Description

Business Description

Post recent transactions, Platyech’s business is roughly evenly split between the #1 B2B online gaming provider globally and B2C CFD brokerage. Both business segments are benefitting from the secular tailwinds of internet and smartphone/tablet penetration, increasing speed of connectivity and increasing regulation allowing online gaming and CFD trading into new markets. This is a double-digit top line grower, with >40% margins and extremely low capital requirements selling for just c.11x fwd P/E.

The company’s core strategy revolves around using its scale, technology leadership and market leading CRM capabilities to consistently remain ahead of competition in understanding the next phase of technological development and consumer preferences. In the gaming segment the company uses this technological edge to develop additional products to upsell to its existing licensees while in the CFD segment the strategy is to use the same CRM know-how and leading technology to improve its own trading platform, customer experience and recruit new customers.

Investment Thesis Summary

Looking at Playtech 5 years ago, the company’s shares were significantly undervalued due to several factors including:

• Corporate governance concerns around related party transactions between the company and its largest shareholder, Teddy Sagi
• Listed on AIM rather than LSE main market
• Uncertainty around the prospects for the company’s stake in William Hill Online
• Uncertainty around the impact that the transition to regulated markets would have on the company’s prospects

All of these issues have either been resolved or dissipated. The company moved to the LSE main market, the William Hill Online stake was sold at a massive gain, the transition to regulated markets is an ongoing process, but is no longer a concern as the company has continued to post strong results throughout the transition and new opportunities have arisen from this transition. The relationship with Teddy Sagi continues to be an overhang, but investors are now well aware of this relationship and its pros/cons so that it is fully reflected in the company’s discounted valuation relative to its independent prospects.

As a result of this, Playtech shares have significantly re-rated over the past 5 years.

Now, the company’s entry into  a new business segment by acquiring 3 online CFD trading platforms via 3 highly accretive transactions has created a new opportunity as many online gaming analysts and investors do not understand the CFD trading business and are spooked by the regulatory issues at Plus500. In addition, many have translated the foray in CFD trading as an admission by the company that the core online gaming business is slowing.

Below is a refresh of the company’s different business segments and growth opportunities, followed by discussion on how we believe we can achieve 28% IRR over 2.5 years on highly conservative assumptions.

Online Gambling Software

Playtech offers a full suite of B2B services across all online gaming verticals. It is strongest and most penetrated in the casino segment which accounts for c.3/4 of gaming software revenue. There are 3 reasons why casino is so much larger than the other segments 

• This is the company’s longest standing and original vertical so that it is where the largest number of licensees are singed up
• Casino is the most profitable segment of online gaming so that it represents a large proportion of operators’ earnings which is therefore reflected in PTEC’s revenue split
• In addition to the software platform, the casino segment contains revenue from Playtech’s large game content which includes the largest library of online slots, live dealer and other types of key content offerings. Although the company doesn’t disclose its agreements specifically, it is generally understood that content receives a higher revenue share than platform (platform rev share is 3-5% while content is 5-15%). In addition, various verticals (e.g. Bingo) derive a large proportion of their revenue from side games which in Playtech’s case are accounted for in the casino segment.

Over the years the company has added solutions via acquisition which it subsequently enhanced through internal development. The 2^nd largest contributor to the gaming software segment is sports betting, >80% of which is generated by the company’s mobile sports betting platform which is a virtual monopoly in the B2B mobile sports betting arena (competition is from operators with in-house solutions). Mobile sports betting is still in high growth phase (in 2014 the company’s sports segment grew >50% organically).

In addition, to the casino and mobenga offering, the company offers a core online sports betting platform which competes with market leader, OpenBet,  a bingo platform, a poker platform (iPoker) and  a software platform (including content games) for land based slots/machines via its Videobet subsidiary. Videobet has ~65% market share in the UK and is currently expanding into Italy and Finland.

