Description

The business

Evolution AB ("EVO") - a Swedish company listed on the Nasdaq Stockholm with more than €1.2bn in revenue and €18bn market cap - is a leading B2B provider of fully integrated live and slot casino systems to licensed gaming operators[1].

In live casino, a game presenter (dealer) runs the game from a casino gaming table that is followed in real time via a video stream. End users (the players) make betting decisions on their devices (computers, smartphones, tablets) and have access to a 24/7 offering. The business model envisages fixed costs (personnel and technical expenses in relation to the infrastructure) - which become high entry barriers - to be leveraged across the players and making possible lower unit costs/explosive EBIT trend[2]. EVO boasts a portfolio of nearly 600 customers, a majority of online casino operators as well as land-based casinos. The Company provides the services through live casino studios: the 3 main premises are in Latvia (dedicated to English-speaking presenters), Malta (mostly serving customers in Denmark and Sweden and granting passport to operate in the entire EU) and Georgia. The content is played through the interface of the operator (customer) who keeps the relationship with the end-user while EVO retains the responsibility of running the games through its own tables. Majority of revenue comes as commissions calculated as a percentage of the operator's winning generated via the Company's offering.

Innovation is the key pillar of the strategy to set the leadership. To innovate means releasing new titles and updating the existing ones. The core of offering is represented by traditional table games (Roulette, Black Jack and Baccarat). Besides that, the Company continues to propose variants of the originals and new games to attract players. Furthermore, RNG[3] games tables and slots represent an additional boost to continuous innovation and, besides core online casinos, are intended as a new platform-integrated vertical.

Management's goal is making EVO the world's leading B2B online casino provider through both organic growth and strategic acquisitions aimed at enriching the products' offering. In online casinos, the unicity of EVO's platform represents the best marketing tool: the reliability of EVO and its reputation favours the acquisition of new customers and explains the extraordinary track record of the sales team. As far as RNG and slots vertical is concerned, in 2020-2021 the Company executed 2 relevant acquisitions - NetEnt and BTG, both creators and suppliers of slots - with the purpose to enlarge its overall offering scope in the field. Moreover, in the first half of 2022, EVO acquired Nolimit City, another creator of slots. The acquisitions are intended also as cross-selling opportunities for the existing products' portfolio of EVO. Managers/founders of acquired businesses are typically retained with earn-out mechanisms and their competencies become a core part of a more ample EVO's story.

EVO's products highlight an extraordinary market potential considering the rapid expansion experienced by its reference core segment, boosted by solid and permanent developments in technology. Online casino represents a new way of dealing with gaming and betting. Shifting from physical to online appears secured by the advantages granted to traditional operators too, who can reach new users and exploit additional opportunities for business.

EVO's success is demonstrated by its leadership position and the continuous organic acquisition of new customers. The competitive strengths that are driving the expansion and success of EVO are:

• end-user satisfaction, reached through the release of innovative and entertaining games (both improvement to existing titles and issuing of new ones[4]),

• economies of scale achieved benefiting of strong demand for online casinos globally; customers and end-users can be served thanks to an established and proven infrastructure (currently running more than 1,000 online tables).

The market

According to recent Company's estimates, the gaming market is worth nearly €359bn (gross gaming revenues) and grew at 16% CAGR in the last 4 years. Roughly 78% of the figure is attributed to land-based gaming including (i) casinos, (ii) state-owned lottery operations and (iii) gaming machines. Within the online business, the European online gambling market is the largest accounting for nearly 50% followed by Asia and NA (the latter represents the fastest growing area).

Online casino presents as the most promising segment in terms of current and prospective growth. Valued ca.€24bn, the relevant market encompasses live casino (€7.5bn and expanding very rapidly at 31% rate in 2021) and RNG (€16.4bn with a 15% surge in 2021).

The most cited competitor is Playtech Plc (PTEC), a public UK company acting globally but envisaging a different strategy: PTEC's interests are in a wider span of gaming/gambling verticals offered as a bundle (different comparison considering EVO's focus on online casinos) and presents also a retail offer (50% of revenue) that make the B2B significantly smaller than EVO's one. Furthermore, profitability is lower with 25% EBITDA margin. Another recognised peer but on different scale is Pragmatic Play, a private company owned by IBID.

From where the growth comes from?

• Technically, the spreading of the mobile technology supports the distribution of online gaming. End-users want to play from their device enjoying a live and real time gaming.

• From a commercial standpoint, for the online operators online casinos is a chance to differentiate with innovative gaming options and to reach new players via customisation.

• Traditional land-based casinos can overcome the limits represented by the physical facilities shifting part of the business online. The expansion of the market is therefore a result of the technological development and that highlights ample room for further shifts of traditional physical experience towards online. The trend is expected to continue for many years to come.

Important aspect in this field is the regulation: in some places, existing regulation for traditional casinos do not apply to online casinos. Dealing with regulation and its changes is a key factor to position the business for growth and stay compliant. Europe is the most advanced and mature geographical area in the business of online casinos both in terms of demand and regulation. There, EVO has established a stable leading position (50-60% estimated market share). EVO is pursuing a structured expansion strategy in the US where the demand presents particularly high but the state-by-state regulation set the pace of the market widening. According to the CEO. "...ability to follow up with the evolution of regulation is a competitive advantage; eventually the share of regulated markets will go up and that will make the case for (further and continuous) shift to on-line”.

