Neteller NLR.L
October 05, 2006 - 9:55pm EST by
2006 2007
Price: 170.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 394 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Neteller is the leading electronic wallet for online gambling based on the Isle of Man and listed in the U.K. Since the passage of an Internet gaming prohibition bill in the U.S., Neteller’s stock price has been cut in half. However, online gaming continues in the UK, Europe and other parts of the globe. Based on that remaining business, I believe Neteller trades at less than 5x what is likely to be its new EV/EBITDA run rate after the US business completely rolls off.

For significant detail on Neteller’s business please see skca74’s excellent write up and Q&A from July of 2005. I suspect there are at least a few VIC members interested in getting an idea what the remaining business of an e-gaming company may look like. This write-up will focus on the financial metrics.
As of 1H’06 the company had 536,000 active customers, broken out as follows:
                     Customers      Growth in past year
North America         460.7           43%
Europe                58.0            100%
Asia/Rest of World   17.2            101%
Total                535.9              49%
I am assuming that their North American business is 90% US and 10% Canadian, which translates into 415k active customers in the U.S. and 46k in Canada.

The US government now has 270 days to implement regulations enacting the law. I am assuming that once that occurs that all but 1% of Neteller’s U.S. business is gone. (I am maintaining one percent as I suspect at least some gamblers will find a way to circumvent the law.) I am further assuming that the rest of the business grows from mid-2006 as follows:

Active Customers:
                2006      YOY%      2007      YOY%      2008         
                           Growth               Growth
United States     414.9      -99%      4.1         0%      4.1
Canada          45.8        20%      54.9        15%      60.4
Europe          58.0        66%      96.3        33%      64.6
Asia/Other       17.2      100%      34.3        50%       51.5
Total           535.9      -65%      189.7        29%       244.2

I’ve tried to be conservative growth estimates, but it stands to reason that growth could be much higher in unexplored markets.
Neteller reports that in the past 12 months the average customer generated $432 in revenue which amounts to about 14.0 cents per dollar of revenue deposited in their e-wallet.

A oversimplified breakdown of how that revenue might be generated is as follows:
North American Customer:
Instacash                     8.9
Less: bad debt            (2.0)
Tranfers, 2 @ 3.1c     6.2
TOTAL                    13.1

Instacash is the product that allows users to gamble immediately after depositing their funds. Neteller charges the customer 8.9c for the service and in turn guarantees the gaming site that the funds will be good. The charge to transfer funds from site to site is 3.1c.
European Customer:
Fx conversion on the way in/out, 2 @ 1.9c     3.8
Transfers, 3 @ 3.1c                                     9.1
TOTAL                                                     14.9
With the loss of the U.S. business the metrics change as Instacash is really only offered in North America, thus only Canadians are likely to continue using this feature. (Because of this I will reduce bad debts in the income statement by 90%.)

I also suspect that after the U.S. is completely rolled off that gambling websites may stop using US dollars as a main currency and may more often use Euros. (I need to check this, as I am not an online gambler.) If so this may reduce the number of Fx charges as some customers may not need to convert.

I believe this is likely to be somewhat offset by increasing business in other parts of the world including Asia, LatAm and South Africa. If I reduce the Fx charges on the remaining base by 50% (from 2 to 1) I get the following per customer revenue generating picture:

Remaining Customer:
Fx conversion, 1.0 @ 1.9c            1.9
Transfers, 3 @ 3.1c                      9.1
TOTAL                                      11.0

According to the company, Europeans transfer their funds from site to site more frequently looking for better deals, hence the higher assumed number of transfers.
This suggests that the remaining customers may generate 11.0c divided by 14.9c, or 74% of the revenue of the current customer base. If the current active customer base generated $432 in revenue per customer in the past 12 months, then the remaining active customers (and new additions) being non-US may generate about $319.68 in revenue per year per customer. ($432 x 74%)
I see active customers by mid 2007 (assuming loss of 99% of US biz) on the magnitude of 189.7K (see above), which translates into about $60.7M in revenue.