All the company’s products are underpinned by a single common platform called Playtech IMS (Information Management System). IMS is a cross-platform infrastructure, allowing online, broadcast, mobile and land-based products to be managed through a single platform. IMS’ data interrogation software allows real-time reporting and the ability to monitor player performance which is key to driving player retention, conversion and understanding player trends. This is the core of Playtech’s unique CRM capabilities and the key reason for Playtech’s success in acquiring and retaining licensees. In total the company currently counts >120 licensees, including all of the top 10 UK operators. License agreements tend to be 5-6 years in lengths. It appears the length of these contracts is increasing as the 2 most recent high profile deals, Gala Coral and Ladbrokes, were both 10 years deals. As the company adds licensees client concentration is supposed to diminish. However, in reality concentration has barely changed in recent years.

The reason for this is the cross-sell of products to top licensees which contributes roughly equally to growth as the addition of new licensees (more on that below).

There are 3 drivers of growth in the gaming software segment:

• Organic growth: This includes growth from participating in the growth of its licensees as the company is compensated on a revenue share basis and cross-sell of products to existing licensees. The company’s annual report states: ”On average, Playtech’s licensees take a limited number of products. There is a trend for larger licensees e.g. Gala Coral, Ladbrokes and Paddy Power to leverage Playtech’s IMS and take more products from Playtech’s product suite, enhancing their cross-sell ability.” From conversations with management we derive that the average licensee has so far taken only 2 Playtech products out >10 available.
• New business: This is revenue generated from adding new licensees. Historically, the company has added between 5-10 new licensees annually. It also includes revenue from new products sold to existing licensees as in addition to attempting to cross-sell its other platforms, the company is constantly developing new services to supplement its core platforms for which it can either charge an extra fee or benefit from the uplift to the revenue share from licensees who take it up. The latest innovation is the company’s Business Intelligence Technology (BIT) which is a real-time data analytics product around the customer experience, preferences and gaming patterns designed to enhance acquisition and retention rates. This has in part helped develop the Coral Connect Card, which is the envy of the UK bookmakers industry. Through this card Coral has signed up >160k players who can transact in stores and online with a single account.  >30% of Coral’s customers now use both online and the shops. These players are 2x more valuable.
•  Acquisitions:  M&A has played a key part in Playtech’s long-term strategy and this will likely continue though the weight of acquisitions is diminishing as the company’s B2B offering is complete so that only the occasional bolt-on acquisitions should be expected going forward

Online Gambling Services

The large contribution from acquisitions for 2011 and 2012 was for a large part the result of the acquisition of PT Trunkey Solutions (PTTS). While on the software side the company offers operators the tools to run and operate their businesses, but the actual know-how and capabilities to successfully deploy those tools are up to the operator, in the services segment Playtech offers operators the possibility of outsourcing various elements of the actual operations to Playtech. Most operators selecting Playtech’s services will choose just 1 or 2 of the many potential services which include marketing, customer retention, managing player lifetime value and profitability, online payment efficiency, etc. In exchange, Playtech will receive a revenue share for the services provided.

From time to time the opportunity will arise to structure a more comprehensive deal such as the current deal with Ladbrokes. In such a case Playtech will participate across all facets of the operation and be remunerated based on the upside it generates, e.g. in Ladbrokes’ case Playtech is entitled to an earnout that is derived from the EBITDA uplift in Ladbrokes’ online segment at certain thresholds and time intervals. (Note that should the Ladbrokes-Gala Coral merger complete as contemplated, this agreement will be terminated and Playtech will be entitled to a £75m pay-out)

These services are particularly interesting for operators in various newly regulated markets that have strong local brands but no online expertise/capabilities. Recent examples of new clients include Gazetta Dello Sport in Italy, Caliente in Mexico and Trinity Mirror in the UK.

The services segment also includes the recent acquisition of Pokerstrategy.com, an online poker community that is a large affiliate driving traffic to all poker sites. This segment is small and of questionable quality.

The bear arguments on the gaming segment

The bear case around Playtech’s online gaming segment consists of the following arguments

1.       There are no more large enough licensees to add so that growth will slow sharply as the contribution of new business slows

2.       Excluding new business, Playtech’s organic growth roughly equals market growth indicating that its licensees are not gaining share

3.       Playtech continues to generate ~2/3 of revenue from unregulated markets, some of which carry high risk of being shut down, e.g. Malayisia which accounts for 6-8% of revenue

4.       The services segment is not growing much and is mostly geared towards unregulated markets so that it deserves a very low multiple. On that basis, the acquisition (which was from a related party –Teddy Sagi – generated little value so far)

