Description

Elevator Pitch

Galaxy Gaming (ticker: GLXZ) has a strong potential to become a multi-year compounder.  

This is what I like about GLXZ:

ü  Strong unit economics

ü  Ridiculously high (in a good way) margins

o   98%+ GPM and

o   45% - 50% EBITDA margins with potential to expand further

ü  Ownership of unique IP assets

ü  Licensing / royalty business model

ü  Strong focus on NPS and customer happiness

ü  Talented CEO and CFO who are capable of running a lot larger company

ü  Multiple growth drivers are in place. 

ü  I project that EBITDA would almost double between 2022 and 2025. 

ü  Using internally generated FCF, GLXZ should be able to meaningfully delever, which will further enhance equity returns. 

ü  Given very high ROIC and super margin profile, I think a high multiple (15x – 20x) EBITDA is deserved. 

ü  ~200% potential upside by the end of 2025 / ~40% IRR. 

Woop wrote an excellent pitch on Galaxy back in December 2020 (pretty much around the time when I was finishing building my position as far as I recall!).  His write-up is definitely worth reading for background information.  I would intentionally skip such background as I want to keep this pitch concise and up-to-the-point. 

Key Statistics / Key Data Points

ü  Share price = $3.37 (as of August 17, 2022)

ü  Share count = ~25M

ü  Market cap = $91M

ü  Debt = ~$60M

ü  Cash = ~$17.25M

ü  EV = ~$133.6M

ü  2022E Revenue (mid-point of guidance) = $23M

ü  2022E Adjusted EBITDA (mid-point of guidance) = $10.75M.

Major Recent Developments

Plenty of interesting things happened with Galaxy since December 2020, so I would point only most important ones.

ü  Litigation overhang is gone! 

o   Litigation may have been stopping investors from getting involved.

o   The litigation with a former CEO and a major shareholder whose stake was redeemed by Galaxy has been settled on what I view as favorable terms:  Galaxy paid the consideration that it said it owed (~$39M + a small accrued interest for a few months). 

ü  Equity offering that likely was another overhang on the stock never happened and management really impressed me with their capital allocation skills.

o   It was reasonable to expect that Galaxy would need to issue equity to make a settlement payment.  Had an offering happened at let’s say $3.00, it still would have been a pretty good outcome:  redeemed at $1.68 and then sold shares at $3.00.  It would have been very accretive to shareholders. 

o   However, management was able to raise private debt from Fortress on reasonable terms: LIBOR (or successor) + 7.50%, $150K in amortization payment per quarter, 50% cash sweep starting in 2023, and 778,320 warrants with a strike price of 1 cent (so effectively equity sweetener). 

ü  A private investor filed 13D a few months ago.  As a result, another private investor who has been a shareholder of Galaxy for a while was appointed to the BoD a few weeks ago.

Galaxy Provides Proprietary Table Games Content and Helps Casinos Make More Money

Galaxy owns a portfolio of very popular table games (e.g., 21+3, Lucky Ladies, etc.) that a brick-and-mortar casino can license and use to make more money than it would otherwise because patrons find them more engaging and fun to play.

I would oversimplify it here a bit to show the core premise: there are two types of games: Felt and Progressives.  You can think of Felt as “base” and Progressives as an add-on / cross-selling opportunity which dramatically increases profit per casino table for Galaxy (2x – 4x – yes, I know it is a wide range).  As far as I understand, Progressives cannot be installed by itself;  it can only be installed on top of Felt. 

Since patrons are familiar with these games and love those games, they want to play them not only offline but also online.  Hence, Galaxy also has a rapidly growing iGaming business.  Usually, Galaxy does not contract directly with a B2C operator (e.g., DKNG or FunDuel etc.), but instead contracts with a B2B provider (such as Evolution Gaming).  So, in this context Galaxy is a B2B2B2C vendor:  Galaxy-to-Evolution-to-DKNG-to-consumer.  To be clear, I am using DKNG here in a generic sense. 

Multiple Growth Drivers Exist

Galaxy Gaming can lever multiple growth drivers.

Growth Driver #1: Sign Up More Casinos As Clients

In other words, grow customer count.  Why can Galaxy do it?  After the former CEO’s shares were redeemed, Galaxy started getting licensed in new states (for example, California).  Getting licensed is obviously the first step to sign up a casino as a client: if you are not licensed in a state, you cannot sign up a casino.  Ironically, Galaxy started getting licensed right before COVID-19 hit and I believe Galaxy has not fully exploited the opportunity of signing up to as many casinos as it could.  2021 10-K states clearly:  “Since the redemption transaction, we have received new or expanded licenses in 21 jurisdictions in North America”. 

