Description

GVC Holdings is the amalgamation of a decade of consolidating high potential/underperforming online gaming assets under a management team that has done an excellent job in accelerating these brands to above industry growth rates and extracting synergies through vertical integration and platform consolidation.  This includes the former bwin.party (which I wrote-up on here in 2012) and Ladbrokes (which I wrote-up on here in 2013 and later merged with Coral), and prior to those Sportingbet in addition to some smaller bolt-ons over the years. In 2018 GVC formed a JV with MGM to roll-out online sports betting and igaming across the US.

Whilst Flutter and Draftkings share prices are up significantly this year, +32% and +247% respectively despite the shortfall to revenue earnings from the disruption to sporting events this year, GVC shares are still down 12% YTD, albeit after a sharp recovery from the March lows.

The underperformance is due to a number of quantifiable overhangs, all of which will likely dissipate over the next 12-24 months. At the same time, the underlying business has strong momentum, the market opportunity in the US continues to expand, there are substantial new market opportunities and there are still synergies to deliver from the Ladbrokes-Coral acquisition. Overall, this sets up nicely to be a strong performer over the next 12-24 months.

What we like about GVC’s business:

•  Strong online business underpinned by vertical integration: Through the various acquisitions GVC has become fully vertically integrated with in-house tech and a full B2C offering across all verticals. This is a strong competitive advantage that allows for faster roll-outs and adjustment of products, timely adaption to regulatory requirements in different jurisdictions and enabling faster entry into new markets, scale in bonus pools and player liquidity where  it matters and larger cost synergy opportunities in M&A as this industry continues to consolidate. The full tech stack also makes GVC an attractive acquisition target for a strategic buy
• Attractive customer acquisition opportunity through retail betting shops: roughly 1/3 of EBITDA is generated from the UK and Italian retail business (mainly betting shops in the UK and a couple of EU countries). This business is viewed as structurally challenged and valued at low multiples. Whilst it is a fair assessment that retail revenues likely see small annual declines over time, the retail presence is a key competitive advantage as a cheap source of customer acquisition. Customers acquired to the online business through the retail estate cost less to bring in and such omni-channel players tend to achieve significantly higher LTVs. This is particularly important in markets such the Italy and the UK where regulators are becoming increasingly restrictive on advertising. The reduction in advertising channels for online-only operators drives upward pressure in customer acquisition costs through remaining channels and further increases the strategic value of the retail estate.
• Best in class online revenue growth in recent years: GVC has a very strong track record of driving growth and accelerating the performance of key brands post acquisition. There are many examples of this given over the years (notably the substantial acceleration in the Bwin and PartyPoker brands). As a result of this, GVC has achieved the fastest organic revenue growth of the listed peer group over the past 3 years (2017-2019) in its online gaming business, maintaining double-digit organic growth for the past 18 consecutive quarters
• Well positioned for the nascent US opportunity: In July 2018 GVC established an exclusive 50/50 JV with MGM. The combination of MGM’s large national footprint with GVC’s strong igaming capabilities will enable a strong offering with access to most of the key markets as they open up. More on GVC’s position in the US below. 
• Strong position in Brazil which is about to open up: Brazil passed gambling legislation in 2018 which requires online sports betting regulation to be published within 2 years (i.e. this year). This has now been somewhat delayed and will likely happen in 2021. Through the Sportingbet and Betboo brands, GVC currently has a leading position in that market. In addition, several other countries in the region are at various stages of liberalisation (e.g. Argentina, Colombia and Peru) so there is likely are broader latam opportunity developing that is not talked about enough in the context of GVC
• Additional new markets: according to the company, there are >50 regulated markets in which GVC is currently not active representing $45bn of gross gaming revenue. Through the combination of its in-house tech and know-how with potentially some bolt-on M&A this offers a material long-term growth opportunity

Despite the above, GVC trades on a large valuation discount to peers, on single digit forward P/E and EV/EBITDA multiples and a double-digit free cash flow yield. We believe there are several key reasons for this and see a pathway for all of them to be resolved within the next 12-24 months:

