March 01, 2015 - 7:11pm EST by
2015 2016
Price: 1.79 EPS 0 0
Shares Out. (in M): 159 P/E 0 0
Market Cap (in $M): 285 P/FCF 4.7 0
Net Debt (in $M): 593 EBIT 0 0
TEV (in $M): 878 TEV/EBIT 0 0

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  • Greece
  • Gaming
  • Lottery
  • Micro Cap
  • Growth stock
  • Highly Leveraged





Buy INTRALOT equity. This is an opportunity to buy a growth-oriented business with predictable cash flows at a distressed valuation, even after factoring in many of the macro and company specific risks.  At current levels, I estimate (its not straight forward and I will discuss in detail below) the total enterprise value is €878mm and the market cap is €285mm.  At a group EBITDA of approximately €206mm, the capital structure is valued at a 4.3x multiple and the equity throws off a FCF yield of greater than 20% assuming a normalized level of capex.  If management can demonstrate to the market that they can successfully throttle back growth capex spend without hurting the business, FCF could approximate €50 – 60mm per annum (before assuming any benefits from refinancing debt at lowers rates) and the stock would likely rerate at that point.  Even at an undemanding 6.0x EBITDA multiple, the market cap would approximate €615mm providing what I believe to be a very compelling risk/reward setup at current prices.

This investment is speculative for several reasons: 1) while the business is truly global, the Company is based in Greece where almost every investment can arguably be called risky, especially these days given the front page news flow; 2) the balance sheet is levered and equity represents only a third of the total enterprise value; 3) an increasing portion of the Company’s recent growth and cash flow is coming from emerging but volatile countries such as Greece, Turkey and Azerbaijan; and 4) the lottery/gaming industry comes with regular accusations of corruption, money laundering, bribery and other such unethical or illegal activities.

Given the rich opportunity set for credit in Europe, I think the Company’s bonds are fairly priced at a YTM of ~7.5%.  However, it’s worth noting that the 9.75% notes are callable in 2016 and I believe that it’s highly probable that the Company will take them out then.  With the bond trading at ~106 and a call price of 104.88, the IRRs for a potentially short duration bond may be reasonably attractive for some. 

A quick comment on the front page news flow – while I have no opinion on the eventual outcome of the Greek drama, it would be fair to assume that this investment would perform poorly under a “Grexit” scenario.  Therefore, buying some tail risk type protection (currency+equities) against this position would be prudent.


Company Overview

Headquartered in Athens and trading on the Athens Stock Exchange, INTRALOT is a leading vendor in the gaming sector and also a licensed lottery operator through 28 individual licenses in 16 jurisdictions.  As one of the largest global gaming providers, the Company has a presence in 57 jurisdictions in 45 countries on all 5 continents with more than 5,700 employees. 

The Company was established in 1992 as a game systems provider and early on formed a partnership with OPAP, the Greek gaming monopoly, to provide terminals and software. It gradually expanded into management contracts in Greece and later decided to expand abroad into State tenders for gaming systems supply and management services.  The Company quickly succeeded in becoming a major worldwide supplier of integrated gaming systems and by 2008, the business had expanded significantly that Greece represented less than 15% of total revenues.  While starting out mainly as a hardware and software technology vendor and a provider of management contracts for State lotteries, the Company later developed its own licensed operations where it operates and controls every aspect of the gaming offering.

This chart below (from 2013) summarizes the Company’s business lines: (side note: one of the frustrating parts of diligencing this Company is that disclosure is limited and reporting is poor and dated)

As of the LTM, revenue breakdown between these business lines is as follows:

- Technology and support services: €1.4bn (80% of total revenues)
- Management contracts: €139.4mm (8% of total revenues)
- Licensed operations: €212.7mm (12% of total revenues)

INTRALOT’s games library includes more than 400 types of games and variations, such as Numerical Lotteries, Online Games, TV Lottery Games, Sports Lotteries, Fixed-Odds Betting, Instant Lotteries, Pari-mutuel, Video Lottery, Monitor Games and Interactive Games.  The chart below (also from 2013) summarizes its portfolio of gaming offerings:

Thanks to these extensive offerings, INTRALOT now has a dominant market share in Europe, Latin & Central America, and Asia, with a significant presence in North America, and continues to expand into regions like Africa. The Company’s significant investments in recent years on technology and infrastructure to build out this international footprint has resulted in a large portfolio of stable and long-term oriented projects in developed markets as well as in emerging markets where there will be significant growth in the coming years.