We address these arguments by partially refuting them and partially accounting for them in our estimates as follows:

1.       No more large licensees:

·         Partial rebuttal: The opening of new regulated markets is constantly adding licensee opportunities for Playtech as local land based operators (e.g. Holland Casino in the Netherlands) and brands (e.g. Gazetta Dello Sport in Italy) look to compete but lack an existing product and online operating knowledge. Playtech’s management boasts a long list of such opportunities including a significant existing pipeline. In addition, these licensees are likely to take a larger number of Playtech products from the start as opposed to traditional new licensees that would join for a specific vertical/product. Therefore, the revenue opportunity of one domestic operator may match that of several traditional licensees combined.

·         Taking it into account: We assume just 2 new licensees per year going forward vs historic rate of 5-10 per annum.

2.       Licensees not gaining share:

·         Partial rebuttal: the growth of Playtech’s licensee is partially reflected in the ‘new business’ line because they are growing with new products. If we add that into the equation, we can see that Playtech’s licensees have been gaining share

·         Taking it into account: we assume organic revenue growth in line with overall online market expectations going forward (i.e. we don’t assume market share gains or losses)

3.       2/3 of revenue from unregulated markets:

·         Partial rebuttal: not really a rebuttal, but the company’s regulated markets revenue is growing faster than unregulated portion so this will gradually decline. Also the new financial segment will significantly improve this mix as it is basically 100% regulated

·         Take it into account: this is fully reflected in Playtech’s multiple which is at a very large discount to NetEnt for this specific reason

4.       Service segment is not growing and deserves a low multiple:

·         Partial rebuttal: growth has started to improve last year and this is likely to continue as the segment benefits from new licensees as discussed above (1H15 organic growth +15% y/y)

·         Taking it into account: we attribute a low multiple to this segment in our SOTP

Overall the assumptions we have made in relation to the above yield an organic growth rate for the gaming segment of c.13%. However, for the purpose of conservatism, we expect a 2015-18 organic revenue CAGR for the gaming segment of 10%. On a reported basis 2015 is much stronger as they benefit have a significant FX benefit.

Financial Segment

In recent months, Playtech has made 3 acquisitions of online CFD trading platforms (Plus500, TradeFX and AVA) for a total price (including earnouts and minority buyout options) of €1.2bn (Plus500 and AVA deals will be completed this month). On our (highly conservative) estimates this new segment will contribute €442m in revenue and €200m of EBITDA in 2016, representing a forward acquisition price of 6x EBITDA.

The cheapest of the 3 acquisitions was Plus500 for which we estimate they paid c.4x EBIT as they announced the deal at a moment when the company completely lost investor confidence after they mishandled an FCA review of the company’s client on-boarding procedures and the communication around it. Playtech astutely recognized that the issues were temporary and the noise around the poor customer service (many accounts were frozen for over a month and the company’s communication with clients was a disaster) would not spread far beyond the UK, which accounted for only ~15% of revenue. Like online gaming, there is high customer churn in online CFD trading which means that only a small number of Plus500’s current customers would still have contributed to revenue in the later years. The negative headlines were mostly concentrated in the UK and Plus500 was able to on-board many of its customers to its Cyprus license to minimize disruption. Plus500’s final Q2 results prove that this was the case as it achieved flat y/y revenue despite being out of business for several weeks during the quarter. The business is now in full recovery mode with its market leading technology intact.

The 3 deals were financed almost entirely with cash on hand and debt. The company raised €317mm in equity, but c.€200m of that was earmarked for future deals on the gaming side (including a 9.7% stake in Ladbrokes). As a result, these new acquisitions will be highly accretive, nearly doubling the company’s earnings power.

The 3 operators Playtech has acquired operate at the low end of the CFD trading market with ARPU’s that are considerably lower than IG Group’s, the leading CFD broker in the UK.

The typical Plus500 and Markets.com (TradeFX’ platform) customer is very similar to the typical online gaming customer. Therefore, customer mix, acquisition channels and churn rates are also very similar to online gaming. In addition, the number is juriusdictions where the product is legally allowed trumps the online gaming market so that the addressable market is considerably larger. As a result, there are some potentially significant revenue synergies from combining the 3 business under Playtech’s single roof.

