RP iGaming Index: The only way is up?

2018 ended with a now familiar pattern of volatility, writes Regulus Partners’ Paul Leyland, although the Index seemed to have found its bottom, and for once outperformed the NASDAQ Overall, the RP iGaming Index was flat for the period to 4 January 2019, vs. a 3.3% decline in the benchmark (see below). Volatility was somewhat reduced in what tends to be a quieter trading period, with three stocks up and displaying double-digit growth (LeoVegas, Scientific Games, Sportech) and seven down by over 10% (Codere, Gamenet, GiG, IGT, Intralot, Nektan, Stride). The period was not quiet from a news flow perspective, however, with both Italy and Romania delivering last minute negative tax changes. While the latter is not a significant market for any listed companies, the former is and explains the share price reactions of fourof the main fallers (Codere, Gamenet, IGT, Intralot). Tellingly, however, Playtech ended the period up slightly despite indicating a material hit to profitability. This is perhaps unsurprising, given that Playtech’s shares have fallen by 50% since the inception of the index. Investors likely considered enough expectation of bad news had already been priced in. Another potential big value influencer of the index was the timing of the UK’s ban on the B2 element of gaming machines in betting shops. The required legislation was passed in the period, meaning that GVC could cancel its contingent value rights (CVR) and be assured of paying no more for Ladbrokes Coral. GVC also has a material exposure to Italy through Ladbrokes Coral. However, the fact that the shares increased by 2.8% demonstrates both that the market fully understood and priced in the CVR risk while also that GVC’s business is sufficiently diversified internationally that big changes in Italy are not necessarily hugely significant for the group. In the coming months of regulatory change, this diversification is likely to be much appreciated by investors. One group that has not responded as a bloc are Swedish-facing operators, despite the introduction of point-of-consumption regulation in the market during the period. Most traded within a normal single-digit range, while LeoVegas materially outperformed (see stock in focus, below). This indicates to us that the market is not expecting big changes from Swedish-facing performance other than that already understood and priced in (e.g.tax impact) without further evidence (indeed, the fact that the market is now regulated is not that price sensitive, since everybody knew it was coming). However, as we have written before, the Swedish market could shape out quite differently from current expectations, with the negative pressures of social responsibility requirements and greater monopoly competition not fully understood by .com operators or the markets. Evidence may lead to correction, therefore. Stock in focus: LeoVegas LeoVegas has had a troubled period within the index. Prior to inception the stock was something of a sector darling that appeared to do no wrong: strong organic growth, savvy M&A, highly respected management. The Q3 performance wobble (UK and Sweden-led) took much of the shine off this and the stock has halved during H2. In this context a 19.4% increase during the period is perhaps not much to shout about – the proverbial dead cat (or in this case lion) bounce. However, LeoVegas continues to have strong fundamentals and the market is likely to be expecting it to recover its performance and continue to outperform (see Figure 1). One of the issues we have with this view is the group’s confidence in regulation growing markets. For instance in its 2017 AR the group demonstrated its analysis that about half of 20% GGR tax can be mitigated by market growth and efficiency. There is clear evidence (and logic) to suggest that where marketing andpayment channels are materially restricted then regulation which lifts those restrictions will grow the market. However, we do not see those restrictions as material in Sweden, certainly not compared to interventions on bonusing, the requirement to market in a ‘moderate’ way and, most importantly, the direct competition of the two largest online gambling companies for the first time (i.e.competition might go down in volume but it goes up a lot in quality). LeoVegas is therefore something of a canary in the mine for whether regulation grows markets almost regardless of the nature of the previous market or the regulatory requirements being introduced. Thanks to the company’s strong operations management and highly transparent granular reporting, performance in 2019 will be a very useful and very visible test of this theory. 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.