Description

Bally’s is in the final stages of closing what is a merger of equals with Gamesys group (GYS:LON) out of the UK. As a long time shareholder of Gamesys group (aka Jackpotjoy aka Intertain) I have come to appreciate the fabulous management team that went from a start-up in 2001 to become the 235mm GBP EBITDA, highly cash generative business it is today. Looking to keep my exposure to this business I got up to speed on Ballys and believe today’s trading price provides an attractive entry point.

Once the merger is complete sometime in Q4, the company can be valued on a SOTP: the brick and mortar regional casino business of Bally’s, the Gamesys assets and the igaming opportunity. At today’s price we are effectively getting the I-gaming optionality for free, despite large investments being made into the Sinclair relationship.

Ballys must appreciate this management group as well, as it is rare to see the CEO of the acquired business go on to run the combined entity.  As well, Gamesys founders and management have elected to take the share exchange option on buyout, which at current prices works out to 12.00 GBP vs the 18.50 GBP cash offer for independent shareholders such as myself. For management to get the same value as independent shareholders, they will need to drive Ballys stock up 54% from these levels.  With the pending deal close expected in October or November the time to get up to speed on the name is now.

Quick summary of the 3 businesses:

Gamesys

Gamesys is a leading operator of online casino and bingo led brands. Roughly 58% of the business is in the UK, 30% in Asia, 9% Europe and 3% ROW/America. It has previously been written up 3 times on VIC, first by Avahaz in 2016 (when it was trading in Canada as Intertain), by myself in 2018 (when it was trading in the UK as Jackpotjoy) and most recently in 2019 by gary9 as Gamesys (GYS:LON). I will provide a brief timeline of the important corporate events since its founding in 2001:

All in, the founder Noel Hayden has cashed out about 335mm GBP by my count, and still retains 15mm shares which at the cash offer takeout price is currently worth 278mm GBP. He’s done alright for himself. 

This entire business was grown using internally generated capital. They should grow EBITDA to 235mm GBP this year, which is up from 158.4mm in 2019 (22% CAGR last two years). Revenue should come in at 829mm which is up from 505mm in 2018, good for a 3 year CAGR of 18%. They did this by being leaders in the space, first through online bingo led sites.

Gamesys was a covid beneficiary as people stuck at home tend to gamble more. I provided the long term numbers to show it has been a consistent grower and is not just a covid beneficiary. Historically Gamesys has been a 10-15% top line grower with last year the exception at 28.7%. Growth should come in at 14% this year. In H1 ’21 growth came in at 17% but this was heavily weighted towards Q1 where it was 27% and we saw tough comps result in an implied 7% growth rate for Q2 ’21. That said, this was the toughest comp of the year, and management recently disclosed in a proxy statement that their application for the deal financing was forecasting close to 18% revenue growth in 2021. 

Margins are very stable, with most of the costs being variable. Adjusted ebitda margins should be just north of 30%. Note margins were a bit higher before UK POCT changes in 2019 which resulted in a one time step down (taxes taken here are above ebitda line item.

Capex is extremely light, being an IP business, they run 3%. ROIC is off the charts (literally) if we back out intangibles and goodwill. Hard long term assets were 46mm at year end and with negative working capital, the denominator in the ROIC calculation is negative. 

The company is a well run cash machine with dominate market share, that has consistently grown. No wonder Ballys wanted it, and it’s management team for their I-gaming push.

Ballys:

Ballys is a regional casino rollup play. They currently have 16 properties in 15 different states. It was initially called Twin River Casino, and had been private until 2019 when it did a reverse takeover of publicly listed Dover downs. It is partially controlled by its chairman, Soo Kim who’s hedge fund Standard General is the largest owner at 23%. They acquired their stake in 2016 while it was still private. As you can see below they have been very active on the roll-up strategy, particularly during 2020 when multiples were reasonable.

The company talks about the total properties having done pro forma north of 300mm in EBITDA in 2019 and with some capex having been put into the properties since that time, expect them to be above that number under normalized conditions.

In Q2 Ballys generated 83.8mm EBITDA (including corp expenses and some online losses) so they are clearly on track for that number. I don’t view this as a great growth business like Gamesys, but should be a stable cash generative business with easy to transact assets. The company has pursued a mixed real estate model where they own over 2/3rds of their properties but have recently funded some acquisitions through sale-leasebacks. Long term they will continue to own a minimum of half their real estate with the rest available for financing should the need arise. 

