Description

Jackpotjoy (aka Intertain) is the dominant online Bingo provider in the UK and Spain. In the past year the story has been significantly derisked. The company has been trading on London since January, the major earnout payment was made in June, results have come in better than expected, the one-time charges have ceased, and the debt has been refinanced. While the stock has rallied 40% since being listed in London in January of 2017, I believe it still has 70% upside in 2018 and even more in future years.

VIC member Avahaz did an excellent write-up and Q&A in July 2016 that most certainly deserved a better rating than it received. I suggest and will assume that readers start with his posting and read the Q&A messages as that explains the business and why it has such good qualities. The intention of this post is to update the reader on developments since that time as well as discuss the current outlook heading into 2018. All numbers discussed below will be in GBP.

Timeline:

2018 was a good year for JPJ as management accomplished much of what they set out to do. Financials came in better than expected (discussed in more detail below), there was strong EBITDA to cash conversion, and the balance sheet was significantly improved.

June 2017: The major earnout to Gamesys was made, totaling $94.2mm. This was financed through cash on hand and available room from the term loan, first and second lien lines.

There remains a final earnout payment due in June 2018. While carried for less on the balance sheet, management estimates the total will come to another $50mm. This will be comfortably paid.

October 2017: Andy McIver announced he is stepping down at year’s end. Simon Wykes will replace him as group managing director. Andy was CEO for just over a year. Normally this would be a red flag, however he was a placeholder CEO. His primary duty was to successfully see the London listing, which he accomplished. Incoming Wykes was formerly CEO at Gala Leisure and a director at Gala Coral. Those who closely read Avahaz’s piece will realize that exec Chairman Neil Goulden ran the Gala Coral group of companies for 14 years. It seems clear that Goulden wanted the story to play out and derisk before bringing in his man to run it.

November: A further catalyst occurred at the end of November, when JPJ announced an agreement in principal to refinance their debt (successfully closed in Dec). Prior to the debt refinancing, the various term loans and liens had interest rates ranging from 8.32%-11.75%. It was also partially denominated in USD, introducing fx risk to the balance sheet.

The new Term Facility matures in 7 years, is in both Euros and Pounds and carries a much lower rate of interest, currently around 6.6%. Management estimates this will save $9mm annually or 12p per share. 

Also announced in November was that The Stars Group had completely divested of their 7.5% stake. This was a legacy item for pokerstars, acquired when Amaya first sold some assets to the newly created Intertain. This removes a key overhang.

Financials:

As mentioned earlier, results have come in much better than expected YTD. Here is a rough snapshot of key items by division for the 9 month period. Important items highlighted in yellow.

Overall the business has a highly variable cost structure, with one of the main reasons for lumpiness being uneven marketing spend. We see that in the 9 month results where the ebitda growth has closely matched revenue growth.

Revenue growth has come in better than expected as mobile growth has taken off. 60% of revenues are now derived from mobile which now carries a higher ARPU than desktop as bingo and slots lends itself well to tablets and phones.

Growth should continue at a fast pace into 2018. JPJ relaunched its marketing campaign around new ambassador Paddy McGuiness in Q3. This caused marketing spend to ramp heavily in Q3, depressing JPJ ebitda, and may continue into Q4. That said, this heavy marketing will lead to continuing high levels of revenue growth into 2018. Churn should be reduced due to the new UK tax rule changes and the difficulty competitors will have stealing customers away from #1 by market share JPJ.

 KPI’s continue to outperform. Active customers grew 13% in the TTM period to September 30^th with 2% growth in ARPU, explaining the roughly 15% revenue growth for the company overall.

Mandalay has been weaker with management consciously deciding to ramp down marketing spend ie bonuses, hence the decline in revenue and improvement in EBITDA. Management said on the Q3 call they may merge the assets into JPJ at some point or continue to milk it for fcf.

One time items:

These were frequent and large in 2016 as management had to work through the expenses of the special committee, firing the old CEO, and listing on London. As can be seen below, one time items/transaction costs have declined 88% YTD to a reasonable $2.7mm from $28.6mm total last year.

While we may see some more charges in Q4 associated with the debt refinancing, that is a reasonable charge to take with a quick payback period. Having dealt with all the majors issues, there should be no charges in 2018.

Balance Sheet:

The balance sheet was always a concern for JPJ, ending 2016 with debt/ebitda of 4x when including future earnout payments. Throughout the year, leverage was reduced as the cash generative nature of the business manifested itself and earnouts were paid off. As of September 30^th, and including the $50mm earnout yet to be paid in June 2018, total leverage was 3.4x TTM EBITDA. I see this dropping to 3.2x at year end 2017. With forecasted ebitda growth in 2018, this ratio should reach 2x on a TTM at Dec 31^st 2018, setting the stage for a large dividend to be imitated in 2019.

The new term facility is set for 7 years, at a greater reduced interest rate, and naturally hedges the fx risk of the business by being proportionally denominated in Pounds and Euros as opposed to USD.

The $50mm earnout payment can easily be funded by existing cash on the balance sheet and 1 quarter of earnings (likely to show over $50mm cash on the 2017 year end statement).

