Intralot S.A. INLOT GA
October 01, 2018 - 2:50pm EST by
2018 2019
Price: 0.69 EPS -0.12 -0.05
Shares Out. (in M): 157 P/E 0 0
Market Cap (in $M): 108 P/FCF 0 0
Net Debt (in $M): 608 EBIT 0 0
TEV ($): 716 TEV/EBIT 0 0

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Intralot (INLOT GA) is the 3rd largest lottery services company globally (International Game Technology (IGT) is #1, Scientific Games (SGMS) is #2), with lottery games providing about 30% of Intralot’s total sales. They are also a big player in sports betting which is about 60% of sales, and where they should garner a meaningful share of the burgeoning U.S. market for legal sports betting.  Given that Intralot USA has an 11% share of the U.S. lottery market (measured by dollar amount wagered on Mega Millions, Powerball, etc. in the 12 states they serve), if they captured a similar share of the legal sports betting market here as it emerges, it could be a big growth driver over the next five years.  The company believes that they will have their first sports betting contract in the U.S. before year-end.  The lottery and sports betting businesses are very recession resistant, providing dependable, highly recurring sales and cash flows.

The stock is down 40% YTD on emerging markets exposure (about 50% of proportionate EBITDA), weakness in gaming stocks in general, and macro-economic / political concerns about Italy (12% of proportionate EBITDA in 2017) and Greece (less than 5% of EBITDA). Intralot’s debt has grown sharply over the past few years as they complete a heavy investment cycle, but that excess cap-ex (most of which has been spent in the U.S.) should begin paying off next year.  Also, a confusing corporate structure with many joint ventures and minority interests means that reported consolidated EBITDA overstates reality versus the more economically relevant proportionate EBITDA number, which is just over 60% of the reported consolidated number.  We think all concerns are overly discounted in the valuation, and see fair value at 8x proportionate EBITDA that we estimate will grow significantly to €130M in 2019, minus €630M proportionate net debt at year-end 2018 (up from €608M on 06/30/18, gross proportionate debt €766M minus proportionate cash €159M), = €410M equity value divided by approx. 157M shares outstanding = about  €2.60 per share which is 277% above the closing price of €0.69 on 9/30/18.  Scientific Games (SGMS $25.40) is down 51% YTD and yet still trading at 8x EBITDA, with a similarly leveraged balance sheet at 6.3x net debt to EBITDA.

Intralot is domiciled in Greece, and controlled by a Greek billionaire, 79-year old Socrates Kokkalis, with just over a 20% stake, but with no discernible history of minority shareholder abuse.  Mittleman Brothers LLC is the second largest shareholder with just over a 10% stake.  The Athens listing keeps many investors from taking a closer look and is a primary cause of the undervaluation.  If you look past the Greek listing (which few do), you’ll see that 94% of Intralot’s sales come from outside of Greece, and almost all of their cash is held in bank accounts outside of Greek banks (only 6% of cash deposits held in Greek banks).  So, if Greece were to default and revert to the Drachma there is a built-in currency hedge, and the valuation in such cases normally adjusts immediately such that the security’s price in the new currency adjusts upwards to offset the decline in the exchange rate.  We’ve seen this happen with other foreign currency earners in countries that saw major currency devaluations like Mexico in December 1994 and have no doubts that Intralot’s enterprise value would be preserved in this way should Greece leave the Euro.  Sell-side coverage of the equity is scant, with only four small Greek brokerage firms following it, only one of which, IBG Research, rates Intralot a “buy” (€1.20 price target (+70% from current price, but still less than half of our fair value target of €2.60).