Growth Driver #2: Sell More Felt to Existing Casinos

This is more of blocking and tackling.  Galaxy has sold Felt to a casino.  Casino has it on 3 tables and does not have on another 3.  Galaxy could sell Felt to remaining three tables.

Growth Driver #3: Upsell Progressives

Casino already has Felt installed but not Progressives.  Why does a casino have one but another the other?  Maybe it would never get Progressives?  The main reason is again a regulatory one:  in a number of states Galaxy was licensed to sell Felt, but not Progressives.  After the redemption transaction, Galaxy started getting licensed with respect to Progressives in more states.  Again, I will quote the same sentence from 2021 10-K:  “Since the redemption transaction, we have received new or expanded licenses in 21 jurisdictions in North America”.

2021 10-K also says:  “As of December 31, 2021, we served 515 casinos worldwide, had content on 4,500 tables in those casinos and had a total of 6,709 billable units in those casinos”.  These data points have never been disclosed in such detail before which means that I cannot run a historical analysis. 

Let’s put that in perspective.  Average tables per casino stands at 8.7.  Average billable units per table stands at 1.49.  Management explains that billable units per table can be in theory at 4:

“In the physical casino market, we have a “three-dimensional” growth strategy. First, we seek to increase the number of casinos we serve with our games. Second, within a casino, we seek to increase the number of tables on which we have placements. Our current product placements are concentrated around blackjack, and we have developed side bets and other game content to address other table game categories such as baccarat, roulette and craps. Finally, by adding our enhanced systems to tables that already have our content, we can increase the billable units per table. For example, on a blackjack table that has one of our side bets we can add a second side bet and a progressive jackpot for each side bet thereby increasing the billable units for that table from one to four.”  (2021 10-K).

Growth Driver #4: Expand Internationally

This is somewhat overlaps with #1, but I view Galaxy’s international expansion as a separate growth driver.  Galaxy has pretty robust presence in the UK.  However, in the majority of other countries its presence is quite limited.  I think it could change over time.  For example, recently Galaxy signed a distribution agreement with a company that would cover German speaking countries in Europe. 

Growth Driver #5: iGaming Growth in Existing States

In its iGaming business Galaxy gets paid a per cent of revenue and not a flat fee (which is the case for Felt).  It means that as more people play iGaming, the more revenue Galaxy could generate. 

Growth Driver #6: New States Legalize iGaming

This is self-explanatory.  Importantly, Galaxy could enter those new states riding the coattails of its partners: DKNGs of the world and EVOs of the world.  For example, in 2022 Galaxy entered Ontario.  It is my understanding that Galaxy had to do fairly little (which is wonderful!) to enter Ontario; most of the work fell on B2C and B2B players.  I believe that incremental margins on expansion into Ontario were / are very high. 

How Fast Can Revenue and EBITDA Grow?

I think high teens or low 20s revenue growth rate is very achievable over the next 3 years. 

Importantly, I think that OpEx should grow slower than that (let’s say at half the rate of revenue growth) which would result in margin expansion.  I think in 3 years Galaxy could achieve 55% - 60% EBITDA margin.  I also think that in the hands of a strategic acquirer Galaxy could be run at 75% or even higher EBITDA margin.

Simple Financial Model

Below I share a fairly simple and concise financial model.

I assume that Galaxy would pay down ~$25M – $30M of debt by the end of 2025.  Let’s call it $30M (I think that Galaxy could refinance Fortress’ debt with a traditional bank loan with a lower interest rate in 18 months or so). 

Hence, I think that by the end of 2025 the capital structure would like along these lines:

I am modelling ~3% dilution per year and grow the share count accordingly. 

If Galaxy achieves $20M of Adjusted EBITDA in 2025, it would be trading at ~5x EV/EBITDA which is way too cheap. 

Working backward, I think achieving a ~40% IRR by the end of 2025 is reasonable. 

Risks and Mitigating Factors

ü  Leverage is the main risk. 

ü  Management team has demonstrated very strong execution and capital allocation skills so I feel comfortable takign the leverage risk, but it is still a risk.

Catalysts

ü  Revenue and EBITDA growth.

ü  I also hope that that management would start hosting earnings calls and participate in investor conferences.  I believe that management attended only one conference over the last 2-3 years. 

Disclaimers

I do not hold a position with the issuer such as employment, directorship, or consultancy.

I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

ü  Revenue and EBITDA growth.

ü  I also hope that that management would start hosting earnings calls and participate in investor conferences.  I believe that management attended only one conference over the last 2-3 years.