Description

Asymmetric risk/reward opportunity in small-cap merger arbitrage with 56% - 81% IRR over the next ~6 months.

On 11/8/23, GAN announced a definitive agreement to be acquired by Sega Sammy Holdings, a Japanese conglomerate operating in the entertainment, gaming, and resorts businesses with a $3B+ market cap.  The cash purchase price of $1.97/share represents a 120% premium over GAN’s unaffected price.  The shares currently trade hands for $1.55/share, and the deal is expected to close in late 2024 or early 2025, representing a gross return of ~30% and an annualized IRR of anywhere from 56% to 81%.

The board unanimously approved the transaction, the deal is not subject to financing conditions, and GAN shareholders have already voted in favor of the merger.  In late June, GAN received CFIUS clearance.

The only remaining hurdle to deal closure is the approval of certain gaming authorities.  This appears to be ordinary course and just a matter of time.

So why the outsized spread?

GAN sports a $70mm market cap and only trades around $150,000/day, but I believe the primary cause for the spread centers around the market’s concern about a potential MAE related to GAN’s operations in Chile.

The relevant condition to closing is found in Section 8.2(h) of the merger agreement:

(h) Chilean Operations. The National Congress of Chile has not enacted any Applicable Law or issued any Order that has the effect of making the Company’s operation of online gaming illegal in Chile and is not reasonably capable of being overturned, cured or otherwise remedied on or before the End Date.

What’s this all about?

Brief history of gambling in Chile –

For decades, land-based casinos in Chile have thrived, generating significant revenues. However, the online space has remained largely unregulated, with offshore operators catering to a growing demand for sports betting and iGaming experiences.  Realizing it was missing out on significant tax revenue, the government’s position has been that all online gaming in Chile has been illegal, despite estimates that the offshore market generates ~$150mm annually.  Offshore operators argue that the absence of any law explicitly prohibiting online gambling renders it legal.  The government disagrees.

The Chilean government has thus begun the regulation process of online gaming, and in December 2023, the Chamber of Deputies passed a bill that would pave the way for a legal and competitive online gaming industry.  The bill is currently sitting with the Senate.

The problem for this merger is that the language of the proposed bill is such that GAN’s operations in Chile will effectively be banned the moment it passes.

According to Article 13 of the bill: “The Superintendency will reject applications for an operating license when any of the following circumstances occur: having operated a betting platform without the proper operating license, or without the certification that authorizes it to operate in accordance with this law, or advertised or offered its services in Chile in the last 12 months prior to the request.”

Coolbet, GAN’s B2C offering, certainly meets the criteria for rejection, and if this bill is passed, the condition laid out in Section 8.2(h) of the merger agreement will not be satisfied, which will allow Sega to walk away from the merger.

But note the language in the agreement: “…has not enacted any…law…making the Company’s operation…illegal in Chile and is not reasonably capable of being overturned, cured or otherwise remedied…”

On its face, it seems rather silly and economically obtuse to ban offshore operators that have spent the past couple years investing marketing dollars and partnering with local sports teams, only to invite new offshore operators to begin that process anew.  I would think it much more likely that some kind of deal is cut between the government and the existing offshore operators to compensate the government for lost tax revenue.  Nevertheless, this eventuality appears, on its face, to offer Sega a way out of the deal.  Hence, the wide spread and the opportunity today.

The Buyer – Sega Still Committed

Section 8.2 Additional Parent and Merger Sub Conditions also clarifies that the buyer – if it wants to – can simply waive any of these conditions: “The obligations of Parent and Merger Sub to consummate the Transactions, including the Merger, will be further subject to the satisfaction or, to the extent permitted by Applicable Law, waiver at or prior to the Closing of each of the following conditions (any of which may be waived exclusively by Parent and Merger Sub).

So Sega can walk, but the big question is whether it wants to.

Sega is a strategic buyer that intends to use its acquisition of GAN to expand into the growing US online gaming market.  Sega has cited the complementary nature of GAN’s technology and Sega’s gaming equipment, content capabilities, and land-based casino customer base as factors that will facilitate increased distribution of Sega’s content and expanded customer reach.