Revenue                      60.7M
Cust Support                 5.5      9.0% (up from ~7% now)
Website maintenance    2.1      3.5% (up from ~2+% now)
Depost/Withdr fees       3.9       6.5% (same as now)
Bad debts                     0.8       1.3% (One-tenth of current 12.6%)
Depreciation                 10.0            (same absolute number as now)
G&A                           15.2      25.0% (See below.)  
Operating income           23.2

Tax                             2.3       10%   (Isle of Man)

Net income               20.9

EPS                          $0.17

Shares                       123M

EBITDA               33.2
NI + Depr            30.9
Less: capex      (10.0)
Free Cash            20.9

I’ve tried to be conservative, especially with the G&A estimate. I’m using 25% which is well above the ~11% of revenue in 2004 when the business was of a similar size to what I believe it is now going to be and also above the 17% they are at now. This assumes they cut back some admin due to the loss of the U.S. but not all.

As of the end of the 1H the company had $136M in cash. I believe they are likely to generate approximately $60M in additional cash by year’s end, leaving $200M in cash on the balance sheet. After the U.S. business is gone the company should also free up restricted cash on the order of $26M. This represents 90% of the restricted cash. This restricted cash is cash in excess of the funds needed to manage Instacash and which should return to them when the U.S. business ends, less the 10% or so of it needed to manage the Canadian Instacash business.

Finally, as noted above, one year of business without the U.S. should generate another $20M in free cash.
Taken together:
Balance sheet cash 6/30/06          136M
FC generated by 12/31/06            60
Return of restricted cash               26
Cash first yr smaller biz               20
TOTAL by end of 07                242M
Market Cap:
Shares                                      123M
Price 170pence
FX to USD at 1.884 GPB/$ =      $3.20 per share
Market Cap                          $394M
Enterprise Value:
Market cap                      394
Less: cash                      (242)
Enterprise Value                152
2007      2008
EBITDA                                                          33.1      42.7
EV/EBITDA                                                   4.6       2.9

(To get my 2008 EBITDA, I use the active subscriber estimates from the top of the write up along with the same metrics and margins used to obtain 2007 EBITDA and free cash.)
The assumptions provided suggest the stock is cheap. Now the future of the company rests on the regulatory regime established in the rest of the world, particularly Canada and Europe.

Canada does not permit online gaming companies to operate in its jurisdiction. However, Canada serves as a location of operation for a number of online gaming operators (or portions of their ops) by virtue of carve outs for Indian reserves. (The PartyGaming IPO prospectus is a good primer on regulation throughout the world.)

The UK has already developed a set of laws and regulations governing Internet gambling. This insures these companies have a safe location from which to operate. A number of other countries in Continental Europe are making noise about restricting e-gaming in order to preserve local monopolies, France in-particular. Unlike the U.S., the restrictions are typically not based on moral objections (such as the U.S. law), but rather on the potential loss of tax revenue.

European Union Article 49 provides that no member state may impose restrictions on the freedom to provide services from one member state to another. However, they can impose restrictions to safeguard the public interest. If a country already permits gambling then to restrict e-gambling is not a matter of public interest.

I am just ramping up on the country-by-country situation. France has arrested executives of bwin, stating that their activities violate the French state monopoly on gaming. However, this would be in direct opposition to EU law and is one of a few different examples of how this could be brought to a head.

In searching the web, “Gambelli decision” is a good key word as it will bring up a related case in which the EU has begun to lay the groundwork for overturning efforts to prohibit gaming in states which have other forms of gaming.

I had excellent access to information regarding the proceedings to ban e-gaming here in the U.S. Lacking that access in Europe, I do not know what the outcome of the European regulatory environment will be or have a way to monitor it other than the news. While I can’t predict the outcome of the EU situation, I think it is wrong to make a blanket assumption that it will turn out like the US. First, at the EU level e-gaming is likely to be supported based on the trade mandate of the EU. Second, the regulatory battle is likely to go from state to state (as opposed to one big vote like in the U.S). With the UK already in-line it sets a model for other states to follow and makes it harder for other states to oppose it, at least in the end. (Long-term, I do not believe the U.S. government or the E.U. will manage to stop the spread of internet gaming.)


Markets seeing that business is being conducted as usual outside the US. Clarity on European regulator situation.
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