Description

Inspired Entertainment Inc (NASDAQ:INSE) is an under-the-radar gaming technology operator, which supplies content, platform and other products/services to online and land-based gaming companies, globally.  INSE was launched in 2002 as a mobile entertainment technology startup, with 10 employees in London.  By 2006, INSE had launched its market leading Virtual Sports betting platform.  By 2010, INSE had grown its Server Based Gaming and Virtual Sports business, and it attained its first contracts in Italy.  It was acquired by private equity firm Vitruvian in 2010, and went public via SPAC in 2016.  Vitruvian’s shares were an overhang on the stock, until it recently exited its position on May 25, 2021.

THESIS

INSE has a higher composition of its revenue from high growth, high margin businesses; and this argues for a premium multiple closer to that of SGMS.  INSE trades at a significant discount to peers, despite its superior growth profile.  In 2020, INSE's Virtual Sports and Interactive divisions together comprised 23% of total revenue.  These divisions are much higher margin businesses than the more traditional Gaming and Leisure segments.  Interactive is a high topline growth segment, whereas Virtual Sports growth appears closer to the traditional business segments.  However, Virtual Sports has an online component that is likely growing more rapidly, and this growth may be obfuscated by the non-online portion (and covid's impact thereon).  So, I treat all of the Interactive and Virtual Sports divisions as "Growth" (i.e., higher growth/margin business segments).  Comparing INSE's 23% to the "Growth" divisions of peers, you find SGMS at 32% and IGT/AGS/EVRI all at <=5%.  This differentiating factor seems to be reflected in SGMS' EBITDA multiple (11-12x) well above peers (7-9x).  INSE trades at just ~6.5x EBITDA.  I see upside to $22/sh (+100%), based on 8x 2022 EBITDA of $100mm.

Like all covid-impacted businesses, modeling normalized financials is especially difficult right now.  B-Riley's approach to capitalize mgmt’s 3Q guidance for $30mm of EBITDA ($28-30mm range) based on 30% seasonality implies EBITDA well above Street.  While we see this as a rather blunt approach, mgmt did not push back on it, when we spoke with them.  It is clear that they see significant upside over and above what Street is modeling. 

Why does this opportunity exist? 

• INSE is a smaller business, with a market cap of ~$250mm and EV of ~$500mm.  Its peers are larger and have a longer operating history.  However, it’s size and digitally native origins make it more nimble and likely to succeed in the increasingly online/mobile gaming landscape.  Additional buyside/sellside coverage of the stock will increase awareness and likely benefit INSE’s valuation multiple. 

• While much of its growth is coming from the USA, its mature segments derive most of their revenue from the UK and Europe.  The slower reopening of most European countries has been a drag on INSE, but that headwind is finally abating.  Thus, INSE is a compelling “reopening laggard” play.

• Warrants for 9.5mm shares remain outstanding through 12/23/21.  Their strike price of $11.50 is just 5% above the current share price.  Thus, there is some dilution that will occur on upside above $11.50, in addition to the potential technical/psychological overhang on the stock through year-end. 

BUSINESS OVERVIEW

INSE is a B2B provider of the gaming machines, technology and content demanded by leading online and land-based gaming operators around the world.  These gaming operators serve the consumer end users in a variety of retail gaming venues and online settings.  It’s Gaming and Leisure segments are mature businesses, which operate under long-term recurring revenue share contracts.  It’s Virtual Sports and Interactive segments are more unique, higher growth and margin businesses. 

Gaming (~55% of revenue, ~33% EBITDA margins): Supplies gaming terminals, as well as gaming software and games for the terminals, to betting offices, casinos, gaming halls, and high street adult gaming centers, utilizing server-based gaming technology.  The game portfolio is fully digital and interacts with the central server, over the Internet and proprietary networks.  Geographically, revenue is comprised of ~60% UK, ~25% Italy/Greece, and 15% ROW.  Revenue is over 70% recurring.

Leisure (~22% of rev, ~20% margins): In pubs, bingo halls, and adult gaming centers throughout the UK, INSE provides pay-to-play gaming terminals, pool tables, prize vending and jukeboxes.  Revenue is 100% UK based and near 100% recurring. 

Virtual Sports (~16% of rev, ~82% margins): Designs, develops, markets and distributions ultra-HD games, which allow players to bet on a simulated sporting event, in either a streaming or on-demand environment.  Games are offered through land-based venues (50%) and through online websites (50%).  ~60% UK, ~20% Italy/Greece, and ~20% ROW.  ~95% recurring revenue. 

Interactive (~7% of rev, ~63% margins): Provide a range of iGaming content from feature-rich bonus games to Euro-style casino free spins and table games, incorporating well-known first and third-party brands.  Release several new titles per month, with content distributed via remote gaming servers.  ~34% UK and ~66% ROW; 99% recurring. 

UK REGULATORY ENVIRONMENT

·        History/Timing

o   Last review began in 1999.  Not completed until 2005 (the "Gambling Act 2005").  Thus, there is a perception that the government takes a long time to complete these reviews.  

o   Latest review of the act was a response to public outcry, particularly related to the proliferation of advertising by gambling operators on TV and professional sports jerseys.  

§  UK was quick to allow online gambling without much restriction, because there was already a well established legalized gambling market in retail (physical locations).  All players were allowed to have websites and advertise for online gambling.

o   The body conducting the review ("Gambling Commission") lost their chief suddenly a few months ago.  Interim replacement does not have a history in the gaming industry and will need to quickly get up to speed.  Could slow process.

o   Conventional wisdom is that the Commission will publish a white paper by year-end, with regulation to follow in 2022.

·        April 2019 Triennial Review/Wager Caps

o   There was a smaller review conducted, which resulted in a GBP2 cap place on slot bets in betting parlors.  This had a significant impact on INSE's financials.

o   However, there is no such cap on online slots.  E.g., one of the most popular games, "Rainbow Riches" has a GBP2 cap when played in a slot parlor, but you can go online and play the same game with no cap.  

o   If such wager caps were to be implemented online, it would have a very material impact.  However, it does not appear to be likely.  The industry argues that the better data/analytics of online operations allows them to manage player limits in ways not possible at physical locations.

·        Review of 2005 Act

o   It is still unclear as to the focus of the review and likely regulation, but it appears to revolve around (i) restrictions on advertising, and (ii) player protections, such as deposit limits.  

§  The advertising by gambling companies became so widespread that the "average joe on the street" became annoyed/concerned about the amount of exposure that they (and their kids) were having to endure.  

§  Advertising restrictions will make it more challenging to direct new/impulse traffic to online websites.

§  Player protections could take many forms, but are ultimately geared towards making sure people gamble only within their means.  The operators have been working hard to provide the government with ample information on their processes already in-place to accomplish these ends.  

o   Unlikely to focus on further regulating physical betting parlors, as they were already hard hit by the 2019 regulation and covid.

DISCLAIMER:  DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK.  THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP.  THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.  

Catalyst

Further Interactive penetration into USA gaming and lottery markets.

New initiations and coverage of INSE by sellside.

Expiration of warrants in Dec 2021.