fact, Class II games could be the next big boom in the slot manufacturing trade.

In a nutshell, Class II gaming is an outgrowth of bingo gaming on Indian reservations. What began as paper bingo tickets, punch cards, pull tabs and tip jars, has expanded into electronic, state-of-the-art gaming machines which often look and play like traditional slots.

But unlike its older brother, Class III gaming, which encompasses Nevada-style table games and slots, Class II gaming for years has been what tribes had to "settle for" when they couldn’t get Class III gaming onto their native lands.

But all of that changed earlier this month when the U.S. Supreme Court refused to overturn a lower court’s ruling that Class II games were not the same as Class III slot machines, and therefore don’t fall under the jurisdiction of state regulators.

In its appeal to overturn the lower court’s decision, the federal government argued that a machine qualifies as a gambling device when it "looks like a slot machine, sounds like a slot machine and plays like a slot machine."

But the Supreme Court ignored those arguments and let stand a ruling that Class II games were merely "electronic aids" to bingo and not "slot machines" as defined under the Johnson Act.

The upshot is that tribes may install as many of the Class II slot look-alikes as they please. That could be a huge boon for tribes in states such as California, which currently caps the number of Class III slot machines at 2,000 per tribe. Now, there’s no limit to how many Class II games tribes can install.

"This is great news for the industry," said Deutsche Bank analyst Marc Falcone. "It provides new opportunity to sell games to previously reluctant buyers."

Falcone added the surge in Class II games might not occur until 2005, although manufacturers have already ramped up their efforts to produce Class II machines. "It will take some time for companies to bring their products to the market, but 2005 will be a strong year."

Initially, Falcone predicted an additional 30,000 to 50,000 units would be sold to tribal casinos in California, Oklahoma and other states that are heavy into Indian gaming.

Other analysts believe the size of the potential market is much larger.

"On first blush, we estimate the number of Class II machines could grow by 100,000," J.P. Morgan analyst Harry Curtis wrote in a research report, which added that IGT could be a big winner, garnering between $550 million and $730 million in added revenue through its subsidiary Sodak Gaming, which produces Class II machines for tribal casinos.

Other manufacturers expected to reap huge rewards in the Class II market is Multimedia Games, currently the largest producer of games for Native American casinos, and Alliance Gaming, whose recent purchase of Sierra Design Group puts them squarely into the Class II picture.

Rob Miller of IGT’s Sierra Design Group says Class II games differ from slot machines because the outcome of the latter is determined by a random number generator, while the Class II outcome is determined by the outcome of a bingo game.

But that outcome can be "displayed" or presented in the form of reel slots or video poker hands. Thus, Class II games often have the same themes as slot machines, such as IGT’s wildly popular Cleopatra series of video slots.

"We offer the widest selection of proven games from around the industry," Miller said. "On one hardware platform, our customers can operate games from IGT and others. This gives them more flexibility in floor layout and game choices."

Technologically, the concept is slightly difficult to grasp. Theoretically, a slot machine can hit three times in a row because of the random number generator. But a Class II slot operates differently. There is no random number generator. Instead, each game has a precise number of winning and losing spins of the reel of deals of poker. Once the wins for each round have been completed, the machines start over to begin new games.

Although the explanation may be difficult to grasp, the fact that tribal casinos and slot manufacturers will emerge as big winners isn’t in dispute. Over the next two weeks, we’ll take a closer look at the players in the Class II industry, and the manufacturers who expect to enjoy another Gold Rush-like slot boom.