|Shares Out. (in M):||77||P/E||5.6||5.3|
|Market Cap (in $M):||591||P/FCF||0||0|
|Net Debt (in $M):||520||EBIT||0||0|
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A poor corporate governance history that has now been largely resolved, a terribly flawed short-sell report, a shareholder base that is not familiar the company’s assets and industry, and the overhang of a large earnout payment have created the opportunity for a >150% total return over the next 2 years.
While Intertain is perceived as a roll-up (with all the negative connotation that this carries these days), it is actually an LBO of 2 world class online gaming assets, that are growing rapidly, highly cash generative with close to zero capital requirements.
In Q4, the company will move its listing to London where there is a large constituency of investors that follow and understand the sector and (perhaps more importantly) are familiar with the company’s key brands which are primarily UK focussed.
Next June, the primary earnout to Gamesys for the Jackpotjoy acquisition will become due so it will likely be paid shortly thereafter.
By then, the company will be listed in a ‘normal’ market for its sector and geography of business, the new (highly experienced and credible) management team will have been in place for over a year, the company will have demonstrated its attractive growth and cash conversion metrics for 7 or 8 consecutive quarters and its net debt (incl. earnouts)/EBITDA ratio will have dropped to <2x. We can think of no reason why this business wouldn’t then sell for (at least) the average multiple of the London listed peer group, currently 11.5x EV/EBITDA. Applying that to our estimated 2018 EBITDA we derive a share price of C$26 which is 160% above yesterday’s close.
Intertain generates approximately c.90% of its earnings from online bingo. Its key brands are Jackpotjoy in the UK and Sweden, Costa Bingo in the UK and Botemania in Spain. For most online gaming operators bingo is a niche product to which they dedicate little attention and/or resources. It is usually simply added to the website in order to complete the offering of a full suite of online games. This is not for lack of an attractive market. The online bingo market has grown at 14% CAGR between 2008 and 2015 reaching >$2.5bn in total gross win last year. In addition, players tend to remain with the brand for a long time. >50% of Jackpotjoy’s 2015 revenue was generated by players who have joined the site at least 3 years earlier. That is a staggering level of player retention in online gaming terms. However, the barriers to success are very high.
Unlike the fragmented online casino and sportsbetting markets, online bingo is quite consolidated with a few large operators dominating the market. Intertain is the market leader in the UK with c.25% market share. The top 5 operators control ¾ of the market. In Spain, the company’s Botemania brand has a market share approaching 50%. Virtually all the growth is absorbed by the leading operators while the smaller brands are stagnating at best.
The key reason for this dynamic is the unique demographic of bingo players. The typical Jackpotjoy customer is a 42 year old housewife. 73% of the company’s customers are women. This is very different from your average sportsbook punter. Recruiting and retaining players is therefore vastly different in online bingo compared to the other online gaming verticals. For starters, the marketing channels are different. Jackpotjoy’s key marketing efforts include ads and partnerships with the most popular woman’s magazines and TV programs that have a disproportionate share of female viewers. Its ads carry messages and promotions specifically designed to attract recreational female players and its website uses colours and themes designed to appeal to that demographic.
Player retention efforts also differ. The company goes to more lengths than any other to build customer trust and create a sort of community feeling for its player base, organising 12 special VIP events every year, employing dedicated VIP managers, paying jackpots in a single lump sum rather than through years of instalments, never changing the payout ratio of a game (peers often change returns-to players after a successful launch) and having a strong focus on resolving issues in a fair and timely manner.
This type of operation requires strong focus and customization. Therefore, the ability to simply build a bingo product by cross selling it to an existing casino/poker/sportsbetting player base is very limited.
In addition, even if someone was to consider dedicating the type of focus required to try to effectively compete with the market leaders, there are 2 additional barriers. The first one is chat. For most women, part of playing Jackpotjoy bingo is about chatting with friends and other players on the site.
Chat takes up 1/3 of the screen space. This is a barrier to competition for 2 reasons. Firstly, it creates a social network effect that is very hard to compete with. Secondly, having many people in a chat room creates an environment where there is always someone winning something on the bingo or more importantly on the side games (the slot games on the left side of the screen). This constant feedback from winning players telling other players that they are winning creates a positive atmosphere as well as a notion that people do win on the site.
The 2nd competitive moat is jackpot liquidity. While most players on Jackpotjoy consider themselves bingo players, c.80% of the site’s revenue is generated from slot games played on the side. This is basically a female oriented slots product parading as a bingo game and social network. Having more players on the site enables larger jackpots and a higher frequency of winnings. This is a key attraction to the site. Jackpotjoy’s scale allows the company to operate with an average payout ratio of 85% compared to peers retuning only c.70% to players.
Despite the significant investments in the player experience and the higher return to players, the business generates an operating margin of >40%, among the highest in the industry. In addition, the company generates nearly all its profits from fully regulated markets where they are paying taxes out of revenues so that this is actually their post-tax margin.
When valuing online gaming businesses investors tend to attribute a significantly higher multiple to earnings derived from fully regulated markets because they do not bear the risk of being shut down or turned unprofitable from the introduction of economically unviable tax rates. Intertain has the highest proportion of earnings derived from regulated markets in the sector.