I model the B&M segment to do 312mm in cash EBITDA in 2022 (ebitda – rent expense), pretty much flat from this year. Most casinos have been over earning in Q2 and Q3 as guests have come back, but marketing and service levels (read costs) are down. This isn’t sustainable long term (though management claims some of the labor savings are) so I model a return to more normal margin levels. 

The company is led by CEO George Papanier who has been with Ballys since 2004 first as COO and then CEO. Post merger he will effectively be the President of the B&M division, which is sort of a demotion but more in line with his skill sets. Sellside analysts I spoke to describe him as very competent. While he isn’t a star he is good at the blocking and tackling of running a casino. We aren’t reinventing the wheel here.

I-Gaming:

With the 2018 Supreme court decision to allow individual states to legalize sports betting, there has been a slow roll out state by state of legislation. The bigger players in the industry have all been preparing to make a push into what is effectively a land grab in this nascent industry. While a small opportunity today, the TAM at maturity if all states were to legalize is a gross gaming revenue of anywhere from 20 to 50 billion, based off extrapolations from what the earlier states to have legalized are seeing today. 

Bally’s has thrown their hat into the ring as well, and has stated they are aiming for a 10% market share in the states where they operate. Generally, an online operator is required to have a B&M presence, or partnership with a B&M operator, to gain an online license. Therefore having a large, diverse footprint is beneficial as it gives you a broader reach. This is partially why Ballys pursued an aggressive M&A strategy. You can see here the states they are positioned in:

Of course, just having a license doesn’t guarantee success. Acquiring customers is hard and requires a lot of marketing and media. Many of the I-gaming companies are now entering relationships with sports media to gain an edge, which we first saw when Stars group (now part of Flutter) entered into an agreement with Fox sports.

Bally’s has taken their shot, after announcing last November a comprehensive deal with Sinclair and their vast collection of local and sports stations. In total, 21 of the regional sports networks acquired as part of the Fox/Disney forced divestment will be rebranded Bally sports, and the 190 local TV stations Sinclair owns will promote the Bally sports brands through integrated marketing and product info. There will be custom betting content embedded into programing on the RSN assets, and a heavy advertising component. In exchange Sinclair becomes one of the largest owners of Ballys stock through newly issued penny warrants and performance warrants. 

The rebranding has already occurred, with the RSNs now called Ballysports. Ballys is in the process of rebranding their land based casinos over to the Ballys name to support the full integration of assets. And Ballys believes that can tap the 14mm customers in their loyalty databases as a cheap way to start onboarding customers to the I-gaming platform.

This was actually the genesis of the Gamesys acquisition. According to the filing the two management teams began discussions last December about exploring different partnerships. Ballys has the physical B&M presence, whereas Gamesys management has the digital expertise. Gamesys was looking for a way into the US market. In the end Ballys decided that it would make sense to buy out all of Gamesys and have Lee Fenton run the combined enterprise. 

In my numbers I assume they can roll out to the 10 states that Ballys has a physical presence in who have legalized I-gaming. I assume they are launched in H2 2022 in these states and can get a 5% marketshare (lower than managements 10% estimate). I value this division on a sales basis, given it will still be running small losses at that point in time. I use 5x my 2023 sales estimate discounted back to today. 5x seems fair as the division will be growing in excess of 100% yoy and is generally a 75% gross margin business (Gamesys is a 30% EBITDA margin business, so margins at scale are healthy). Draftkings, one of the only publicly traded pure-plays going after the online gaming market in the US, currently trades for 11x 2023 sales. The Score, which is in the process of being acquired by Penn, was taken out at what could be described 80x the forecasted 2023 revenues from the 4 states they were launched in. I think those last two examples are ridiculous, but included them to highlight that 5x revenue is reasonable for the growth rate an opportunity, and this would translate into 16.67x scale EBITDA.

To be fair this is all a bit of a guessing game at this point, but the opportunity is real, the investments and relationships are already on track and the plan makes sense. At this stock price I think you are getting this upside for free. If management does hit their 10% market share target this division could be worth $40 a share in 2023. 