The table below shows the geographic breakdown of the Company’s revenues.  Note the increased contribution from the Other Countries category towards the overall profitability of the group and the normalization of the margins at the mature regions.  (Note: Other Countries bucket includes Australia, New Zealand, China, South Africa, Turkey, South Korea, Lebanon, Egypt, Azerbaijan, Taiwan and Morocco).


Industry Overview

The global gaming industry has been steadily growing (4-5% CAGR) and should continue to expand (3-4% CAGR) on account of further liberalization of lotteries, privatization and legalization of lottery games, the current under-penetration by the industry players, introduction of new games, and the increasing demand for online betting.  The lottery industry presents many challenges (regulations, taxation, etc.) but also plenty of opportunities (technological convergence, new business models, new demographics, etc.).  Governments around the world are seeking to increase revenues so that they can fund the budget deficits, especially in the current difficult economic environment, and are looking to the gaming markets to help accomplish this.  Additionally, given the large underground markets and the social implications of the illegal gambling, governments are increasingly looking to legalize gambling so that revenues can be generated from license sales and gaming taxation.

In addition to INTRALOT, the other key players in the industry include Scientific Games, GTECH, Tattersalls Group, Camelot Group, Pollard Banknote, among others.  The barriers to entry for new players are high as the technology and security know-how along with the long-term nature of the contracts make it a formidable challenge to displace the incumbents.  As growth rates slow, new taxes and regulations come into effect, consolidation in the gaming industry has started to pick up.  Recently, two of the Company’s key competitors have made large acquisitions to diversify away from the lottery business – GTECH acquired IGT and Scientific Games acquired Bally Technologies.  Consolidation will only increase because as the lottery industry has matured, margins have declined across the board. The high margin contracts in the industry from a few years ago are becoming scarce and so companies have to manage their business with smaller margins and from a larger operation in general.



The balance sheet is levered but in decent shape.  The Company has €612mm in total debt, most of which is unsecured.  There are two bond issues, which trade at a YTM of ~7.5%, and a €200mm facility that is mostly undrawn.  Cash interest should approximate €42mm per annum and this should be adequately covered given the EBITDA generation of the business. On a gross basis, leverage is 3.0x EBITDA but after adjusting for the €214mm in cash, net leverage is 1.9x EBITDA.  However, true leverage is actually higher given the existence of significant minority interests and the leakage of dividend payments to these minorities – this is why I approach this investment opportunity from the perspective of a levered equity situation.

The Company has no financing needs until 2018, which is when the 9.75% notes mature.  I believe the likelihood of the Company calling the 9.75% notes in 2016 at 104.88 is high given the excess cash on the balance sheet as well as the debt capacity it has at the secured level.  Assuming a bank deal at 6.0%, interest savings would be in excess of €12mm, or 4.3% of the current market cap.  It’s unclear to me why the Company has chosen the unsecured market to finance its operations.  It would appear that its interest costs would be meaningfully lower if the balance sheet had more secured debt.

Minority interest of €195mm represents a significant portion of the overall enterprise value.  Please refer to the valuation section for discussion on how I arrive at this estimate, which differs from the Company’s figure of €90mm.


Summary Financials

INTRALOT has been in a growth mode in recent years having increased the top line from €904mm in 2009 to a current run-rate of nearly €2.0bn.  The combination of significantly increasing the number of jurisdictions where it has a presence and new customer contract wins has contributed to this strong growth.  While EBITDA continues to grow, margins have been trending lower, mainly due to two reasons.  Historically, the Company was the beneficiary of two very profitable contracts – OPAP technology contract and Inteltek contract tender – where it was significantly overearning.  As these contracts become a smaller portion of the overall revenues and get renegotiated to market terms, margins have adjusted to normalized levels.  Furthermore, the new contract wins in recent years came with high launch costs that temporarily had a negative impact on margins and profitability.  A quick additional comment on margins – whereas the Company reports revenues on total wagers, many of its competitors report revenues net of payout on player winnings.  As a result, the Company’s reported margins appear a lot lower versus its peers but on an adjusted basis, they should be comparable to its comps.

