Zeal Network ETR:TIMA W
January 11, 2020 - 2:30pm EST by
2020 2021
Price: 19.22 EPS 0 0
Shares Out. (in M): 22 P/E 0 0
Market Cap (in $M): 430 P/FCF 0 0
Net Debt (in $M): -128 EBIT 13 21
TEV ($): 302 TEV/EBIT 22.5 14.6

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Zeal Network is undergoing a transformative M&A process, involving significant synergies and a business model shift, through its recent acquisition of Lotto24. Zeal’s legacy business is an online secondary lottery platform in Europe (focusing on Germany), whereby Zeal replicates state-run lotteries and their payouts (earning a commission and taking on risk in the process). 

Zeal is converting its more profitable secondary lottery business to a licensed lottery brokerage business (Lotto24’s model which incurs no payout risks). This shift will hurt near-term revenue and profitability, but the pro-forma company will emerge as a much stronger entity. Pro-forma for this merger and business model change, Zeal will control a dominant share in the under-penetrated, regulated, online lottery brokerage market of Germany. Put simply, you are purchasing the existing users on Zeal’s platform for the current EV (all future growth is free) – and I expect the business to CAGR in the teens for years to come as online lottery purchasing takes share of offline; I believe this is a double.  

For framing the investment, while Zeal is acquiring Lotto24, it is really Lotto24 whose business model is the focus of study. As such it will be the focus of this write up. 

What is Lotto24?

Originally a spin off from Zeal Network in 2012, Lotto24 leads the online lotto ticket brokerage market in Germany with 34% share in 2018. The Company takes no “lottery” risk – it has a license to sell lottery tickets online, with commission, on behalf of the Deutsche Lotto und Totoblock (“DTLB”) – the state lottery operator. We want to be clear – this is not a “gambling” business. This is a tech platform. Once acquired, customer-churn is miniscule (we believe sub annualized churn is sub-10%). The framework to be applied is that of offline to online share shift and massive customer NPV accruing over-time. We think this is misunderstood; the PF entity trades just the NPV of existing customers alone and we think this business has a long runway of growth as online-brokerage takes share. 


The German online lottery market is in the early innings today given restrictions placed on the market until 2012; online lottery offerings were completely forbidden until mid-2012. It has quickly grown since. From 2012 to 2018, the online German lotto market has grown from EUR 35mm to EUR 937mm, or 13% of total lottery bookings. This 13% pales in comparison to online lotto penetration in other countries, like Finland (~40%) and Slovakia (~50%). 

Within this under-penetrated market, Lotto24 has 34% share and is 10x the size of all other private competitors combined (EUR 322mm of billings in 2018 vs a collective EUR 32mm for other primary-lottery brokers). Its main competition, today, are state-owned online operators (whose actions are sort of centralized by the DLTB). This group of state-owned operators, collectively, represents 64% of the online lotto market and should cede share over time. 


Lotto24 runs web-based and mobile platforms that facilitate the purchase of lottery tickets, which are primarily for the Lotto6aus49 and Eurojackpot lotteries. For context, see their webpage below – it is a simple & clean website that easily facilitates ticket purchasing:

To understand why this is an attractive business to be in, let’s review the unit economics of Lotto24. The average registered user spends ~EUR 160 a year in lottery tickets – of which Lotto24 takes a ~11-12% commission on, netting ~EUR 19 in revenue per registered user. Direct opex to facilitate this revenue stream (mostly payment processing) is exceedingly low at just EUR 1.5 (8% of rev). There are a host of fixed costs that Lotto24 has been leveraging over-time, the primary items are personnel expenses (EUR 5 / registered user) and indirect opex (mostly IT) at EUR 3 / registered user; D&A is extremely low as this business is capital-lite. This profile results in extremely high incremental EBIT margins (I estimate ~80%, or ~EUR 10.8 in net income per new user per year) and all-in EBIT margins of ~50% (including all fixed costs). 

It costs ~EUR 26 to acquire a new customer, which we believe lasts, on average, close to a decade (based on billings by cohort, in appendix). Since the business has not been around for a decade yet (so we might be missing certain churn effects), to be conservative we peg the avg. customer life-time at 5-7 years. That results in a customer-level IRR between 60 and 70%. This is a great business:


So we get it, Lotto24 is an interesting business and historically they have had good unit economics – but why is Zeal acquiring it and why own Zeal Network now? 


My investment in Zeal boils down to three main points:

  1. The Zeal acquisition is really just a cheap way for Lotto24 to acquire new customers

  2. Continued offline to online shift will drive growth for years

  3. Pro-forma, Zeal will have a dominant share of the market and should out-compete any new entrants. 

Zeal and Lotto24 Combination

The key to understanding why this combination is so value-accretive is that prior to Zeal acquiring Lotto24, its business model tied up significant cash in hedging operations related to its secondary lotto business. Because Zeal was replicating payouts of official lotteries (rather than just acting as a broker – as Lotto24 was), it tied up significant amounts of cash on the b/s to reserve for potential payouts. At year end 2018, Zeal had a EUR 176mm market cap and EUR 102mm of net cash (an EV of just EUR 74mm). Zeal has a total of 3.9mm registered users and 400k monthly active users. If we assume most of these convert to Lotto24’s business (i.e. they participate in the primary lottery business), then this is an effective CAC of EUR 19 (~30% lower than Lotto24’s organic rate). 

What’s more, you are buying the combined company today at an EV of EUR 302mm (EUR 430mm market cap and EUR 128mm of net cash) – which gives the Zeal-stub an implied valuation of just EUR 33mm (14mm Zeal shares were issued in the buyout of Lotto24; at the spot price of EUR 19.22 per share, this equates to a purchase price of EUR 269mm). Looked at that way, Lotto24 is “acquiring” Zeal’s registered customer base at just 8.4 euros each (1/3 it’s typical CAC)!