Financial information

EVO is a highly profitable business in the framework of rapidly rising demand. Organic growth and expansion through strategic acquisitions represent an extraordinary mix: revenue grew at a 48% compounded rate over the last 9 years while EPS expanded at a 56% CAGR.

The Company successfully managed to extraordinarily expand the margins while growing rapidly. That occurred mostly thanks to the benefits of scale. Management set a very ambitious 70% EBITDA margin for 2022 despite the existing inflation pressures. My understanding is that margins are sustainable considering the limited competition and the efficiencies gained by scaling up.

In 2021 EVO posted €1bn in revenue with record EBITDA at €735m, net income in excess of €600m and €550m FCF envisaging outstanding cash conversion rate. This is an asset-light kind of business with €3bn capital employed (mostly goodwill from recent acquisitions).

Market cap SEK200bn (corresponding to nearly €18bn) highlights a 22x leading multiple on 2022F earnings. Stock topped at 1,600 SEK in April 2021 and is down 40%.

Current trading highlights excellent performance in the first half of 2022 with revenue reaching €670m (+36% YoY), EBITDA €470m. LTM figures[5] are impressive with revenue exceeding €1.2bn, €870m EBITDA and €730m net income. LTM operating cash flow net of Capex set at €680m.

The transactions of the last couple of years enlarged the capital employed (issuance of EVO stocks in particular in relation to the 2020 acquisition of NetEnt which was pretty entirely paid with shares). Economic benefits are still not entirely visible. The perspective is to create a one-shop platform for online gaming leveraging on the peculiarities and uniqueness of these businesses integrated into EVO. ROIC set at 26% in 2021 and it is confirmed on LTM basis.

Shareholders and management

The founders (Jens von Bahr and Fredrik Österberg) retain a joint 10.7% stake into the Company and are board members. Richard Livingstone retains a 4.7% stake and is represented with a board member (close relative). Other board members highlight exposure to the business through equity stakes.

Management is experienced, with sizeable skin on the game and attractive economic incentives through granted options. The 3 key people are:

• The CEO Martin Carlesund, aged 52, retaining 440k shares (worth SEK413m/EUR39m) and additional rights through 1,650k warrants.

• The Chief Product Officer Todd Haushalter, aged 41, retaining 83k shares (worth SEK78m/EUR7m) and additional rights through 250k warrants. He joined the Company in 2015 bringing a long land-based casino experience.

• The Chief Strategy Officer Sebastian Johannisson, aged 41, with the Company since 2008 and retaining 892k shares (worth SEK838m/EUR80m) and additional rights through 250k warrants.

Management strategy appears very clear: (i) to continue organic growth in new markets leveraging on the existing proven platform and the leadership in terms of overall offering and (ii) to pursue strategic acquisitions aimed at enriching the products' portfolio. My understanding is that the management is appropriately focused on the long-term success of the business (the CEO always refers to a 10-year perspective for growth and does not invite to focus on quarterly projections/launching of new studios). According to the CEO:

• "...if there is a trade-off between margin and market share, we will always go for market share and what we believe are the right decisions long-term for Evolution...".

• "...we are in an investment phase with full focus on further increasing the gap in competition and to prepare for our future growth...".

Furthermore, my sense of the management's attitude towards employees is positive. Company retains key employees through 3-year warrant-based incentive programs. Quality of employees is the core of the business considering that many are in front operations (game presenters are the largest group of the workforce). Most of them join the Company as a starting job and are internally trained. Average age is therefore pretty low and the Company's framework ensures rapid careers progress and multiple career paths.

The quality of investors relations is set very high: communications are transparent, reports are straight-forward. No questions on the integrity of this management based on the background and track record.

Investment case

EVO's profit margins are uncommon and outstanding. The business is highly cash generative and that ensures funding for both the organic growth and M&A. There is no need to use the theoretical ample borrowing capacity considering the low capital intensity of the business.

I anticipate the potential issuance of new shares in connection with certain transactions deemed as really strategic and fitting EVO's core goals. The management proved to be effective in appropriately managing this tool to set deals with a long-term perspective and, at the same time, preserving the terrific trajectory of EPS growth.

EVO remarkably encloses many of the possible attributes to be deemed as one of the strongest moat in the field. The Company benefits of wide economies of scale thanks to its size, global reach and solid technology platform. Switching costs are theoretically low but for an operator it is far from automatic switching from EVO to a competitor based on cost considerations. EVO's offer is unparallel and the competition is on the quality of product, not on pricing. Moreover, EVO is building up a unique house in the relevant industry also by adding recognised brands to its (already) strong portfolio. Acquiring customers and increasing players create network effects and reinforce the brand (the players recognise the games).

This is an extraordinary compounder available at an attractive price taking into account the current and potential growth rate. A proper alignment between founders-shareholders and management ensures protection for the interest of a minority long-term investors. The current capitalisation represents a fair entry point to project at least a 15-20% annual return for the years to come. Any potential drop in connection with a generalised stock market decline should be considered as an opportunity to increase the size of the investment.

Appendix: detailed financial performance

[1] In some jurisdictions, suppliers like EVO also need business-to-business license to operate.

[2] Thanks to limitless user base.

[3] Random numbers generators.

[4] More than 88 releases expected in 2022.

[5] BTG consolidated since half 2021.

Catalyst

Growth of the business.