Evolution Gaming Pitch
My Current Investment Analysis & Updated IRR Expectations
This will be a quick investment pitch on why you should consider investing in Evolution Gaming. Below is what I will cover in this pitch:
Growth Drivers: Updates & Assumptions
IRR Expectations
Conclusion
This pitch will not cover the business model or the analysis of the competitive dynamics within the industry. I have covered those topics extensively in my previous post on the company. If that material interests you, please read my post below!
Also, here’s an interesting fact for you, this writeup is still my most successful to date with the most engagement and free subscribers ever added, even with having a fraction of the audience. In my opinion, it’s worth the read if you’re new to this security or iGaming industry.
1. Growth Drivers: Updates & Assumptions
Before going to the updates, I’d like to revisit my assumptions from September 2023 to see how they have held up so far, what I would update, and how to conceptualize the share movement since then:
Topline Growth: 17.4%
Net Income Margin: No change overlong term; Short term hit with EU baseline tax rate increase
Capital Return / Dilution: Net Capital Return of 1.25% a year after subtracting for dilution
Multiple: 20x PE - “bond” style multiple
Output: 19% forward CAGR
I think the fact that I have these original inputs is valuable, because I’m able to revisit my original investment thesis and think about if its broken or not. Since the release of the article, the stock has not flourished, especially in comparison to the Semiconductor fueled S&P 500 benchmark.
Luckily though, we can find out why that is. I would say the largest hit to this thesis has been the topline growth of 17.4% held up over a decade, which would imply revenues of near $8.6 billion and a GGR between its partners of between $60B and $85B, give or take.
With revenue growth rates slowing drastically in the past year to 20%, 17%, 17% year over year, I think it’s safe to say that I was probably too bullish in this department. The area indicated in the purple segment on the right is the past few quarters of revenue CAGR. As you can induce, the revenue growth has slowed drastically from the past few years.
I think it’s clear that the company’s growth has slowed from the initial rates of the 30%+ CAGRs that I was seeing when I made this assumption. Although, I would say that it’s also fair to say the company is also in a temporary hangover in revenue growth from the hyper growth stage of 2020-2021, which is the case for many popular global consumer discretionary companies. To illustrate this point, I chose a number of global consumer discretionary stocks that are related to highly non-essential items.
Below I’ve put the revenue CAGR's of the following companies to give context:
EVO 0.00%↑ Evolution Gaming (blue)
LULU 0.00%↑ - Lululemon Athletica
MC 0.00%↑ - Louis Vuitton
ABNB 0.00%↑ - AirBnb
RMS - Hermes
I mostly point this out to say that the global consumer discretionary area has slowed down drastically in recent years, stressed by inflation, high rates, and slower growth. However, the world and the investing world goes through cycles. We are in a clear down cycle for growth across the board and Evolution is still growing the topline 17-20% year over year. As a mature investor, you should not be irritated by this execution as long as the opportunity on the horizon is still large enough to provide a proper IRR.
So, if we were to revise our topline estimates… what would be our conclusion?
Analyzing the Topline Potential
Now in hindsight, my original assumption of 17.4% seems innately just a tad bit high. However, I do not think you need that high of a revenue growth rate for Evolution to be a quality investment opportunity, especially with the quality of the company’s earnings and its competitive position within the market.
As good investors, we need to build out an informed assumption on the growth rates for the market. On Evolution’s Annual Report for 2023, we received the following pieces of information:
Total GLOBAL 2023 Gambling Market is 489 Billion EUR.
Total GLOBAL 2023 Online Gambling revenues $107.6 Billion EUR. With Evolution’s 1.8 Billion EUR 2023 revenues, the company has approximately a 1.7% market share within the online gambling market.
Another big metric is online gambling makes up 22% of the Total Global Gambling Market, up from 21% the previous year.
*All data provided by H2 Gambling Capital: Detailed Global Summary Data (€), 15th February 2024
Now, I’m not going to dive down deep into a spreadsheet to analyze the market shares between lotteries, sports betting, RNG games, vs Live Casino, while adding on conditionals for game shows, Evolution’s new product launches, etc. Then, layering all of that analysis back to the top growth drivers of how much the overall market will grow.
I think this analysis would be analytical and interesting, yet completely arbitrary and non-value adding for readers. As the old adage goes, “I’d rather be approximately right than exactly wrong.” So, let’s make some assumptions:
The overall Gambling Market for the past years grew at an average 4.6% CAGR. Let’s assume for the next 10 years, it grows at a 3% CAGR.
The overall Online Gambling Market share in 2023 was 22%, up from 21% the previous year. Let’s assume in the next 10 years, Online Gambling, due to its ease of accessibility (similar to e-commerce), grows to 30% market share.
Then, Live Casino vs RNG let’s keep constant. In my opinion, I think Live Casino grows to more of the revenues, but it’s hard to make that assumption without inserting heavy subjectivity into the enjoyment I think players get out of the alternative medium.
Finally, Evolution owns 1.7% market share of the online gambling market in 2023. Let’s assume Evolution Gaming can grow to a 3% market share of the online gambling market in the next 10 years. There are many avenues for gaining this market share including:
Asian aggregators spreading its games through grey markets
Evolution providing the cleanest Live Casino game experience from UI/Operations perspective, which is good for North American regulators - as verified by the New Jersey Court system recently.
Evolution spreading globally with new table languages, increasing its competitive advantage further.
New potential product lines and the growth of the “Game Show”.
Evolution also signed Bet365, one of Europe’s largest online gambling companies, in Quarter 1 of 2024.
