SINGAPORE (May 13): Two UK gambling-related stocks stood out during our recent stock filter to help identify growth stocks. Playtech, a developer and provider of software platforms for both online and land-based gambling operators, had a five-year compound annual growth rate for cash flow, net profit and revenue that was higher than its growth in price over a five-year period.
XLMedia — which was listed on the Alternative Investment Market (AIM) of the London Stock Exchange in 2014 — is an online performance marketing company that has reported consistently positive operating cash flow and free cash flow since IPO.
These two stocks showed up because, despite their strong fundamentals, their share prices underperformed the FTSE All-Share Index, particularly since the Brexit vote in 2016 (see Chart 1). For instance, XLMedia, which was listed at 49 pence in 2014, last traded at 48 pence, despite surging to £2.12 in January 2018. Yet, through the rise and fall of its share price, its fundamentals continue to improve. Similarly, -Playtech has not captured investors’ interest since the Brexit vote.
Despite the share price underperformance, these companies’ fundamentals have improved over the same period. Take Playtech, for example. Chart 2 shows its weighted value growth (the blue line) compared with its price growth (the red line). The blue line comprises a combination of growth in revenue, adjusted net income, retained earnings, operating cash flow and free cash flow. The blue line is in positive territory, compared with the red line, which is in negative territory. This means value continues to grow despite falling prices. The positive divergence between price growth and weighted value growth points to undervaluation.
Similarly, XLMedia’s weighted value growth has been positive while its prices have declined (see Chart 3). This is despite a temporary negative value growth for a one-year period. The company’s earnings and operating and free cash flow continue to remain positive.
Good yields
Yields are a reflection of the attractiveness of a company at current prices based on fundamental indicators such as earnings, cash flow and dividends. The yields are then benchmarked against the risk-free rate to compare their relative attractiveness. Playtech’s yields (see Chart 4) — earnings, dividend and operating and free cash flow — are all noticeably higher than the UK risk-free rates. Our in-house valuation of the company, primarily using a discounted cash flow (DCF) model, suggests a fair price of £6.71. Playtech currently trades at £3.97, suggesting that it is significantly undervalued.
XLMedia’s yield analysis is similarly positive, and also consistent with the price-to-value analysis. Its dividend yield, earnings yield and operating and free cash flow yields are all noticeably higher than the UK’s risk-free rate (see Chart 5). In particular, dividend yield is high at 10.4%, a yield usually associated with distressed credits and companies. Investors can recoup their initial investment within 10 years from dividend payouts alone. Our in-house valuation of the company, primarily using the DCF model, suggests a fair price of 88 pence. XLMedia currently trades at 48 pence, suggesting that it is markedly undervalued.
What Playtech does
Playtech operates a four-part business, which includes the B2B (business-to-business) and B2C (business-to-consumer) models. The B2B segment focuses on supplying software platforms and technologies to gaming operators in key regulated markets such as the UK, Italy and Colombia.
The B2C segment involves the ownership of gaming operators — Sun Bingo (focused in the UK) and the recently acquired Snaitech (focused in Italy).
The third division is TradeTech, the financial division of Playtech. TradeTech provides B2C and B2B multi-channel trading software, systems and services. The fourth part of Playtech’s business is the B2B segment in Asia, which provides only content to the market.
The UK company’s main growth driver will be to leverage its acquisition of Snaitech in June 2018. Snaitech is the second-largest online gaming operator in Italy, with a retail betting market share of 20%. The management has guided an additional €62 million ($94.6 million) earnings before interest, taxes, depreciation and amortisation contribution for FY2019 from this acquisition, which represents 18% of Playtech’s FY2018 total Ebitda.
Sun Bingo is expected to turn around from being loss-making to contributing €20 million Ebitda to Playtech based on the management’s guidance. Playtech’s focus will also be on improving contribution from regulated revenue in the UK, Italy and the rest of Europe, which increased from 54% in FY2017 to 78% in FY2018.
Playtech’s balance sheet contains a large quantity of intangible assets. The margin-of-safety analysis, which discounts assets based on their quality and tangibility, suggests a fair price of £2.05. Playtech’s net asset value (NAV) and net tangible assets are £3.66 and -80 pence respectively. It appears to be negative from this aspect, but it is important to consider the nature of the company, as software companies are not traditionally valued using NTA. Moreover, with a net gearing of 17.8% and interest cover of 2.3 times, the company’s long-term solvency is pretty much secure.