Intralot’s stock has fallen about 40% YTD through 9/30/18, for reasons mostly unrelated to performance of its business operations.  First off, there has been general weakness in the share prices of gaming companies, with Intralot’s primary competitors like IGT down 24% YTD and Scientific Games (SGMS) down 51%.  But impacting Intralot in particular, in May of this year, a Greek online news service wrongly tied the company to a short-seller’s report on FF Group (FFGRP GA), which owns retailer Follie Follie and with which Intralot has no connection whatsoever.  That caused instant and severe panic selling as the FF Group situation centered on accounting fraud.  The short-seller himself claimed that he had no position or report to issue on Intralot, and yet rather than recover, the stock has fallen much further since, despite aggressive stock buyback activity by the company (YTD through 8/29/18 Intralot bought back 8.1M shares (5% of shares outstanding) at avg. cost of €0.96 per share), and significant insider buying.  Beyond that, weakness in the emerging markets, where Intralot does significant business, has weighed on the stock.  In particular, their operations in Turkey (15% of proportionate EBITDA) and Argentina (8% of proportionate EBITDA) were affected by currency weakness in those countries, with the Turkish Lira down 37% YTD vs. the USD (from TRY/USD 3.80 to TRY/USD 6.00) and the Argentine Peso down 53% YTD (from ARS/USD 18.62 to ARS/USD 39.63).  However, the vast majority (80%) of Intralot’s cash is kept in EUR and USD, which substantially mitigates the FX risks.  And the currency weakness in those markets has obscured the strong local currency results of those businesses, with sales up 30% (albeit aided by inflation in Turkey running near 18% lately) and EBITDA up 18% in Turkey in local currency terms during the first half of 2018, for example.  Management also believes strongly that growth in Turkey will accelerate again in 2020 as the Turkish government will allow the payout percentage to rise, which usually leads to dramatic increases in sales.  On the last quarterly conference call, 8/31/18, management estimated that if Turkey and Argentina saw their currencies stabilize at recent levels, the overall hit to EBITDA for the full year of 2018 would be approx. €20M on a consolidated basis, and approx. €10M on a proportionate basis (the more relevant number).  So we’d expect proportionate EBITDA to drop from €109M in 2017 to about €105M in 2018 (currency impact muted by strong growth from their 20% stake in publicly-traded Italian gaming company Gamenet (GAME IM €9.49), before jumping to €130M in 2019 on contribution from the Illinois lottery contract which kicks in beginning December 4, 2018 and which mgmt. estimated will generate about USD20M/€17M in EBITDA annually, and further strong growth in proportionate EBITDA from their 20% stake in Gamenet in its first full year post-merger with Goldbet, a privately-held Italian sports betting company bought at a €256M EV valuation (6.4x EBITDA of €40M pre-synergies) announced 7/24/18 that should close before year-end, offset partially by lower profitability on their contract with OPAP, the Greek lottery company, plus other adjustments.  Impressively, Intralot sold its break-even business in Italy to Gamenet in March 2016 when Gamenet was still a private company, and today the value of Intralot’s 6M shares of Gamenet at €9.49 per share is €57M, which we think substantially undervalues that business. Intralot receives €3.6M a year in cash dividends from those shares.

Intralot has won big new contracts (Illinois, $340M over 10 years starting December 4, 2018) and key renewals (Ohio, along with four others, maintaining a 90% renewal rate since 2008 in the U.S., avg. contract duration now 7.6 years) recently to serve lotteries in the U.S.  Intralot is now serving 11 states plus Washington, D.C. in the U.S. which account for USD 60M/ €52M EBITDA  (50% of proportionate EBITDA estimated for 2018).  The U.S. business should grow substantially in 2019 with the Illinois contract (expected to add USD 20M EBITDA in 2018), and the company expects to sign their first sports betting contract in the U.S. before year-end 2018.  The company is actively considering doing an IPO for their U.S. division, which we would expect to garner at least an 8x EBITDA valuation (USD 480M on USD 60M EBITDA in 2018, to USD 640M on USD 80M EBITDA in 2019), whereas in Greece the Intralot parent company trades at 5.7x EBITDA our estimate of €130M for 2019).  We think the timing for an IPO of their Intralot USA division couldn’t be better given the recent legalization of sports betting here, a business where Intralot already has major scale and should win some significant contracts.  Intralot is also bidding on the Pennsylvania State lottery contract, which is a huge contract, with the results due late 2018 or early 2019 (initially due in June 2018, but one of the other bidders, IGT, filed suit against the PA state lottery agency claiming an unfair process which structurally advantaged the incumbent, Scientific Games. The Governor of Pennsylvania then interceded and terminated the tender and demanded an investigation.  So the entire contract award process has thus been delayed).  An Intralot win there would increase their U.S. EBITDA dramatically.  Regardless, we believe that an IPO of Intralot USA, if valued at least at 8x EBITDA, would likely cause an immediate doubling of the stock price on the sentimental relief of having achieved a very substantial deleveraging at a reasonable valuation.  There is also a possibility that Scientific Games buys out Intralot USA, as each company has about 11% market share in U.S. lotteries, versus 78% for IGT, but with Sci-Games more exposed to instant-win printed games, and Intralot more on lottery systems.  Putting the two together would be a much more balanced and potent competitor to IGT, and a 22% market share player versus a 78% share giant shouldn’t bother anyone in the anti-trust dept. of the FTC. 