To give investors a visual on Evolution Gaming’s market share growth over time vs the Online Gambling industry, here are the comparable topline growth rates since the company went public.
A 3% market share in the next 10 years implies roughly a roughly 6% average growth rate difference, which I think is achievable considering the company’s track record.
**ASSUMPTION: If you add all this up, you get a reasonable 12.5% revenue CAGR over the next 10 years to nearly 6 billion Euros in revenue.
Now, there is ridiculous amounts of nuance in this admittedly over-simplified assumption. However, I am simply trying to articulate an avenue that Evolution Gaming investors can underwrite a reasonably probable conservative growth with a long-term vision.
Personally, I think that Evolution will likely gain more market share within the online gambling segment to closer to 4-5% of the online gambling market. This would imply a difference in the growth rate being between 8.9% and 11.4% per year over the next 10 years.
This can be supported by the company growing 8.5% faster than the market in 2023, even in a down year.
In all transparency, this 12.5% rate is a good conservative estimate to underwrite as a base case. However, I think the actual growth rate for the next decade will come in much higher in the 14-16% range, assisted by new product growth, online gambling growing secularly and growing the gambling TAM, and Evolution growing its partner base and geographic footprint further.
A bullish set of terminal assumptions might look like:
4% Gambling TAM CAGR
40% Online Market Share
4% Market Share of the Online Gambling Market
REMEMBER THESE BULLISH ASSUMPTIONS FOR LATER IN THE NAPKIN MATH SECTION.
*With these hypothetical changes, Evolution’s topline would grow 20% a year on average, much closer to our original estimates of 17.4%. However, these are the bullish assumptions. This example is just to show investors not to set anything in stone. All these variables are levers that can impact the growth rate over time.
Analyzing Capital Return Growth Driver
The second growth driver that I think is important for investors to analyze is the capital return or dilution by the company via dividends, buybacks, or Share-Based Compensation.
Dilution: I’m keeping my 1.2% annual dilution rate constant
Dividends: I’m assuming the company will keep returning 50% of net income to shareholders via dividends - 2.5% yield (20x earnings).
Buybacks: I’m assuming the company will return on average 30% of net income to shareholders via buybacks going forward. This is supported by the company returning 90% of net income to shareholders this previous year via dividends and the increase in buybacks at these lower levels. I am assuming that investors will keep a lower valuation, due to the company’s “sin stock” status and inherently more risky Asian Revenues - 1.5% yield (30% on 20x earnings).
As you can see below, Evolution Gaming has returned 827M EUR in the last twelve months to shareholders of the 1.09 Billion EUR of net income.
With this in mind, let’s make the assumption that Evolution Gaming can return 2.8% a year to shareholders with a starting valuation of 20x earnings. Obviously, this ratio changes depending on the forward valuation. However, if multiple expansion occurs I imagine investors will be happy. If the multiple compresses, the rate of return will increase via more efficient buybacks and a higher dividend yield. Win-win for investors.
Terminal Multiple
I want to assume that the company will continue getting derisked over time and the robust growth, high margins, and capital efficiency will be appreciated. However, investors are consistently worried about the stability of the company’s Asian revenues, as discussed in my previous post. Therefore, I will adjust my terminal multiple to a more risky terminal valuation of 15x terminal earnings.
Assumption: 15x terminal PE multiple, 7% yield on earnings.
2. IRR Expectations
With these assumptions, you end up with the following napkin math:
Revenue CAGR 12.5%: (1.125^10) = 3.25x
Net Income Multiple Constant: (1/1) = 1.00
Capital Return 2.8% a year: (1.028^10) = 1.32x
Multiple 19x PE (Now) to 15x PE (Terminal Multiple): (15/90) = .78x
[ (3.25) (1) (1.32) (.78) ] ^.1 = 12.8% CAGR
However, with the bullish set of assumptions from earlier (if you remember) for the topline of 20%, the implied CAGR (6.2x) would be: 20.1% CAGR
*With these two options as alternative futures, you’ll probably get an average set of outcomes in the mid-teens (14-16%) IRR range for this investment. If that intrigues you, I wish you the best of lucks. Make sure to subscribe for more Pitches like this.
3. Conclusion
There are many unknowns went underwriting this investment:
How big will online gambling and by extension online casino be in the following years as a percentage of gambling revenues, 30%? 40%? 50%?
Will Evolution’s margins continue expanding after it digests the growth of the recent years expansion in products and geography?
Will product growth support Evolution’s market share closer to 4% of the online gambling market, implying a 9% delta between the market and Evolution’s growth per year?
Will Evolution Gaming be able to continue to grow through its Asian Aggregator partners or will regulation hit the company’s distribution channel?
Will Evolution’s stock price fail to hit its compensation targets for Share-Based-Compensation, making dilution come in lighter than expected?
Will bond rates drop making Evolution’s high yield seem more appealing to investors, making 15x PE too low?
All the unknowns to these questions are the reason for the company’s trailing valuation shrinking to the lowest trailing valuation ever and is a compelling no-brainer investment today!
Investing is all about playing the odds though and finding games where the game is rigged in your favor. The real question for investors is… are you willing to invest in the leading B2B Online Gambling company at these levels with the risks and the knowns available to us?
I think the investment is compelling here and investors can conservatively underwrite market beating returns. DISC: I own shares.
Isn't your calculation of Evolution's market share off? Evolution presents revenue in net basis, which means gross revenue - the market revenue - is roughly 10x, and thus market share is also 10x your calculation. Or am I thinking about this incorrectly?
Great analysis William! In my opinion evolution is one of the best opportunities right now