Evolution gaming – High quality growth at a reasonable price

A Swedish company founded in 2006, Evolution Gaming is a pioneer and leading B2B solutions provider for casino operators offering live casino, live game shows, slots and more. The company generates its revenues through licence fees and charges a % based commission on the casino operators’ winnings generated through the company’s solutions. This revenue model gives Evolution exposure to the general growth of the online casino market despite not having direct access to end users.

Evolution is the typical business that Effectus likes to invest in, it is a highly profitable business with a market leading position in a massive and growing industry. The company boasts 70% EBITDA margins which continue to expand due to economies of scale

Operational excellence

The company’s management team has proved exceptional in executing their strategy, the company continues to exploit growth into new geographies that have low penetration of online casinos; In 2018, Europe accounted for over 51% of revenues, whilst Asia and North America accounted for less than 10%, fast forward 3 years and the business looks different, Asia has grown from just 14% of sales in 2019 to 27% in  2021 and North America has doubled from 6% in 2019 to 11% in 2021.

Evolution’s growth strategy is built on M&A and a culture of high innovation evidenced by continuous launch of new gaming studios across different geographies. Just in the past 5 years, Evolution has successfully launched 15 new game offerings with 13 of those launched in the past 3 years. Furthermore, Evolution has acquired three companies in the past 2 years, one of which is DigiWheel which is a developer of the world’s first patented HD spinning wheel gaming.

Effectus is aware that Evolution’s M&A growth strategy can be high risk, but we draw comfort from the company’s history wherein acquisitions have been bolt-on and non-dilutive to profitability. Acquisitions have a track record of enhancing the company’s gaming portfolio

Evolution gaming is a service provider to casino operators, this means that we do not have to choose which operator or geography will be successful but rather, we are betting on the continued growth of the gambling market and increased penetration of online casinos around the world.

Huge growth runway

At Effectus, our research has laser focus on the opportunity size in assessing the runway for growth. The global Gambling market is estimated at $470bn and the market is expected to grow at 5.8% CAGR until 2030. The growth is driven by legalization of gambling across different geographies. Land-based (Physical) casinos are still the dominant mode in which gambling in done around the world (think of Las Vegas in the USA) but digitisation, increased mobile penetration, improved internet access and covid-19 are driving the shift away from land-based gambling to online casinos.

Over the past 5 years (2017-2021), Revenues generated by Land based casinos have declined at 8.2% CAGR whilst Live casinos have grown at 31.1% CAGR, this clearly shows that online casinos are gaining market share and they are the preferred future mode of gambling. Global online gambling penetration is estimated to be around 16%, and just like E-commerce, we believe this is far from saturation.

Europe has the highest penetration of online casinos at 23.2%, Asia is the largest gambling market and online casino penetration remains below global averages paving a way for continued growth. In North America, online casinos have registered a revenue growth of 39% CAGR over the past 5 years, this against a decline of 2.2% for land-based casinos; the above stats bag the question: will online casinos in America lead to the fall of Las Vegas? Definitely not but the growth runway for online casinos is clear.

Demographics and country dynamics are also in agreement

A survey conducted by H2G highlights that 63% of millennials talk about gambling with family and friends, and 28% talk about gambling on social media. Another research by H2G showed that 15% of gamblers aged between 18-24 believe that gambling is a reliable way to make money whilst 11% gamble to demonstrate skill (think about how big sports betting is in Europe).

The case for online gambling/casinos is solid, developed countries seem to have higher preference for online casinos as the picture above shows. India has the largest preference for online gambling at 76% which is important since India is the second biggest country by population and still a developing, high growth economy.

Investment case

Unlike some US listed high-tech fallen angels, Evolution has been generating positive earnings and positive free cash flows since listing in 2015. The company is self-funding and has a debt free balance sheet with a growing net cash position. Evolution gaming has a superior cost structure, a leading product portfolio and the business is addressing a huge market, we believe that Evolution gaming presents an attractive investment. Evolution currently trades at a 1-year Fwd EV/EBIT of 17 times which is in line with its historical average of 18 times and a 2 years Fwd EV/EBIT multiple of 13 times. Also, the company trades at a PEG ratio of 0.8 and the current share price is more than 30% below our DCF valuation of 1113 SEK providing us with margin of safety. ECM draws comfort in the fact that Evolution continues to grow at above average rates. The company reported a 34% y-o-y revenue growth with more than 100bps EBITDA margin expansion for the 3 months ended June 2022.