What’s interesting here is that this bill has been working its way through the Chilean government for a long time, and predates the announcement of Gan’s deal with Sega.  The issue was sure to come up during Sega’s due diligence.  As a result of the real possibility of a total ban for GAN’s Chilean operations, one logical conclusion is that Sega’s offer baked in virtually zero value for this piece of the business.  Again, the primary strategic imperative of Sega’s acquisition of GAN is to expand into the more attractive U.S. online gaming market. 

Proxy Statement is Telling

The proxy statement offers additional color on this point in the background to the merger.  It details that on September 11, 2023, the Chilean federal government approved resolutions proposed by the Chilean Economic Commission and Chamber of Deputies that paved the way for the regulation of gaming in that country and the creation of a framework for prosecuting illegal gaming operations.

Having taken an entire month to digest the implications of this development, Sega then communicated a reduced offer price to reflect this new risk:

“On October 11, 2023, representatives of SMBC Nikko advised representatives of B. Riley that SEGA SAMMY HOLDINGS was reducing the per share purchase price in its offer to $1.90 per share, subject to agreement on outstanding legal issues, citing concerns over risks related to the potential regulatory changes in Chile as well as the recent changes in GAN management.”

Moreover, GAN management also prepared financial projections for an alternate scenario which included adjustments from its Base Case Projections to address the potential impact that a 2024 adverse regulatory change in Chile, a significant market for GAN’s B2C business, would have on GAN’s operations in that market (referred to as the “Downside Case Projections.”  They are below, and reveal a significant impact to projected EBITDA:

In summary, the negative effects of Chile’s potential new regulation were fully contemplated and considered in negotiations and we can see clearly that Sega feels that a price of $1.97/share adequately compensates them for any incremental Chile risk that has developed since merger discussions first began.

Sega’s Post-deal Actions Support the Deal

On top of this, Sega announced two weeks ago an even larger acquisition, this time in the Netherlands.  Sega will acquire B2B iGaming content provider Stakelogic for 130mm EUR.  In the deal announcement, Sega goes out of its way to highlight the synergies between Stakelogic’s content and GAN’s B2B platform.

In the press release announcing this deal, Sega’s CEO makes the synergies with GAN abundantly clear:

“After the integration of GAN, we believe that the addition of Stakelogic’s unique gaming content to the GAN B2B platform, which is their strength, will enable it to become a gaming service provider that can offer a comprehensive range of services. This will accelerate the speed of our growth in the gaming market and create an even greater competitive edge than GAN’s stand-alone development.”

Strange language, indeed, for a buyer about to walk away from the GAN deal.  Doing so at this point would call into question the value of this even larger deal with Stakelogic, and I think can be taken as strongly indicative of Sega’s intentions to close the GAN deal.

Finally, GAN reported its Q2 numbers on Friday and reiterated their expectation for a successful close in late 2024 / early 2025.  The CEO from the call:

“Looking ahead, our focus remains unchanged. We will continue to optimize our overall cost structure and roll-out product enhancements. We continue to work through the gaming regulatory requirements for our planned merger with SEGASAMMY and anticipate a successful closing in late 2024 or early 2025."

To be sure, GAN is not a great business and in the event of a break, GAN’s stock will be in something of a free fall with no way out on account of its poor liquidity.  But the deal seems very likely to close and we are getting paid well for taking on what I think is minimal deal risk.  Size accordingly.

A full timeline of the important events below:

Links to relevant documents:

Merger Agreement: https://www.sec.gov/ix?doc=/Archives/edgar/data/0001799332/000149315223039812/form8-k.htm

Proxy Statement: https://www.sec.gov/Archives/edgar/data/1799332/000149315224001777/formdefm14a.htm

Stakelogic Acquisition Press Release: https://www.segasammy.co.jp/en/release/52418/

GAN Q2 Earnings Release: https://investors.gan.com/websites/gan/English/2110/news-detail.html?airportNewsID=c2dbc88f-801f-4195-83cf-1aded5e113e6

Catalyst

Deal closure