I believe most of Zeal’s customer base will transfer over to Lotto24’s business-model. Zeal has given an indicative guide of ~75% retention. For conservatism (and since Zeal’s MAU / registered user rate is less than Lotto), I assume only half their customer base will transition to Lotto24’s business (2mm users). This is still a CAC of EUR 16.5 (using the Zeal-stub valuation) – a great deal. 

I think this deal is highly misunderstood. The merger will bring about significant synergies – much of-which have already been realized over the past quarter (headcount reduction). I’ll not belabor this point, but just note that the Company expects a total of EUR 57mm in opex synergies. This is truly accretive M&A. From just my special situation goggles, this seems to already be a home run. 

To be clear – this combination is complete as of May 2019 but the business model shift only started in October of 2019; due to this no published financials are inclusive of any results of this business model shift. Since commission and margins are higher on secondary lotto – we should see near-term degradation of consolidated financials (which will likely be misunderstood by the market). 

Offline to online shift

Online share of total lottery bookings has quickly grown over the years in Germany. From 0% penetration in 2011 to 13% in 2018, I expect online to continue to take 300bps of share each year for the foreseeable future. I am comfortable with using ~30% as a terminal value given the online penetration seen in other markets (aforementioned 40-50% penetration in Finalnd and Slovakia) as well as the natural demographic shift that should occur (favoring online mediums). Please note that for market share, below, I am making some assumptions for the combination of Zeal and Lotto and resultantly market share jumps from 34% in 2018 to 54% for the combined business (market share has a step-function change as customers are rapidly converted from secondary lotto – not in the denominator – to primary lotto brokerage):

Online lottery brokerage is simply a superior value proposition vs. retail brokerage. You save time and convenience of not having to keep track of physical receipts when in an online medium (one can even save face to the extent their lotto purchase habits are frowned upon by a family member). 

Market Share

One of the most interesting attributes to the online brokerage industry is the fact that the DTLB had the majority share (through its various state-owned companies). Zeal is competing against a bureaucratic entity in a tech-driven business which by itself is normally a recipe for share gain. For online lottery, this dynamic particularly advantages private operators as they are able to dynamically flex marketing spend when cost per lead is lowest. Cost per lead is lowest when conversion is highest. As it turns out, the primary determination of conversion is simply the appeal of a given lottery winnings pool – when the jackpot is really big, the cost-per-click expense of the same google ad run to acquire new users accrues an immensely higher ROI (as conversion ratchets up). 

State-run online lottery brokers are severely disadvantaged here because they are bound by a given budget that is approved (I believe this is annually reviewed). If ROI’s are skyrocketing due to huge jackpots (whose timing is immensely variable / based on probabilities) – they simply will not be able to flex up marketing spend in the same way pvt operators can. This is akin to two lemonade-stands a block away competing when marathon runners finish a near-by race -- only Zeal in this analogy can spend to advertise their block!

On top of that, given Zeal is more than 10x the size of the next largest competitor – they should be accruing significant marketing scale advantages (the classic scale dynamic to marketing spend – Zeal can run TV ads at good ROI’s whereas competitors 10% the size cannot). Resultantly, they should continue to gain share – though I assume their share will remain flat (for conservatism). 


Putting this all-together, we find a really cheap business no matter what way you stack the chips:

  • At an 8% NPV, a customer lasting just 5 years (I believe avg. lifetime is longer), contributes EUR 62 in EBIT. Year-end 2019, PF for converting Zeals 3.9mm registered user base to just 2mm users for Lotto’s lotto brokerage business, Zeal will have ~4.6mm registered users. At EUR 62 a pop, that is an EV of 285. This compares to current EV of EUR 302mm. You are buying future growth for free – try finding that in Western SAAS companies. 

  • Excluding marketing expenses (assuming the business goes ex-growth), Zeal trades for 9x my estimate for 2020 EBIT. 

  • Assuming business as usual and online penetration continues as I expect (with Zeal taking only its fair share – no incremental share), by 2021, the business will trade at 15x consolidated EBIT and by 2022, it will trade at just 9x EBIT. This is burdening the financials fully for customer acquisition spend (too cheap of a valuation for a business growing EBIT 10-20%+ per annum thereafter)

In summary, I believe this small-cap European company is being mis-properly valued for two reasons: 

1) The transformative M&A between Zeal and Lotto will accrue significant new users for the brokerage business at very low CAC.

2) Sales & marketing (for acquiring new customers) is expensed directly – making consolidated financials variable (and not attractive to an investor not using the right valuation framework). In reality, Zeal/Lotto have to spend very little in marketing to keep their existing customer base. 

Putting a 20x multiple on 2024 EBIT, I get to a EUR 1bn terminal value for the business. Adding in existing cash of EUR 128mm and ~EUR 100mm of interim cash to likely be generated, I get to a 2024 YE market cap of EUR 1.2bn. Discounted back 5 years at 8%, this is roughly a double vs. the current market cap of EUR 430mm. 

Please see below for a quick & dirty model I made for you all: 


I’d be happy to field any questions on risks in the comments section. The primary risk most would point to is the renewal of the brokerage license (which is coming up next year). I’ll have to talk with management to get more clarity here, but I do not believe they will get squeezed upon renewal (it is fairly standard). 



Billings per customer cohort (almost no degredation)


Disclaimer: This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation. This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

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.


Completion of business model shift

Continued offline to online shift of regualted lotto ticket purchases in Germany

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