Description

July 25, 2023

Codere Online (CDRO) 

Significant Upside with a Material Margin of Safety; Throwing the Baby Out with the Dirty SPAC Bath Water 

Investment View

Codere Online (ticker: CDRO) is well positioned to capture robust, profitable growth in the Spanish and Latin American online gaming market. CDRO’s balance sheet is pristine with zero debt and ample cash to reach positive free cash flow in early 2024. CDRO can be purchased for approximately 0.25x EV to revenue (2024) based on a $3.25 stock price – a product of a poorly placed SPAC transaction in 2021, in our opinion. We conservatively calculate fair value closer to 2.5x to 3.5x 2024 enterprise value to revenue, which yields a valuation range of $14.00 to $18.00 per share (on a fully diluted basis). 

Potential Catalysts

There are two relatively short-term potential drivers to unlock value, which are a product of the majority shareholder’s need for liquidity: 1. outright sale of the business in the next two years 2. dividend distribution commencing in 2024, which corresponds to CDRO moving from cash burn to cash generation. A share repurchase program, potentially initiated in 2024, is also an opportunity – but does not solve the majority shareholder’s liquidity issues.  

Majority Shareholder

It’s difficult to understand the opportunity in CDRO (and above-mentioned catalysts) without understanding the struggles of its majority shareholder, Codere Group (Retail). Based in Madrid, Spain, Codere Retail is a gaming business with regional licenses, concessions and ownership of gaming machines, betting shops, bingo halls, casinos and racetracks in Spain, Italy, and Latin America (Argentina, Mexico, Colombia, Panama, and Uruguay).

Codere Retail had a manageable level of debt relative to cash flow coming into the pandemic in 2020 but forced closures over the ensuing twelve months led to a balance sheet restructuring during 2021. EBITDA and cash flow were slow to return at Codere Retail with the second and third waves of COVID. Initially, Codere Retail was restructured with the view that cash flow would have a sharp recovery to pre-pandemic levels. This recovery process took longer than expected, and Codere Retail burned cash while accumulating additional debt. Furthermore, cash conversion from the Argentine Peso to Euro became less favorable, choking Codere Retail of needed cash. At present, Codere Retail is raising additional capital to fund its business model – approximately €100 MN. Needless to say, Codere Retail never had the proper amount of capital to invest in Codere Online.

In order to remedy a lack of available capital but still maintain a controlling stake, Codere’s online business was listed on the Nasdaq in the U.S. via a merger with a SPAC entity in December 2021. Upon completion of the transaction, Codere continued to hold a 66.5% interest in the listed entity. Baron Capital provided the PIPE for the deal and owns close to 10% of the equity. The two largest shareholders account for approximately 75% of the equity float. The SPAC deal provided CDRO with critical capital to scale its business.

Today, distressed hedge funds own the debt and equity of Codere Retail. A recent document associated with the 2023 capital raise at Codere Retail notes that CDRO could be for sale with proceeds used to reduce leverage at the parent company. Notably, Codere Retail has approximately €1 BN of debt and holds 30 MN CDRO shares – a mid-point monetization could derive approximately $450 MN of proceeds to the parent, reducing debt by almost 50%. With most distressed debt players involved for over 2.5 years in Codere Retail (and a desire to typically turn capital in a locked-up investment vehicle every five years), we think CDRO will be sold sometime in the next twenty-four months.

On June 30th of 2023, Gonzaga Higuero was appointed as the new Chief Executive Officer of Codere Group (Retail). Importantly, Mr. Higuero’s prior two leadership roles resulted in the sale of one company and the IPO of another.

Balance Sheet

At the end of 1Q23, CDRO had a clean balance sheet with €49 MN of cash and no debt. The company guided to €20 MN to €30 MN of negative free cash flow in 2023, which would reduce cash to €25 MN at the mid-point. We expect negative free cash flow closer to €15 MN in 2023, which would reduce the cash balance to €35 MN at year end. Importantly, with free cash flow six months away, liquidity concerns should be a non-issue. We estimate positive free cash flow in 2024 of approximately €20 MN – this number can flex higher or lower primarily based upon marketing spend. To wit, CDRO could be free cash flow positive this year if management chose to pull back marketing spending. At year-end 2024, CDRO could accumulate approximately €55 MN of balance sheet cash or over one dollar per share.