It’s worth pointing out there are some heavy hitters in this space with Penn National, MGM, Caesars, Flutter and Draftkings all expected to make a strong push and go after market share. As well, Ballys may be a bit late as they put their beta rollout of ballysports.com on pause until the Gamesys acquisition closes and the new management team can take the reins. That may be a blessing in disguise though as this fall is expected to be a bloodbath on the marketing spend for the upcoming NFL season amongst all the entrants. 

Valuation:

At today’s price of $50, we have decent upside to $66 based on a SOTP, good for 32% upside today. However, I believe with the long term growth of Gamesys, and the natural delevering from cash flow next year there is long term upside to these numbers.

The company also trades cheap to the comp group at 9.1x 2022 EBITDA vs the peers who are making an online push trading between 9.4x and 16.9x  

On a pure cashflow basis (adding back the small losses from the I-gaming push), Ballys also screens cheap, with leverage quickly brought down to reasonable levels.

Why its cheap:

I do not believe US investors are familiar with the management team of Gamesys or the great success they have building up the business over the last two decades. Instead they view the international component as overly complex to what was a relatively clean play before on a B&M regional casino operator with an I-gaming angle.

As well, given the quantity of M&A done in the past two years, there are integration questions. While this one is more difficult to disprove, I view the Gamesys assets and management as phenomenal and a big addition to the story. In fact I wouldn’t be considering the stock if not for the pending merger. 

Risks:

The biggest risk to me is the ongoing UK review of the 2005 gambling act. The UK represents about 60% of Gamesys revenues and therefore 35% of the pro forma EBITDA. The UK is in the middle of this review of the rules and regulations of the gaming sector with online a big portion of the discussion. There was a 16 week call for evidence which ended March 31st and we are now waiting for a white paper to be published by the UK government later this year.

The conversation about changes needed to the industry have been broad, but I calculate the odds of a material negative event for Gamesys as low. In 2019 UK lawmakers did make adjustments to the gambling act which were quite punitive. These included setting much lower maximum stakes in fixed odds betting terminals, tighter age and identity checks, banning credit cards to deposit funds online and most punitively, changing the off the top point of consumption tax from 15% to 21%. 

The conversation this time around seems to be much more focused on protecting consumers rather than taxing gaming companies. Many of the conversations seem to be around advertising restrictions and stricter paperwork requirements. However law makers do seem to want to strike a balance on protection for problem gamblers and putting up too much red tape for ordinary people. You can read the transcript of a parliamentary debate here for July.

https://hansard.parliament.uk/commons/2021-07-22/debates/1EBFA6A1-69E4-4D37-A089-FC92DDCF27DB/ReviewOfTheGamblingAct2005

Many of the changes being discussed (such as banning sports sponsorships) would have minimal impact of Gamesys. I also doubt regulators would consider raising the POCT again, as this just occurred and I haven’t come across any serious conversations about that being on the table this time around, however it is always a risk. It’s worth noting in 2019 when the last changes came into effect, the end results was some of the smaller, weaker operators could not absorb these changes and the market leaders only got stronger.

Another risk to me would be grey markets. Gamesys currently generates 32% of their revenue from Asia, and that has been the geography with the biggest growth. The largest market within Asia by far is Japan, and here Gamesys operates in a gray zone. They are not violating any laws operating as they are but it is always possible regulations come into force which would create a licensed framework and gamesys would risk losing share. It happened to them before in Sweden when the market switched from grey to regulated in 2019 and Gamesys lost share. However in Japan Vera and John now have good brand recognition and if the market did become licensed they would have an edge on new comers. 

And of course, how could a risk section be complete in 2021 without saying Covid. This clearly would impact the B&M casinos, though Gamesys assets would benefit by renewed lockdowns in the UK. 

Conclusion:

I believe with Bally’s you are getting a phenomenal business in Gamesys, a simple but cash generative business in Ballys, and free upside optionality should Ballys win significant I-gaming market share. The combined entity is being led by a great incoming management team that the street in North America is not appreciating. While leverage is currently high, the highly cash generative assets will lead to leverage coming down to reasonably levels over the coming quarters. The stock will likely trade around these levels until the deal closes, but I expect it to start trading higher in 2022 as more and more states are rolled out in the I-gaming market and incoming management hits the road to tell the story. 

Appendix:

Just a couple of extra slides from Gamesys demonstrating the attractive nature of the asset:

Catalyst

Deal closing Q4
New Management getting on the road to tell the story
Actual rollout of I-gaming to new states H2 2022