To top it all, the company has some very interesting growth opportunities in the pipeline. In its existing markets the business has only just started scratching the surface of the mobile opportunity. Driven by a revamped mobile product, Jackpotjoy’s revenue growth has accelerated from mid-single digit rates to >20% for the past 3 quarters. In addition, after 3 years of being prohibited from offering slots to its customers in Spain, Intertain’s Botemania brand has received a license to launch slots last year. This will drive huge growth in the short-term because, as discussed earlier, slots account for c.80% of bingo revenue so replicating that alone would quintuple the Spanish business.
Finally, a number of countries are in advanced stages of regulating online bingo which will allow Intertain to launch its platform in those markets. The most significant of those is Mexico where the company could launch with very little incremental costs as it can leverage its Spanish platform and marketing content to this potentially large market.
Intertain’s other significant asset is the Vera&John online casino including its proprietary casino technology (something very few online casino operators have). This is an excellent asset run by an excellent management team (happy to elaborate on this asset in the messages section if anyone has specific questions). In Q1 V&J revenue grew 53% y/y and its profit margin expanded 820bps y/y.
Addressing the issues
Poor corporate governance: IT’s prior CEO, CFO and some board members have a questionable past. This is a key tenet of the bear case. This bear case payed out somewhat through lavish payments the CEO and CFO received as compensation for closing the JPJ acquisition and another big severance payment the CEO received when he was finally forced out last month. Last month the company has appointed a new chairman of the board (UK based senior gaming executive with decades of experience in the sector) and a new CEO (UK based with >a decade of experience in the sector including as CEO of publicly traded Sportingbet which was later acquired). They have also added Jim Ryan (previously the CEO of Partygaming and co-CEO of Bwin.Party) to the board of directors. These changes have 2 effects. Firstly, the business is now in the hands of respectful executives with a long credible history in the sector and secondly, there is unlikely to be any further M&A. Rather they will be focussed on delivering operationally and creating value for shareholders.
The Spruce Point short report: when this was published last December the stock dropped 40%. However, other than pointing out the questionable background and comp structure of past management, the 120 slides were loaded with nonsense. It’s too long to elaborate on all the claims in this write-up, but happy to address any concerns that may arise from reading the report in the messages section.
Shareholder base that doesn’t get it: we believe Intertain’s Canadian shareholder base includes lots of people who don’t understand/care about the quality of the company’s assets and how to value them. They are focussed on the short term accretion from acquisitions and more recently on the potential for IT to be acquired. This can be clearly seen from the share price reaction to the news that the company will be relisted in London rather than be acquired (stock down >10% despite saying they won’t need to raise any equity to pay the earnout). There is also too much read across from other Canadian blow-ups such as VRX and AYA which have little/no connection with this business. Moving to London will open this opportunity to UK/European investors who know the brands and understand the quality of the assets and how to value regulated earnings vs unregulated earnings given the large number of online gaming companies traded on European exchanges. Local investors will also be able to carry out extensive due diligence on Gamesys and the company’s assets (as we have done) which are all based in the UK.
The Gamesys relationship: some people are concerned about the fact that JPJ runs on Gamesys technology and most of the content on the site is developed and operated by Gamesys. There are 2 important points to realise: firstly, most online gaming operators use third party technology and services (to varying degrees). This is the bread and butter of someone like Playtech. There is nothing too unusual here. Secondly, there are approximately 250 people at Gamesys who are working exclusively for Intertain’s brands. They are being paid by Gamesys, but that cost is fully reimbursed by Intertain. After the earnout the company has right to take all these people in house if it so chooses. Lastly, Noel Hayden, Gamesys’ owner, is Intertain’s largest individual shareholder so his incentives are very much aligned. We have been to Gemesys’ offices several times and met with Mr Hayden and Gamesys’ CEO, Lee Fenton (2 top quality executives in the sector) and are very comfortable with this relationship. In fact, it is a key attraction for this investment.
High financial leverage: roughly half of the company’s leverage is in the form of an earnout payment which is subordinate to the company’s debt and its payment can be postponed while cash is being accumulated to pay it. Obviously, the earnout is a function of the company’s profitability so this liability only kicks in if the business is successful to a point that the earnout is affordable. Outside of the earnout (which will be gone late next year) financial leverage is not high.
While there is a lot to discuss here, that is what has created this huge dislocation. We believe that 12 months from now all of this will beb behind us and as the company gains credibility it will achieve a similar multiple to the UK listed peers (if we included the Scandinavian listed peers the multiple would be higher). We are using EV/EBITDA to take into account differences in capital structure. Note that taxes are paid out of revenues so EBITDA is a close proxy to operating cash flow and c.80-90% of EBITDA is converted to free cash flow.
Using Bloomberg consensus numbers, the 7 London listed peers we use trade on an average EV/EBITDA multiple of 11.5x. We believe the company will generate at least C$215m in EBITDA in 2018 (using current exchange rates) and will end the year with c.C$350m in net debt. With 80m diluted shares out we derive a per share value of C$26 in 24 months (giving it 12 months to get past the earnout another 12 months to further build credibility in the market). This represents 160% total return or a 61% IRR over 2 years for a non-cyclical, high margin, high growth, and low risk business. We don’t see many such opportunities in the marketplace these days…
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