·         Playtech has market leading CRM capabilities which will enable the platforms to improve customer life cycle management and value. This is already partially reflected in the fact that Markets.com, which was partially owned by Teddy Sagi, generates a higher ARPU than Plus500.

·         Customer service: Plus500 has historically had very poor customer service. Leveraging TradeFX’ existing customer service infrastructure and Playtech’s know-how from the online gaming side could yield further ARPU and customer life time value benefits

·         Marketing capabilities: Plus500’s marketing machine is technologically unparalleled in the industry. This is what has enabled the company to grow at the pace it did. Applying these capabilities to the other brands and into new regions is a key synergy

·         New regions: some of the brands are licensed in jurisdictions that others are not. e.g. AVA owns a license to operate in Japan, which is apparently very hard to obtain. Conversely, Plus500 is UK licensed and TradeFX has a relationship with a local broker in turkey allowing it to operate there in a fully regulated manner. Cross selling the 3 brands using the existing licenses is another potentially significant revenue synergy.

·         Growing outside Europe: Overall the 3 businesses combined generate c.70% of revenues from Europe. CFD trading is not defined as gambling. Therefore, in virtually every country where financial institutions can operate online, these platforms can be legally operated. One major example is China. So far all 3 of these platforms have barely scratched the surface of this opportunity. Playtech’s intention is to push this further. 

·         Mobile platform: TradeFX has significantly lagged Plus500 on the mobile side of things. Plus500’s mobile platform is best in class. Applying its technology to Markets.com and to AVA (who is currently on MetaTrader, which is a third party platform used by everybody in the sector) will further enhance those offerings.

In addition, to the revenue opportunity, there will clearly be some synergies on the cost side as back-office and executive functions can be shared. In addition, TradeFX is based in Cyprus where it pays a much lower tax rate than Plus500 does in Israel. Reallocating Plus500’s profits to the Cyprus entity will yield significant tax savings.

In the 1^st half of 2015, revenues at TradeFX increased 60% y/y and Ava revenues increased 34% (for Ava the number is Jan-May). As the base for the 2^nd half at TradeFX is higher, we are assuming much lower growth (~25%) for the 2^nd half of the year. At Ava we are simply keeping the current run rate of growth. For Plus500 our FY15 numbers incorporate management’s guidance given in last month. Note that given the market volatility in July-August our estimates for the 2^nd half are probably too low.

Going forward our estimates look highly conservative considering the growth rates these businesses are currently exhibiting on a standalone basis and the large number of revenue synergy opportunities discussed above. 

Cost Assumptions for all segments 

• Gaming software segment: we assume consistent pattern with Playtech’s history, i.e. c100bps annual margin expansion, adjusted this year for the c.250bps step down due to POC introduction in the UK
• Services segment: flat margins (also adjusting for the POC tax)
• Financial: assume significant margin pressure at Plus500 this year (as seen in 1H results), followed by c.200bps annual margin expansion for the segment, which is far below historic rates (Plus500 has increased its operating margin by 23ppts between 2012 and 2014)

Valuation Considerations 

• We account for the TradeFX earnout and minority buyout option as debt
• We have fully diluted the convertible debt into the share count as the converts are well in the money
• We have assumed a continued 40% dividend payout ratio, in line with historic rate
• With that, the company ends 2015 in a net neutral position and builds up a net cash position again from here

·         We are valuing Playtech on a 2018 SOTP basis. (all amouints in EUR)

Considerable further upside

If we were to build a bullish scenario for Playtech, we could argue that:

• Organic growth in the software business would at least match the 13% discussed above
• New customers at videobet given the convergence of online and offline products
•  Bingo revenue could grow mid-single digits in line with the industry (we are assuming its remain flat) 
• Revenue and cost synergies on the financial segment
• Significant re-rating potential of the financial segments as IG Group currently traders on 12x EBITDA and other online brokerage businesses in the US trade at even higher multiples
• Further M&A could be incrementally accretive as has historically been the case

Catalyst

• Completion of 2 Plus500 and AVA acqusition and analysts factoring their number into models resulting in singificnat forecast upgrades
• Delivering strong results for the financial segment, thereby building investor confidence in this new segment
• Further growth and re-rating of the gaming segment and especially the service side of it