Description

I believe OPAP (Athens Stock Exchange: OPAP) is an attractively-valued, growing company. By virtue of its monopoly status and superior business model, OPAP generates a significant amount of free cash flow and returns most of this cash flow to investors through dividends. The forecasted dividend yield for 2003 is approximately 7%, and the stock is attractively priced at 10x FCF.

OPAP is the largest gaming company in Greece, with the exclusive concession to operate and manage all numerical lottery and sports betting games until 2020. This includes fixed-odds sports betting, primarily European football (75% of total revenue), and Lotto-type games (25% of revenue). They run all lotteries in Greece aside from scratch tickets (unprofitable business), a national raffle and 9 casinos operating in the country. Gaming is 3% of Greek GDP and has plenty of room to grow as there is a huge black market which the government is trying to reign in because of lost tax revenue.

Here are some quick financial statistics:
- Stock trades at Euro 11 with an equity market capitalization of Euro 3.5 bb
- Net cash position of approximately Euro 300 mm
- Valuation: 10x Cash EPS and 10x FCF
- Estimated YOY revenue growth in 2003 of 10-15% on top of 9% revenue growth in 2002
- EBITDA margin = 20%; ROA = 34%; ROE = 75%
- Company pays out substantial dividends. In 2002, approximately 86% of adjusted net income was paid out as a dividend. The forecasted dividend yield for 2003 is 7%. Management claims they have the second highest payout ratio of any European company.

- 2003E Revenue: Euro 2.3 bb
- 2003E EBITDA: Euro 475 mm
- 2003E CapEx: Euro 40 mm (normalized capex is estimated to be Euro 20-30 mm)
- 2003E Cash EPS: Euro 1.06

OPAP has a very attractive business model. The company takes minimal risk in betting activities, as the lotteries and sports betting are subject to fixed payout ratios. In the case of sports betting, the setting of odds and risk management has been outsourced to a company called Intralot, which guarantees OPAP a maximum specific payout ratio (60%). Revenues from bettors are collected across a network of 5,300 agents (not owned by the company) and the net proceeds, taking into account the payout, are given to the company. In terms of economics, for each Euro wagered, OPAP pays out 60% as prizes to the bettors; Intralot gets 9%; and the agents get 11%. Therefore, OPAP gets about 20% for each Euro wagered. The only thing I can think of that is comparable in the US is GTECH (GTK), which operates on-line lotteries in the US, but they receive about 1.5-2.0% of the gross revenue for the functions they serve in the US.

The business also requires very little overhead. Bets are executed over an electronic network, so agents wire money to OPAP twice a week and the Company just makes sure wire transfers clear for correct amounts.

Furthermore, the introduction of new games requires minimal capital (basically a software installation). One of the interesting developments within the company is the introduction of Kino in late 2003. A very conservative estimate for Kino revenues in 2004 is Euro 100 mm. Capital expenditures for Kino will be less than Euro 10 mm for a game that will generate AT LEAST 20mm of FCF in year 1.

There is also plenty of room for growth as gaming deregulates. The company cannot yet accept wagers on individual sports matches (only outcomes of tournaments and league championships). There is also the possibility of betting on horseracing.

Why it is interesting now:

- When the Greek government gave them the concession, the government essentially held 100% of the equity. In a recent secondary offering, the second since OPAP was given the concession, they sold down to 51% (78mm shares at Euro 9.44 on July 12), and probably will not be selling any more anytime soon. The secondary was a big overhang on the stock. Furthermore, the offering doubled the float.

- Introduction of Kino in Q4 2003. They have a network of 5,300 agents across Greece. In 2004, the Company plans to roll out Kino to all 5,300 outlets, and for the first time, they are introducing their gaming machines to 1,000 non-agent locations such as pubs, cafes, bus terminals, etc. They are testing the game to run from 9am – 9pm and have drawings every 5 minutes. Early indications are encouraging, as many agents have been reporting bottleneck issues with their OPAP terminals. While some analysts estimate Euro 100mm of revenue, the game can do significantly better. Management has been vague on guidance but has indicated its belief that Kino will easily be the company’s second largest game behind Stihima (sports betting game). Joker (a numerical lottery game), the company’s current second largest game, has 2003E sales of just under Euro 200 million. As an additional reference point, when the concession was first granted, they thought fixed odds sports betting would do Euro 150mm in annual revenues and it immediately became a Euro 1.5 billion a year business.

- The Olympics in 2004 will definitely increase traffic and visibility for the Company.

Risks:

- Arbitration Proceeding with Intralot – OPAP had promised Intralot to offer fixed-odds wagering on horse races by the end of March 2001. In January 2003, an arbitration court determined that OPAP must compensate Intralot approximately Euro 37 mm for every year they do not provide fixed-odds betting on horse races. The ruling was based on some 20 races a day, 365 days a year and Greek government has not even legalized fixed-odds betting on horse races. OPAP has already provisioned for Euro 147 mm, which takes them through 2004. OPAP filed an action for annulment of the arbitration decision and a hearing took place in October 2003. Management has stated that it expects the current arbitration stage to last up to 12 months. One complicating factor is that OPAP’s current risk-management contract with Intralot for sports wagering expires in 2007. Therefore, OPAP might use this as a bargaining chip against Intralot.

- The Greek government still owns 51% of the company. However, as they sell down equity, the government receives less and less money from gaming in their country in the form of equity appreciation and dividends.

- It is difficult to quantify the risk of owning a Greek company. However, I am comforted by the fact that this is a highly-visible stock. It is one of the larger market cap. stocks on the Athens exchange and about 1 million shares trade each day. Another comforting factor is that the Company pays virtually all of their net income out in a dividend.

Catalyst

- The successful roll-out of new games, namely Kino, across the country in 2004
- The Olympics in 2004 will increase traffic and visibility for the Company.
- Resolution of the dispute with Intralot
- Substantial dividend payouts – forecasted dividend yield of 7%