August 11, 2018 - 3:01pm EST by
2018 2019
Price: 31.90 EPS 2.27 2.94
Shares Out. (in M): 276 P/E 14 10.9
Market Cap (in $M): 8,814 P/FCF 14 10.9
Net Debt (in $M): 5,705 EBIT 1,047 1,214
TEV ($): 14,519 TEV/EBIT 13.9 12.0

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I am recommending The Stars Group (TSG) as a long.  The business trades at 11.8x 2019 EV/EBITDA and 10.9x 2019 FCF (they pay very little in taxes).  I believe the business can grow revenue in the 10%+ range for the foreseeable future, with EBITDA and FCF growing faster.  Pro forma for the transformative acquisition of Sky Betting and Gaming (see below), there is a fair amount of leverage: 5.2x pro forma 2018 EBITDA.  However, the company generates a significant amount of FCF and should de-lever roughly 1x per year. I believe the depressed valuation is mainly the result of TSG’s legacy issues and overhangs, all of which appear to be in the rear view mirror or trending in the right direction.  

TSG, formerly known as Amaya Gaming, is best known for its online poker brand, PokerStars, which dominates the industry with 65% share in its operating markets.  The brand is 8x larger than the 2nd player, which enables the business to benefit from huge network effects.  Online poker is a fantastic business (winner-take-all market as players will migrate to the site with the most liquidity), but the problem is that there is hardly any growth.  Online poker is a flat to LSD growth business, and it is a relatively small market, accounting for only 7% of the global online gaming market ($3 bb).

TSG has historically traded at an undemanding valuation for a number of reasons:

  • Until recently, almost 100% of its revenue came from poker.  In addition to the lack of market growth, the industry has historically suffered from regulatory overhang.  Certain TSG’s poker markets are labeled “grey” markets, in which TSG believes they are operating legally but does not pay any type of gaming duties/taxes.  There have been cases where TSG exits a territory as a result of an adverse regulatory development.
  • Reverse merger dynamics – the company was formed when Canadian micro-cap Amaya Gaming acquired Rational Group, the owner of PokerStars, for $4.9 bb in 2014.  The final deferred acquisition payment was made in the spring of 2017, which allowed the company to have true discretionary free cash flow to de-lever and restore balance sheet flexibility for the first time in the company’s history.
  • Corporate governance – the previous CEO and major shareholder, David Baazov, was alleged to have engaged in insider trading and was subsequently removed from his position in March 2016.  Well-respected industry veteran, Rafi Ashkenazi, assumed the role of CEO and Brian Kyle, who has 25 years of capital market experience (including at publicly-traded companies) was named CFO in late 2017.  

It is our view that the new management team has done a terrific job of “legitimizing” the company, including improved financial controls, enhanced regulatory/compliance oversight, strategic planning and investor communications.  Ashkenazi has added key management depth, including the hiring of Robin Chhabra as Chief Corporate Development Officer in May 2017. Mr. Chhabra was formerly the Group Director of Strategy and Corporate Development for William Hill.  There have also been fantastic additions to the board of directors since Ashkenazi’s arrival (four new directors in the past three years).

Under new management, the company has also done a great job diversifying away from poker by cross-selling its large, captive poker player pool into the faster growing segments of casino and sportsbook.  In addition to being faster growing, casino and sportsbook are vastly larger markets. Sportsbook accounts for 58% of the global online gaming market ($24 bb market) and casino accounts for 30% ($13 bb market).  Unlike poker’s flattish growth profile, sportsbook and casino are expected to grow 7-8% per year through 2022. The company has grown online casino and sportsbook revenues from $0 to over $420 mm (~30% of LTM revenues) in approximately 4 years, mainly through cross-selling its captive online poker customer base, which serves as an attractive low-cost customer acquisition channel.    

The company made a step-change in the makeup of its business in April 2018, when it announced the acquisition of Sky Betting & Gaming (“Sky”) in a cash and stock transaction valued at $4.7 billion.  Including expected cost synergies, the purchase price multiple was 12.8x LTM EBITDA. The business combination, which closed on July 10, results in the world’s largest online gaming company. Sky is the owner of the UK’s largest and fastest growing sportsbook.  The acquisition will provide TSG with multiple financial and operational benefits, including greater revenue diversification, an increased presence in regulated markets, low-cost customer acquisition channels and improved products and technologies across its poker, casino and sportsbook verticals.

Pro forma for the combination, the business is evenly spread across its three verticals: poker (37%), sportsbook (34%), and casino (26%).  In addition, the company has far greater exposure to regulated markets, which now accounts for 75% of revenue. The improved business mix alone will enhance the company’s growth profile.  60% of the company’s revenue now comes from casino and sportsbook. Those two sectors within online gambling are expected to grow 7-8% per year through 2022. Sky, the company’s largest component within sportsbook, has been growing at a rapid clip.  Over the past two years, Sky’s revenue has grown in excess of 30% p.a. and EBITDA has grown close to 40% p.a. Sky is the fastest growing established online gaming operator in the U.K., and the U.K. is the world’s largest online gaming market. Sky’s customer base is young;  its largest segment is 18-34 years old. The customer base is also very loyal. 58% of sports betting customers use Sky Betting & Gaming exclusively. Lastly, 82% of its FY 2017 revenues were generated on mobile platforms. While the overall UK gaming market is forecasted to grow 4%, UK online gaming growth is forecasted to grow 7-8% and UK mobile gaming growth is forecasted to grow 14-16%.  