The Company’s group results need to be adjusted to reflect the significant ownership interests of minority investors in certain subsidiaries.  My understanding is that subsidiaries in Turkey, Argentina and Azerbaijan account for the largest portion of minority interest expense.  Minority interest expense has almost doubled to €35mm per annum since 2010 and cash flow leakage via dividends to minority investors has been a significant outflow.  This can be construed as both good and bad – it means that these subsidiaries are growing and presumably cash flowing nicely but at the same time, INTRALOT shareholders are not realizing any distributions. 

From looking at the historical financials, it doesn’t take long to figure out what the main issue with this business is and why the market is valuing the equity the way it is.  Even with the strong revenue growth and the respectable margins, the Company hasn’t generated much in the way of free cash flow.  From January 2010 through September 2014, cash flow from operations has totaled €381mm but capital expenditures and net dividends to minority owners over this period has totaled €407mm and €68mm, respectively – result is that the Company has burned €94mm over this period.  Capex spend of €108mm in 2010 and €119mm in 2012 were the two biggest contributors to this FCF deficit.  Additionally, changes in working capital during this period totaled -€103mm, however, as growth slows, this line item should start to normalize providing a cash flow benefit going forward.


Normalized Capital Expenditures

Now that INTRALOT is presumably coming to the end of a cycle of capex that saw significant expansion in the U.S., Europe, and Asia, the Company should be entering into a harvesting phase where FCF generation improves materially as investment spend normalizes.  Due to the nature of the Company’s contracts, significant upfront capex is required for terminal assembly, customization of software, software and equipment installation and telecommunications configuration.  This money has now been spent and given the margins and the long-term nature of the contracts, it would seem that INTRALOT is poised to generate significant FCF in the coming years.  While management has stressed lower capex and higher FCF in the past, we have not seen this materialize to date and this has been a major source of frustration for investors.  For this investment to work, management has to improve FCF over the next 12-24 months or else the stock will continue to languish.  In many ways, the good news is that the market will force a lower capex spend for the simple reason that there are not as many new large contract opportunities available

The other issue is that most investors have been unable to estimate a normalized level of capex for the Company.  Management has not provided any guidance and so the range of estimates can be wide – some believe that it could be as low as €25mm per annum and others feel €75mm is more appropriate.  While my confidence level is not high, I estimate that the number is somewhere in the middle and am assuming €45mm in normalized capex.  I arrive at this by looking at the capex spend at the Company’s competitors (mainly Scientific Games and GTECH) that provide much better disclosure in their filings.  By my calculations, SGMS has on average spent roughly 8% of revenues on capex but was trending closer to 6% prior to its acquisition of a more capital-intensive equipment maker WMS Industries.  GTECH has spent 9% of revenues on capex but has also stabilized closer to 6% in recent years.  After adjusting INTRALOT’s revenues for payouts (to make them comparable to peers) and assuming a 6 – 8% capex/revenues range, normalized capex would approximate €40 – €53mm per annum. 



Assuming an EBITDA range of €185 – €215mm and a multiple range of 5.5x – 6.5x, I get to an equity value per share of €2.14 on the low end and €5.22 on the high end.  Given the leverage on the balance sheet, its not surprising to get such a wide range for potential values for this stock.  Two other key assumptions that went into the valuation:

1) While the Company doesn’t provide a breakdown of where all the cash resides, I’m assuming that it’s spread across its many subsidiaries worldwide.  And while the Company has various tools to repatriate the cash efficiently (management fees, intercompany loans, dividends, etc.), I’ve assumed a haircut of 15 – 35% for potential leakage relating to taxes and any unforeseen negative outcomes (devaluation, confiscation, etc.)

2) I place a value of €165 – €228mm on the minority interest which is considerably more than the most recent €90mm estimate by the Company.  I’m not quite sure how the Company arrives at €90mm given how large the minority expense line item has been in recent years