Description

Gamesys Group PLC (GYS.LN) is the product of the merger of the quasi-public JPJ Group (fka JPJ.LN) and the private Gamesys Holdings.  The merger closed in September 2019. It creates a scale player in the secularly growing world of online gaming, with a multi-jurisdictional, market-leading platform for online bingo.  GYS.LN is now a $1.5B EV niche growth tech platform, poised to be added imminently (i.e., December 2019) to the FTSE 250 Index. Furthermore, it trades at less than 5x 2021 cash earnings and has 124% upside to our two-year target price – if that’s something you might be interested in. 

Background.  But first, there is a long and rather torturous microcap backstory here.  It’s not worth rehashing here but most of the saga lives on in 2 prior VIC write-ups. [See JackpotJoy previously written up on VIC in January 2018 by Ahnuld.  Also see, JPJ’s Canadian corporate predecessor, Intertain Group (ITX.CN), written up in July 2016 by avahaz.] Suffice it to say that - despite of several years of attractive sales growth and consistently healthy customer retention - this perennial special sit has failed to get a decent public market multiple due to the untimely surfacing of “issues.” Said “issues” range from: merger-related earn-out payments and shareholder overhangs; actual and perceived regulatory issues; Brexit; small cap lethargy; etc., etc. However, we believe that from here forward, the story around Gamesys/JPJ is imminently poised to significantly improve in many ways – if that’s something you might be interested in.

In 2018, as pre-merger JPJ showed some growth and promise, the stock peaked in August 2018 at 1040p, having gained about 60% in the preceding 12 months.  But the company was then set back by a change in UK gaming regulations and a sharp selloff in the gaming sector. More stringent VIP client KYC requirements introduced in 2018 caused JPJ’s UK business to comp modestly negatively for 5 quarters. Plus, a hike in UK taxes applicable to wagers - which taxes are an above-the-line cost to JPJ - hurt UK margins.  This expense hike and sales slowdown, coupled with some planned platform expenditures and expected shifts in revenue mix, caused a peak-to-trough loss of about 500bps in EBITDA margin between 2018 and 2019. The stock de-rated and troughed at 575p in December 2018 and hasn’t bounced back much this year. 

Even since the closing of the Gamesys merger, this stock hasn’t caught its much-deserved break.  Just last month (November 2019), another “issue” has surfaced which knocked about 15% off GYS’s market cap.  A UK lobbyist group caused waves in the industry by floating a proposal to limit maximum online slot wagers to GBP2.  This measure is, for numerous reasons, highly unlikely to gain legal traction and, even if it did, it would have a manageable mid single-digit effect on GYS total revenues in the worst case.  We humbly submit that this overdone issue contributes to the current great (pre-index addition, pre-revenue inflection) entry point for Gamesys – if that’s something you might be interested in. 

Major benefits of the Gamesys-JPJ merger.  The primary reason for the aforementioned great entry point is the market’s poor reception to the JPJ/Gamesys merger – in spite of its numerous significant benefits to the JPJ story.  This is a gross misunderstanding, in our view, that will be cured ahead by inflecting results, shareholders’ and analysts’ access to new management, and an enhanced mid-cap stock profile.  How has the JPJ/Gamesys story been improved? Let us count the ways:

1) Market cap increase/Index addition - Already mentioned is that Gamesys Group is expected to qualify for inclusion in the FTSE 250 – and index of the next 250 companies after the FTSE 100.  These indices are expected to rebalance and add new members in the month of December. Index-related net buys will help to balance the overhang, if any, of certain pre-merger Gamesys holders who come out of lock-up at year end.  The larger company is less likely to be overlooked by analysts within the online gaming sector.

2) Major management upgrade – We recently had a chance to sit with new CEO Lee Fenton, who comes from the Gamesys side, and CFO Keith Laslop.  They are most impressive forward-thinking executives who talk like private equity principals. Fenton recently bought more stock and has holdings exceeding $10mm.  They sound really excited about the global prospects of this platform and referred to several new markets as eventual “20x opportunities.” They present well and have a strong handle on customer retention metrics.  Pre-merger, a major worry of mine was that customer stickiness seemed somewhat unproven. Lee and Keith aren’t worried about that at all and have the predictive data to back it up. Also, they explained the tangible revenue-synergy benefits they are seeing already as a result of the merger, in terms of an increased liquidity pool for bingo.  Over the next year, as more shareholders recognize the quality of the team here and the merits of the story, we believe the stock will be less misunderstood.

3) Product suite and geographic diversification – One significant knock on JPJ went away with the closing of the merger. JPJ had been licensing software from Gamesys for its main UK bingo operation. Now the company entirely owns its own software, making it ultimately more acquirable.  Furthermore, the Gamesys suite of mobile casino platforms brings diversification by product and higher growth to the overall sales mix. The combined company has a higher percentage regulated offerings (i.e., UK) as well as footholds in several attractive expansion markets, including the US and Brazil.  This is better explained on the GYS IR website under “Investment Case” (https://www.gamesysgroup.com/investors/investment-case/) and in the most recent presentation.

4) Revenue inflection - While this is not their official guidance, they clearly see double-digit overall revenue growth ahead as expected and achievable.  Legacy JPJ in the UK has recently inflected positive after anniversarying the effects of the new VIP client reporting burdens. Its steady-state CAGR should settle much higher (we think HSD).  UK product additions from the Gamesys side grew rapidly last quarter in spite of the VIP regs and should bring the overall UK revenue base to LDD growth. Outside the UK, Vera&John continues to outgrow the rest of the mix, adding more steam to the revenue inflection.  Merger cost synergies, debt retirement and controlled marketing spend should support a stable to improving EBITDA margin - in contrast to the rather messy trailing numbers.  

5) Public market fatigue?  Lastly, management’s frustration with the recent stock performance creates some inference that GYS’s future might be better realized in private hands or in the hands of a strategic acquirer.  As mentioned, the acquisition and internalization of the JPJ software makes this a real possibility as never before. The numbers certainly work for PE and strategics today and the case only gets stronger over time as the company rapidly de-levers.  Whether or not Gamesys pursues this, the possibility should be helpful to the stock.  

Valuation 

Beyond all these positive enhancements to the Gamesys narrative, the numbers tell the story of a company deeply discounted relative to its growth rate and free cash flow prospects.  In accordance with comments from management, we see 2020 as a strong revenue inflection year and arrive at 13% sales growth.  This should drive about 20% FCF growth as Gamesys at long last demonstrates some operating leverage, despite continued investment in growth and new markets.  Projected FCF in 2021 exceeds 20% of the current market cap. De-leveraging should be rapid and material from the current post-merger starting point of around 3x net leverage to well under 2x by the end of FY21.  We do expect stock buybacks to become part of the capital allocation discussion later in 2020. That could be an additional source of upside to our numbers. We set price targets based on GYS proving itself and earning a more healthy 11x cash earnings - although we note that we expect many more solid growth years beyond 2021 and a “growth tech” multiple is not out of the question.  The charts below should reinforce what we mean by “great entry point.”  

Catalyst

FTSE 250 Index addition

Revenue inflection

Access to new management