How we arrive at 277% upside potential:

Fair value estimate of €2.60 per share = EV/EBITDA multiple of 8x our estimated 2019 proportionate EBITDA of €130M (equates to 72% of consensus estimate of €180M consolidated EBITDA for 2019) which is an EV of €1,040M, minus €630M proportionate net debt projected for year-end 2018, equals €410M equity value, divided by approx. 157M shares outstanding equals approx. €2.60 per share. 

At some point the stock market’s focus will shift from the risks inherent in Intralot’s emerging markets exposure to the higher growth potential those markets present, and the valuation discount may even become a valuation premium at some point if/when such above average growth materializes.  At some point the over-spend on cap-ex, which began in earnest 10 years ago in 2008, and will have averaged €95M per year over the 11 years through 2018 inclusive, and the resulting lack of FCF will give way to normalized cap-ex (€120M cap-ex in 2018, drops to €60M in 2019 according to mgmt., and we think €50M thereafter, of which €25M is maintenance, €25M is renewal/growth) with deleveraging and blossoming FCF for the first time in many years.  An investment cycle is giving way to a harvesting cycle. We think that point is beginning now and into 2019.



One negative factor is that much of their business is held in joint ventures with local entities in the various countries in which they operate, so they incur significant dividends to minority interests every year.  From 2005 to 2017, consolidated EBITDA averaged €182M, minority interest averaged €38M, so retained EBITDA averaged €144M.  During that 13-year period, dividends paid to common shareholders averaged €18.5M per year (a 17% yield on current market cap.), but have not been paid since 2009, as a couple of unusually high margin contracts ran out then just as leverage began to increase into their U.S. expansion.  Once the company de-levers adequately (through IPO of Intralot USA and/or other asset sales), we’d expect to see common dividends turned back on, possibly in late 2019, but more likely a 2020 event. 

Intralot is highly leveraged with proportionate net debt set to rise from €608M on 6/30/18 to €630M by 12/31/18 as excess cap-ex in advance of the Illinois state lottery contract is completed, a net debt to EBITDA ratio of  6x proportionate EBITDA est. of €105M in 2018, and 4.85x EBITDA est. of €130M in 2019.  The company refinanced 9.75% notes in 2016 with €250M 6.75% notes due 2021, and refinanced other obligations in 2017 with €500M 5.25% notes due 2024.  That was excellent timing because with the emerging markets fear trade back on, those notes dropped from over $100 earlier this year to $83 and $75 respectively.  We think the company will successfully de-lever well in advance of their debt maturity dates, either via sale in full or in part of Intralot USA, or a combination of other assets (for example: Intralot Australia, does €22M sales and €12M EBITDA (55% EBITDA margin) with little cap-ex needs, probably worth 10x EBITDA; the company had been in talks with lottery operator Tatts in Australia to sell Intralot Australia to them in 2016 before Tatts itself was bought out. They also retain a 20% stake in their business in Peru (est. value €25M), and a 16.5% stake in Hellenic Lotteries (est. €20M), among other salable assets).   It should also be noted that Intralot’s net debt is in-line with peers (IGT at 4.7x, Scientific Games (SGMS) at 6.3x).  For nearly recession-proof, high margin businesses like these, with huge barriers to entry, we think the relatively high leverage is tenable.

Other risks include Italy imposing higher taxes on gaming revenues, and potential currency controls in Turkey or Argentina, but again, we think the current valuation overly discounts those risks.  


*We are long INLOT and may buy or sell additional shares at any time. This is not a recommendation to buy or sell securities. Please conduct your own research and reach your own conclusion.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


- Substantial growth in U.S. business (Illinois contract) and the company expects to sign its first U.S. sports betting contract before year-end.  

- Potential IPO for their U.S. division

- Pennsylvania State lottery contract results due late 2018 or early 2019. An Intralot win would increase their U.S. EBITDA dramatically.  

- Possibility of Scientific Games buying out Intralot USA. Putting the two together would be a much more balanced and potent competitor to IGT, and a 22% market share player versus a 78% share giant shouldn’t bother anyone in the anti-trust deptartment of the FTC. 

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