• Underappreciated US opportunity: GVC shares haven’t rerated since the US opportunity developed despite the massive market opportunity. There are several reasons for this, but we think a key reason is that investors believe GVC’s market share will be small compared Draftkings and Flutter that will dominate the market. Whilst the fantasy guys do have a first mover advantage through their large existing player database, experience from other regulating markets shows that ultimately the operators with the strongest customer acquisition capabilities, an advantageous source of high value new customers and the deepest/most flexible technology and product capabilities are the long-term winners. It is also important to realise that in sports betting, there tend to be 3-5 players with market shares in teens/low 20s% in established market rather than the duopoly the equity market is currently projecting, allowing significant room for GVC’s BetMGM to achieve its target of 15% market share. 2 additional important considerations: 1) no other operator has the experience and successful history in retail-to-online cross sell that GVC has in-house through Ladbrokes, Coral and Eurobet. This positions them very well to monetize the 33m+ database from MGM’s MLife rewards program. 2) Draftkings has essentially zero experience/proven capabilities on the igaming side which is key to driving cross-sell and profitability in an intensely competitive market.  It is also worthwhile noting that through the Yahoo Sports partnership and a potential tie-up with IAC which recently took 12% stake in MGM ($1bn) GVC’s JV is well positioned for further advantaged customer acquisition funnels. We believe that over the next 12-18 months, as new markets come online and GVC starts to demonstrate its ability to gain market share and compete effectively against the ‘incumbents’ investors will start to look at GVC as a key play on the US market and its shares will re-rate substantially.    
• UK regulation overhang: A review of the UK Gambling act will probably be concluded some time next year and the market fears online slots (or even all online casino games) will face a £2 stake limit as was implemented for gaming machines inside betting shops last year. Although the outcome is impossible to predict we can say 2 things: 1) the worst case scenario is already priced into the shares and 2) the outcome will probably be known over the next 2 years, removing the overhang. We estimate that a £2 stake limit on online slots would have a c.5% impact on GVC’s earnings. If the limit is applied to all casino games that would rise to c.10% (post mitigation and stake recycling). There is also a risk the online sports betting tax rises to 21% to match the GGR tax on igaming. This would have a low single digit % impact on GVC. The outcome of this will be known within the next 18-24 months 
• Germany overhang: The German regulatory situation has been in limbo for as long as online gaming exists. However, German states have finally agreed to introduce new regulation that will allow for licensing of all online gambling, including online casino, slots and poker, from 1 July 2021 onwards. Although there will be restrictions (these are not yet finalised), the resolution of this situation will be a major relief for  GVC shares as this has been an overhang forever. Germany represents c.10% of group revenue and they are already fully paying taxes. Restrictions on in-play betting, monthly deposit limits, etc may have an impact, but as with every market that has regulated, there will be an opportunity for market share gains in a larger pie. In the short term (i.e. 2022) this may have a mid-single digit negative effect on earnings. However the impact on the shares should be offset by the re-rating as the overhang is removed.
• Kenny Alexander departure: In July, Kenny Alexander announced his intention to retire. Kenny is the man who built this business through the successful series of M&A we discussed and smart key personnel hires, so this came as a negative surprise and the shares fell. He is succeeded as CEO by Shay Segev who has been COO for the past 4 years and is the guy who led the integration and turn-around of bwin.party and Ladbrokes-Coral. Shay has been a key factor in GVC’s success and we believe the business is in good hands. As the company delivers results, the overhang of Kenny’s departure will dissipate.  
• HMRC overhang: the UK HMRC is investigating payment processors that operated in the Turkish online gaming market. In July it was made public that GVC is also being investigated as part of this. The shares came under pressure when this was announced. We believe this is a side show and will be resolved within our investment horizon. GVC exited its Turkish business in December 2017. In that year (which we understand is the year being investigated), it earned €95m in revenue and €35m in EBITDA from Turkey. Even if it was required to pay 100% of revenue as a fine It would represent just 2% of GVC’s market cap. As this investigation concludes (we expect any monetary impact to be immaterial) the shares will re-rate.

Taking it all together, in a worst-case the UK+Germany regulatory changes could hurt GVC’s earnings by up to 20% in aggregate. Against that, we expect double-digit growth in GVC’s other online markets representing c.60% of online revenue+the various growth opportunities mentioned in new markets+ the LCL synergies+the US.

There are various ways to look at valuation (overall multiples, ex-US investment multiples, SOTP putting retail and unregulated earnings on a different multiple vs the rest, etc) but whichever way you look at it, GVC is trading at massive discount to its closest/most comparable peer which is Flutter. Even William Hill, where the regulatory overhang is much larger, the business mix unattractive and execution has been poor for years trades on a premium to GVC. On the other end of the spectrum we have DraftKings…

Assuming a mid-of the range outcome for UK+German regulation, half the multiple gap with Flutter closes as the overhangs dissipate and the company starts to show success in the US the shares could double over the next 2 years.

Catalyst

• Delivering on growth and market share in the US
• Resolving HMRC probe
• Regulatory clarity in the UK and Germany