Valuation:

I started this by saying that despite the 40% rally, there is still room to run. On my 2018 ebitda and FCFE calculations, JPJ is trading at 7.2x and 6.8x respectively. The peer group trades at 10.7x 2018 ebitda. I believe the peer multiple is justified if not low for JPJ. A business that benefits from network effects, has a market leading position, and is capital light should command a premium valuation. That 10.7x ebitda multiple on a trailing basis gets us to $14.60 by end of year, good for close to 70% upside from todays levels. That would equate to a 11.5x FCFE multiple.

POCT:

Some market participants have been concerned with the UK taxation charge, called the point of consumption tax. The changes which affected JPJ starting Oct 1^st 2017 involve the tax on the gross gaming revenue as opposed to the net revenue. This means that under the old regime, bonus play was not taxed. The new taxation system removes this advantage, charging taxes based on the gross revenue generated including the rake earned from the gaming required to clear the bonus matching. On paper this will lead to a 2-3% profit margin impact on JPJ. In actuality, since bonuses are the main way gaming companies attract new customers this should lower churn for the industry incumbents (JPJ) and make it more expensive for the smaller players to compete. This came up on the last call where John Paulson (significant shareholder) brought it up.:

John Alfred Paulson Paulson & Co. Inc. - Founder, President, Portfolio Manager & Director

This is John Paulson. Could you comment a little bit more on the U.K. point-of-consumption tax that comes out in the fourth quarter and how that will impact profitability and what the potential magnitude of that impact could be?

Keith Laslop Jackpotjoy plc - CFO and Director

Sure. So the new point-of-consumption tax that is coming for us from October 1 means that we also pay point-of-consumption tax on bonuses. Previously, that consumption tax was only paid on NGR whereas now we're paying it on GGR. And the difference between the two is bonuses and promotions. For us, the impact should be, if we choose to bonus the exact same, 3% to 4% impact to our U.K. businesses. The U.K. businesses are roughly 2/3 of our overall revenue, so call that 2% to 3% across our group. Now as I've mentioned in previous quarters, I firmly believe this POC tax increase will be more than offset by revenue gains because the POC tax on bonuses will be most keenly felt by smaller players in the market that tend to use primarily bonusing to market to their players. We tend to be relatively bonus-light.

John Alfred Paulson Paulson & Co. Inc. - Founder, President, Portfolio Manager & Director

I see. And when you say the POC impact could be affected by revenue gains, you mean the normal revenue gains that you've been achieving in the businesses?

Keith Laslop Jackpotjoy plc - CFO and Director

Well, I think the POC impact, so this new tax, it will make it very difficult for new entrants to start up as primarily new entrants have used bonusing as a primary way to attract new players. And smaller players that don't have the deep pockets to market using other ways have historically used bonuses or have been very heavy in terms of bonusing to market towards players. And historically, that's how our smaller schemes have acted as well. So Mandalay historically has bonused very heavily. It's from scaling back aggressively those bonuses in 2017, that's why you're seeing some softness in our Mandalay brand. So you can think of the rest of the -- or the long tail of the market, there are a lot of brands, folks on the U.K. market, that will be reacting the exact same way as Mandalay. And we think that with the long tail of the market bonusing less, new entrants' ability to enter the market being curtailed, it will benefit the market leader, which we're the market leader.

John Alfred Paulson Paulson & Co. Inc. - Founder, President, Portfolio Manager & Director

I see. So this -- the bonus cash will make it more difficult for new entrants to enter, which could benefit you as a market leader. That's interesting.

Risks:

While the company has been derisked, there always remains issues to watch out for.

Regulation and Tax: While 77% of revenues are from regulated markets, there is nothing to stop over-indebted governments from raising taxes on a “sin sector”. The only saving grace is like the POCT change this tends to impact the marginal players more, strengthening the incumbents market position.

Gamesis relationship: I am comfortable with the relationship but new investors should closely read Avahaz’s description of the relationship. I do not believe gamesis has any intention  or motivation to compete with JPJ, but the non compete does end in April 2019. One should also assume that starting in 2020 the gamesis platform fee increases from the current 10% to 12.5% of revenues.

Leverage: While the balance sheet is improved 3.2x is still a higher level of debt than ideal. The positive is the cost structure is quite variable, so margins should not move much with a decline in revenue.

Conclusion:

Much work was done in 2017 by management to clean up the story. The stock has rallied appreciably since the initial listing on the London exchange, but at under 7x free cash flow the company is still significantly undervalued given the growth trajectory of the industry, the leading position of the company, and the sticky qualities of the business.

Most of the bear arguments have been dispensed with and the results have come in better than the bull case from 1 year ago. The industry will continue to grow in 2018 and the POCT changes will actually benefit the market leader, JPJ. By the end of 2018 the balance sheet may be under levered and I expect the board to begin paying a substantial dividend. If the stock continues to trade cheap it would become an attractive acquisition target for a land based player looking to acquire a beachhead position in online gambling. 

Catalyst

FCFE leads to natural delevering

POCT changes result in less churn and better long tail revenue

Dividend initiation