Core Drivers of Positive Investment Case

1. Favorable demographic trends in Latin America - increasing adoption of smartphones, e-commerce, and internet connectivity

2. High barriers to entry relative to developed markets

3. Omnichannel distribution – reducing customer acquisition costs while leading to higher spend and retention

4. Market expertise – Codere Retail has operated in Latin America since 1984

5. Visibility – long-running sponsorships of soccer teams and individual athletes from Codere Retail

6. Competition – much lower intensity of competition versus developed markets in the United States and Western Europe

Risks to the Investment Case

1. Higher regulatory, political, infrastructure and economic risks relative to U.S. pure plays

2. Concentration risk with Mexico as primary growth driver

3. Larger, better capitalized competitors could enter market

4. Limited float on equity

Recent Operating Results

On a high level, the first quarter of 2023 was a watershed moment for CDRO as negative EBITDA was reduced to €2.3 MN versus a loss of €13.2 MN in the prior year’s first quarter. We will focus on Spain and Mexico results as the cash cow and growth engine, respectively. We quote from the Stifel first quarter review:

“Results in Spain were impressive, with the 2-year stack for NGR (net gaming revenue) accelerating nicely despite more measured marketing investment. While the market is mature and continues to face regulatory challenges, management cited continued consolidation of market share amidst incremental marketing restrictions as well as a favorable cost structure given the 10% effective gaming tax rate (Y/Y flow through to Adj. EBITDA was ~60%). While Q1A benefited from World Cup customer acquisition & favorable hold in March, we estimate CDRO's Spanish business is now run-rating ~$20M+ of annual Adj. EBITDA even on a normalized basis.”  

“CDRO's Mexico operations continue to post tremendous growth, outpacing our (and anecdotally management's) initial expectations when CDRO began their post-IPO growth strategy. NGR was up +75%, with the ~+130% 2-year stack accelerating from 2022A despite lower marketing levels. While growth in the region since 2019A has been impressive (+50% CAGR), we continue to see ample runway. Specifically, disclosures from B2B provider Playtech indicate Caliente Interactive, the by-far market leader in Mexico, generated ~€530M of NGR during 2022A (+43% Y/Y). This suggests to us two important implications for CDRO: 1) the market clearly remains under-penetrated with the market leader growing >40% Y/Y, and 2) CDRO is currently taking share, and should continue to do so given a largely comparable product (both use Playtech in Mexico) and the historically fragmented nature of OSB/iCasino market share. We do hear concerns regarding risk that T-1 global operators decide to enter the market, however, we believe operational complexities in Mexico remain underappreciated with operators more likely to opt for a "buy" vs. "build" strategy (which reads favorably regarding takeout optionality).”

General Nuts and Bolts   

CDRO reports its results in EURO but has USD denominated equity. Thus, one must convert financial items by the prevailing EURO to USD rate to properly calculate enterprise value.

There are 45.1 MN shares outstanding today with 6.5 MN warrants (CDROW) struck at $11.50 per share, which, if exercised, would add $75 MN of cash to the balance sheet or $1.45 per fully diluted share.

Current Guidance

For 2023, CDRO guided to a revenue range of €140 MN to €150 MN or 18% growth versus the prior year at the mid-point. Notably, at the end of 2022, CDRO sold its small Italy operation, which had contributed €4 MN to revenue and the world cup will not repeat in 2023, accounting for €4 MN of non-repeatable business in the fourth quarter. Thus, mid-point revenue growth is closer to 26% in 2023 pro forma for the adjustments. To date, CDRO has generally under promised and over delivered from a guidance perspective. First quarter results suggest revenue will exceed the high end of the range for the year, which could generate 35% pro forma revenue growth.

At the start 2023, EBITDA guide was set in a range of (€20 MN) to (€30 MN), however, first quarter EBITDA was only (€2.3 MN). We anticipate the company will revise the range lower to something closer to a mid-point of approximately (€15 MN) for the year. Of note, EBITDA is more or less free cash flow in this business with no interest expense, capital expenditures or cash taxes at the corporate level. Importantly, we project EBITDA will be positive in the first quarter of 2024.

Marketing Spend

In 2020, CDRO spent only €37 MN on marketing compared to €96.3 MN in 2022. Management has indicated that marketing spend will be approximately €80 MN in 2023 and should decline to €60 MN in 2024. Client acquisition costs have remained relatively stable, while average revenue per monthly user hit a high in the first quarter. We project the payback on a dollar of marketing spend is approximately nine months with a revenue tail for almost four years. Based on a first quarter disclosure from parent company, Codere Retail, of the €19.8 MN in marketing spend at CDRO €7.6 MN was growth spending – placing an annual baseline marketing spend at approximately €50 MN. If we assume 25% revenue growth in 2024 and use the base line marketing spend of €50 MN, then EBITDA or free cash flow would be approximately positive €45 MN. That said, management has indicated that 2024 marketing spend should be around €60 MN, which allows for over €10 MN of growth spending.

