RP iGaming Index: One year on

6 June 2019

Marking the first anniversary of the RP iGaming Index's launch, Regulus Partners' Paul Leyland looks at the factors that have led to gaming stocks largely underperforming over the past 12 months, and what needs to be done to make them a worthwhile investment. Stride Gaming is the stock in focus.

The RP iGaming Index is now 12 months old, capturing the initial heady days of the PASPA repeal bounce and then (mostly) grinding operational and negative fiscal-regulatory reality ever since.

Over the last month, gambling stocks have moved broadly in line with a sagging NASDAQ (both down 9%). However, whereas NASDAQ volatility has put it right back where we started tracking it as the benchmark to the index in May 2018, the weighted composite of iGaming stocks has lost 26% of its value.

Investors will not only be looking at share price movement, however. A more important measure for many investors is ‘Total Shareholder Return’ (TSR), which includes the value dividends paid. The NASDAQ has a dividend yield of around 2%, so it still pays to hold its flatlining stocks, especially given where interest rates are in most developed parts of the world (outside the US recently).

The RP iGaming index yields a weighted average of 2.9% - slightly outperforming the broader index, but more as an outcome of some high yielding stocks and some with no yield rather than as a meaningful average (similar, in fact, to the NASDAQ).

There are some high dividend yields that the market probably does not trust to be sustainable: William Hill and GVC are facing big cash flow reductions this year due to UK machine legislation and this may impact payments, as might Gamenet for similar reasons in Italy. Some stocks are also facing commercial and/or regulatory headwinds that could result in a cut in the dividend.

However, more than half of the constituents of the iGaming index pay a dividend and some are now highly attractive. For example, as well as those mentioned above, 888, Bet-at-home, Playtech, NetEnt, OPAP, Rank and Tabcorp all yield over 4%.

Gambling should be cash generative as well as capable of growth, especially once out of an ‘early stage’ investment phase. This means that so long as the capital structure is right (i.e. not too much debt), investors can be directly rewarded for this characteristic. However, in the past year this clearly posed cold comfort, for which we identify three key reasons.

First, fiscal-regulatory headwinds have impacted profitability, forecasts and, in some cases, dividend sustainability. This level of negative pressure is simply too great to prevent share price falls, especially where they erode investor trust.

Second, valuations had got ahead of themselves vs reality – especially around hopes of a post-PASPA US market. Progress has certainly been impressive in a number of areas, but very few operators are yet making any money (bottom line) in the market; it is really still too early to do so. But that means many stocks are in that dangerous ground where promises have been made but delivery has not yet been possible.

Third, while 54% of the index does pay dividends, 46% does not. There are a variety of reasons for this: too much debt, too early stage, EBITDA that isn’t really a proxy for cash (i.e. not cash generative because staff costs are being capitalised or ongoing capital intensity is high) and all of these are valid to an extent. However, what it does mean is that investors are not being directly rewarded for holding the risks inherent in nearly all gambling stocks – online or landbased, domestically regulated or not.

We believe in a simple formula for making gambling stocks great again: honesty about growth prospects + honesty about regulatory risk + operational improvement + M&A with real synergies + clear and sustainable dividends that outperform the market average = an attractive, investable sector. Now is that too much to ask?

Stock in focus: Stride Gaming
Stride is likely to be the next participant to leave the index due to M&A, so it is worth a look while we can. A 151p recommended offer from the Rank Group also made it the index’s strongest performers.

However, a brief look at the chart demonstrates that this outperformance is both short-term and relative. Over the course of the last twelve months, Stride’s share price has been shaped much more by operational and fiscal-regulatory headwinds than being bought for a premium to its recent trading price. A month increase of 26% only partially mitigates a 31% fall since the inception of the index (-46% prior to the bid), especially since the stock yields only c. 1% from a dividend perspective.

These issues continued to be revealed in weak trading in H1. Though while revenue declines were largely blamed upon ‘regulatory headwinds’, though these have typically impacted VIPs whereas Stride’s yield per player increased by 4% on a 23% decrease in active customers.

In our view, this is probably largely due to a £1.9m (-17%) cut in marketing and improved efficiencies – i.e. cutting low quality, low margin (and also probably bonus-driven) revenue for operational rather than regulatory reasons (albeit with the fiscal catalyst of a 6ppt increase in RGD impacting post period as well as duty capturing of bonuses from August 2017). This mix shift is also reflected in the marked outperformance of mobile (+6% vs. implied c. 40% fall in desktop) as well as proprietary vs. third party (-9% vs. -24%).

Another relatively bright spot was the outperformance of B2B, with its flagship Aspers client (generating nearly £1m in platform fees on a 119% revenue increase from a low base, though still early stage loss making as an entity). Fiscal-regulatory headwinds have therefore arguably improved both the operational focus and the underlying quality of the business at the expense of the top line and hitherto ‘easy’ profitability.

However, whether this improved quality can drive sustainable growth from this point remains an open question, making a sale an attractive option, in our view.

Disclaimer
The narrative provided represents the opinions of the authors. Any assessment of trends or change is necessarily subjective. The information and opinions provided are not intended to provide legal, accounting, investment or policy advice, nor should they be used as a forecast. Regulus Partners may act, or has acted, for any of the companies and other stakeholders mentioned in this report.