The combination will also generate significant cross-selling opportunities.  The company now has the unique advantage provided by two very large, low-cost customer acquisition channels: poker and sports.  We have seen the success that TSG has enjoyed by selling an upstart casino and sportsbook offering to its poker base, and now they have a vastly superior sportsbook product to cross-sell as well as the opportunity to cross-sell its poker offering into Sky’s customer base.  The company will offer customers a common wallet and single account for poker, casino and sportsbook, further enabling its cross-vertical loyalty program. Cost synergies are pegged at $70 mm, or ~18% of Sky’s forecasted 2018 EBITDA. TSG and Sky are highly complementary businesses with myriad areas of duplication, such as marketing expenses and data feeds.  The company has suggested that the cost synergies are a bit conservative, but they wanted to articulate a light phase-in as they desire to maintain the culture at Sky.

TSG’s strong global position was further augmented in May by the Supreme Court of the United States’ decision to declare the Professional and Amateur Sports Protection Act of 1992 (“PASPA”) unconstitutional, effectively ending the federal law that limited sports betting throughout the country.  It is now up to the states whether or not they want to legalize sports betting. Seventeen states have already passed or introduced bills making their way through state legislatures to legalize sports betting upon PASPA’s repeal.

We believe this is a major step towards the inevitable move (globally) towards the full regulation of online gambling, an industry we think benefits immensely from the transparency afforded by the internet.  At the beginning of this year, the Southern European countries of France, Spain and now Portugal started to allow for the pooling of inter-country player liquidity for online poker. TSG has seen revenue growth of 30-35% just by the combination of France and Spain.  The company is hopeful that Italy will join this liquidity early next year. In April of this year, TSG launched PokerStars.IN in India. The business is operated by Sachiko Gaming, so TSG’s revenue model here will be through licensing fees. We believe increasing regulation is clearly a net-positive for TSG as it helps legitimize the activity and grows the overall revenue pie (as operators are allowed to market their offering to the public, under certain parameters).  The flip-side is obviously the chance for unpredictable changes in duties/taxes.

In the likely event that social acceptance of online gaming continue to grow, we believe people will increasingly view TSG through the lens of a digital disruptor of the traditional, brick & mortar casino model.  TSG is a 100% digital, asset-light, scalable platform, benefiting from the secular tailwinds towards online and mobile phone adoption. Its data-driven, best-in-class user engagement and attractive, targeted demographics encourage advertising activity, creating the chance to build a sizeable ancillary revenue stream.  One can dream, but is it crazy to think TSG can garner a multiple differential to its brick and mortar peers similar to that of other industries: retail (AMZN), media (NFLX), etc.?

Geographic expansion is a major opportunity for TSG.  The opening up of the U.S. sports betting market is the latest example.  Undoubtedly, the U.S. will be a “jump ball”, with countless online operators, legacy casinos, and others (most recently Buffalo Wild Wings), attempting to grab a piece of the pie.  We feel TSG is well-positioned to capture their fair share. The PokerStars brand has exceptional value in the U.S., and with the Sky acquisition, the company now has a best-in-class sportsbook offering/technology to leverage.  In addition to the U.S., Asia is also worth keeping an eye on. It is interesting to note that Hao Tang, a Chinese businessman, has accumulated an 18% stake in TSG and was awarded a seat on the board of directors earlier this year.  I have no insight into his intentions, but TSG has been focused on how to participate in China. China is an exploding market for internet games. Tencent recently struck a multi-year agreement with Caesars Interactive Entertainment’s World Series of Poker to help educate and grow the competitive game of poker in Asia.  Playtech plc generates 30% of their revenues in Asia through B2B licensing agreements where they distribute Playtech’s products, services and technology to 3rd party consumer facing websites.  It is possible that TSG adopts a similar model.

In late June, TSG completed a stock offering of 25 mm shares @ $38 ($950 mm offering).  We believe increasing investor awareness and liquidity should benefit the stock in the long-run, as no major U.S. or international bank provides research coverage for the company.  Below you can find my valuation estimates. These estimates include the Sky acquisition as well as two smaller but attractive sportsbook acquisitions in Australia. The financials factor in expected synergies as well as some expected adverse impact from pending regulatory actions in the UK.  It excludes any financial impact from the U.S. or Asia, two geographies I believe will be key contributors to TSG over the long term.

In terms of risks, there is a litigation overhang that hopefully will be resolved in the very near term.  The state of Kentucky sued the company for activities that took place while PokerStars was owned by Rational Group and was awarded a verdict of $870 mm ($290 mm of damages, trebled).  The state sought to recover alleged gambling losses on behalf of Kentucky residents who played real-money poker on the PokerStars website during the period between October 2006 and April 2011.  It is interesting to note that the damages were calculated based on gross losses, not net losses. If the losses were net of gains, the damages would have been negligible. The company believes the action is frivolous and plans to vigorously dispute the liability.  A liability of $100 mm has been provisioned on the balance sheet. On April 18, the Kentucky Court of Appeal had an oral argument hearing with respect to both the liability and the damages. Based on that hearing, the company came away highly encouraged as the hearing focused on the substantive issues that TSG has a great deal of confidence in and has been advancing (can a lawsuit be brought here, can the operator of a platform be liable for losses, etc).  A resolution is expected very shortly. I have penciled in a liability of $200 mm, which hopefully is conservative.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Potential favorable resolution of TSG’s pending litigation in KY

Introduction of pro forma guidance for the combined TSG/Sky business

Initiation of sell-side coverage in the coming weeks/months

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