We do not see CDRO expanding into Brazil or the U.S. under the current ownership structure, which helps to frame the above discussion of marketing spend. During the SPAC road show, CDRO discussed the potential of Brazil, but the reality is Codere Retail has zero presence and the language is Portuguese rather than Spanish; in short, there is no definable edge to move into the Brazilian market. On the other hand, there are over 37 MN Spanish speaking Mexicans in the United States. We think a larger player could logically expand CDRO into the U.S. with a focus on this Spanish speaking sub-market.

Logical Suitors

Given the complexities of Latin America and onerous advertising curbs in Spain, we see players wanting exposure to these geographies as a buyer rather than a builder of businesses. We also note that the Codere brand has excellent name recognition due to its long-term involvement in the retail (physical) gaming business, contrasting to an online only brand starting from scratch. Furthermore, CDRO is using a Playtech platform (also the largest competitor in Mexico) for its online infrastructure. We see a larger player terminating this agreement and migrating to an in-house solution, materially boosting margin.

To this end, we believe the most logical suitors would be Entain PLC, Flutter Entertainment, Kindred Group, PLC, and to a lesser extent, DraftKings Inc.

Valuation

The Spanish business is generating positive EBITDA of approximately €25 MN per year (1Q23 annualized) coupled with 39% revenue growth in the first quarter. Larger, slower growing online gaming businesses trade for 10x to 12x EV/EBITDA (in Europe). We suggest a premium for growth of 13x EV/EBITDA is appropriate. We value only the Spanish business for €325 MN or $360 MN.

The balance of the business is generating €85 MN (1Q23 annualized) of revenue versus €49.2 MN of revenue (1Q22 annualized) for growth of 72%. We value this segment, which is primarily Mexico, for 3.25x or €275 MN, which converts into $300 MN. Spain plus ROW derives a value of $660 MN + $75 MN warrant cash + $30 MN low point balance sheet cash summing to an enterprise value of $765 MN or $15.00 per share on a fully diluted basis.

Another approach would be to use projected 2024 revenue of €200 MN and apply a stabilized EBITDA margin of 25% which derives total firm EBITDA of €50 MN or $55 MN. We then apply a 12.5x EV/EBITDA multiple which is the high end of stable, lower growth online gaming businesses. This derives a firm value of $687 MN or $15 per fully diluted share (includes cash from warrants).

Comparable Transactions

In the first quarter of 2023, “CIRSA, the Spanish gambling group owned by Blackstone, announced the acquisition of GanaBet.mx, a Guadalajara-based online gaming operator in Mexico” (Source: iGaming Future). This deal was executed at over 4.0x Enterprise value to revenue.

Entain completed the acquisition of Dutch online gaming operator BetCity from Sports Entertainment Media in the first quarter of 2023. According to Entain, “the total acquisition will be €450 MN, although depending on performance it could be as high as €850 MN.” We believe BetCity controlled 20% market share in the Dutch market and was producing €120 MN (LQA) of revenue. If total consideration was only €450 MN then the acquisition multiple was approximately 3.75x enterprise to revenue.

Company Description

Codere Online (CDRO) is a B2C online gambling operator, offering sports betting and casino games through a proprietary website and mobile application. The company is licensed and currently operates in six core markets: Spain, Italy, Mexico, Columbia, Panama, and the City of Buenos Aires. Codere Online was launched in 2014 as a segment of Madrid-based Codere S.A., an operator of brick-and-mortar gambling venues throughout Latin America, Italy, and Spain. “In June 2021, Codere Group reached an agreement to merge its online gaming subsidiary with SPAC DD3 Acquisition Corp. II, resulting in the creation of Codere Online, the first online gaming operator in Latin America to be listed on the U.S. Nasdaq Stock Market (CDRO), as of December 1, 2021” (Source: Company Description).

“Codere is the official betting partner of Real Madrid C.F. in Latin America, Club Atlético River Plate in Argentina, and C.F Monterrey in Mexico” (Source: Company Description).

Catalyst

M&A