Advertising that works
XLMedia’s business model is simple. As an online advertiser, it gets revenue so long as someone clicks on its advertisements. In effect, XLMedia has three main ways of generating revenue: from attracting paying users from online channels through publications, media buying and network partnering. It either directs users to online gambling sites in return for a share of the revenue generated by the use, or it receives a fee generated per user acquired, or it gets fixed fees, or a combination of any of these models.
The company states that it is committed to a progressive dividend policy and share buyback programme. Its dividend policy is to pay out at least 50% of retained earnings — a strategy that has significant risk as it affects the balance sheet. Given the strong and consistent cash flow of the company, coupled with low capital expenditure since it commenced operations in 2012, the the payout is plausible.
XLMedia’s share buyback programme, which authorises the company to repurchase up to US$10 million ($13.6 million) of the company’s ordinary shares, runs from Dec 18, 2018 to the conclusion of the 2019 annual general meeting of the company, which is expected to be in late May. Between Dec 31, 2018 (XLMedia’s year-end) and March 26, the company bought back US$6.035 million of shares. As at March 31, the company had 212.32 million shares, excluding treasury shares (from the buyback), which translates into a market capitalisation of £102 million.
Despite its small size, XLMedia had a strong balance sheet as at Dec 31. A current ratio of 2.46 implies strong short-term liquidity; a gearing of just 4.2% and interest cover of over 29 times suggest that long-term solvency is not an issue. Though the NTA of the company is 15 pence, most of its intangible assets comprise domains and websites, which are not systematically amortised, owing to their indefinite life. Therefore, the margin-of-safety analysis suggests a fair value of 53 pence for XLMedia. Its NAV as at Dec 31, 2018 was 60 pence.
The company intends to focus more on its publishing segment, which contributes more predictable earnings and is also the most profitable segment. It reported an operating margin of 78% in FY2018 for this segment. At the same time, XLMedia is actively reducing its exposure to low-margin media activities, for which it registered an operating margin of only 11.4% in FY2018. The company intends to further expand its footprint in the nascent US online gambling sector, in which it has committed to spend US$7 million over the next three years. XLMedia is also looking to expand its personal finance sector, especially in the US.
Brexit risks
The British press has pointed out that UK gambling operators are worried about a change in regulations and access to players in the European Union when (and if) the UK leaves the EU. This is particularly so in the event of a no-deal or hard Brexit, since the UK has to fall back on World Trade Organization rules.
While both Playtech and XLMedia are not gambling operators themselves, their customers are gambling operators and could be affected by Brexit. That would in turn have a negative impact on their outlook and earnings. It may be that prices have moved down in anticipation of the worst-case scenario. But, it could also be the case that the downtrend in prices is caused by uncertainty — and it is a known fact that the stock market does not like uncertainty.
In addition, XLMedia’s strategy of paying dividends out of retained earnings is a major risk and would eventually weaken its balance sheet. There is also the danger that dividends could be cut in the future to conserve capital.
Legalising of online gambling buoys sector
In May last year, the US Supreme Court struck down a federal law that prohibited wagering on individual sporting events, opening the door for legalised sports betting nationwide. On April 1 this year, Belarus legalised online casinos. Brazil authorised online sports betting in December, opening the gambling floodgate to a market of over 200 million people. In addition, with the onset of big data and blockchain technology in gambling, companies that operate within the online gambling section of the value chain stand to gain the most in particular.
Chart 1 illustrates the growth of online gambling revenue, which for the 10-year period has grown at a compound annual growth rate of 10.3%. Chart 2 reinforces the notion that online gambling is gaining more traction in terms of growth compared with physical casino gambling. Furthermore, the global online gambling market is forecast to grow at a CAGR of 9.7% from 2018 to 2023, based on a research report from Research and Markets, a market research organisation.
Most recently, in Asia-Pacific, casinos in the guise of integrated resorts are being built. First off the block is Brisbane’s A$3.6 billion ($3.4 billion) IR at Queen’s Wharf. Hot on the heels of the Australian IR is a US$1.4 billion IR near Incheon by Paradise Group. Japan too is likely to get an IR, details of which have yet to be announced.
In Singapore, both Marina Bay Sands and Resorts World Sentosa will be expanding their IRs.
All this can only be good news to online gambling operators as the market share of online gambling has been growing unabated for the past 10 years.
This story appears in The Edge Singapore (Issue 881, week of May 13) which is on sale now. Subscribe here
