Baazov’s Amaya bid: Three outcomes

On Feb 1, Amaya confirmed an IOI (Indication of Interest) from the company’s CEO (partnered with a number of investors) to take Amaya private through an all-cash offer at ~C$21, 40% higher than the previous Friday’s close but 44% below 52-week highs. In our view there are three major outcomes.

Scenario 1: Baazov and his investors take the company private

David Baazov, the Chairman, President and CEO of Amaya since 2006, is responsible for the IOI to the company. After pulling off one of the greatest M&A deals in recent history, he’s watched his stock climb the mountain and then fall off (-50% since 52-week highs vs S&P 500 -10%). While business
fundamentals didn’t deteriorate, product delays resulted in reduced estimates. We believe Baazov, who has purchased shares in the open market as the stock has fallen, has become frustrated with investors (who once believed in the vision of the company) who have sold his stock as the quarter-toquarter
didn’t go as planned. In addition, the dual-listing effort has fallen short, in our view. While the volume has increased, the US name still trades under 250k shares a day (compared to the TSX-listed name, which trades close to 800k per day). Lastly, there has been confusion around several subjects, including a Kentucky infringement ruling of US$870m versus what the company believes could be a maximum of US$20m (what they won from the state’s players during the US grey period). Baazov currently owns 24,564,047 common shares representing approximately 18.6% of the total, and options entitling him to acquire
550,000 additional common shares. There are several overarching questions relating to this scenario:

• Who has the biggest voices at the company outside of the CEO?
Given that Blackstone (GSO) and Blackrock were the two cornerstone backers of the Rational Group acquisition, one would think that they have the biggest voices. However despite their combined Preferred Shares/warrants/common stock ownership of 30-40% of the overall capital structure, the entities lack voting power. With that in mind, why would they convert given that their cost basis on the Preferred Shares is at C$24 and the Notes PIK at 6% per year? In addition, these entities own a significant amount of the senior debt as well. That said, there could be scenarios where the entities double down and play a role on the buying side.
• Who would back the CEO?
There is a long list of private equity companies – which is by no means exhaustive – that have had interest in gaming. These include TPG, Apollo, Wayzata, CVC, Cerberus, Anchorage Capital, Park Square, Permira, Summit Partners, Catalyst Capital Group, Waterland, Fortress, The Carlyle Group, Oak Tree,
Onex, Candover, Cinven. Given the strong cash flow attributes of this business, we do believe that private equity would not fear investing with Baazov, particularly given the current free cash flow (FCF) yield of 11% and our expected growth of FCF of 10%.
• At what price or multiple would investors sell?
After a flurry of acquisitions, in June 2014, Amaya purchased Rational Group (PokerStars & Full Tilt) for US$4.9bn at a valuation of 11.1x 2013 EBITDA (10.2x on FY14) and 11.8x profit, transforming AYA into the world’s largest iGaming company. This is obviously the most important comparison. We believe that other iGaming acquisition EV/EBITDA comps over the past four years fall predominantly within this range (9-12x). Amaya currently trades at 10.8x, but we believe estimates are too low. Using our 15x EPS multiple applied to our 2016E EPS of C$2.18, we arrive at our C$33 (US$24) price target. This also equates to 13.3x our 2016 EBITDA estimate.

Scenario 2: Outside bids from iGaming companies begin to come in

The IOI may increase interest from iGaming companies looking for scale and synergies given higher regulations/taxes. Four major deals in the last 24 months (Paddy Power/Betfair, Ladbrokes/Gala Coral Group, Gala Coral/Caledonia and GVC/bwin.party) clearly highlight that in an increasingly regulated environment, companies are looking to grow margins/scale through M&A in an effort to diversify geographical presence. Given potential synergies with Amaya ($50m+ in other deals), we expect competitors to sharpen their pencils during the next couple of weeks. However, which companies possess the balance sheet or the ability to use their stock to pull off this sizeable acquisition?

While this certainly isn’t a prerequisite (Amaya was a ~C$750m market cap company before the stock rose ahead of the $4.9bn acquisition), we think in this environment, it would certainly be easier for a big company to issue stock vs. raise debt, as was done in the Amaya deal. As mentioned, in the last year, three major strategic acquisitions were announced with the intention to grow globally, expand into new verticals and leverage the overall scale of the business, with the synergy goals ranging from $50m-$150m. Scale is a major reason why Amaya’s industry margins of 40%+ are the highest in the industry.
• Paddy Power + Betfair
With combined EBITDA of ~US$425m on over US$1.7bn of revenues, putting them in the Top 5 in the industry, these two companies are merging to create a stronger combined company with complementary products, capabilities, brands, channels and geographic mixes, while saving US$73m in synergies. PaddyPower currently has 2.4 million online actives (with 99% of revenues in regulated markets), while Betfair has 1.7 million (86% of revenues from regulated markets).
• Ladbrokes + Gala Coral Group
With combined EBITDA of US$572m (pre-synergy) and revenues of ~US$3bn, the highest in the online sports world, these two companies recently merged to create a leading multichannel and internationally diversified business with a strong strategy to accelerate online growth, deliver substantial synergies (£65m) and drive value.
• GVC + Bwin
GVC has acquired Amaya’s main poker competitor in a bidding war against rival 888. The combined company improves its geographical reach and most importantly has found £125m of synergies, which were a main reason why they were able to outbid 888. Other major acquisitions in the space include Caledonia’s US$370m acquisition of Gala Coral, Playtech’s acquisition of TradeFX, the GVC/William Hill 2013 acquisition of Sportingbet and the bwin-PartyGaming 2011 acquisition for £850m. There have been several other deals including Playtech/Sportech, 888/Wink Bingo, PartyGaming/Cashcade, etc.
Both the B2C and B2B segments of the iGaming industry are highly competitive and fragmented, with an estimated 5,000+ B2C companies and over 100 B2B companies providing a full suite of casino, poker, mobile, live dealer and sports betting content and software. We see further horizontal consolidation among B2C companies as they look to gain scale and achieve greater liquidity and product breadth. There are two potential B2B industry impacts from this trend: it may ultimately result in loss of pricing power in B2B platform services if B2C providers ultimately decide to bring B2B services back in house, and it will fuel demand for larger content portfolios. For this reason we believe there will be further B2B consolidation on both the content and platform side. On the B2C front, we believe AYA is in a solid position to continue capitalizing via M&A.

As noted, we believe a major reason for the aforementioned M&A is a result of the scalability in the industry. Most of the costs in Amaya’s model (marketing/acquisition, affiliates, technical support/web hosting etc.) are also scalable, which is why cross-selling margins will be higher than other company’s segment margins.

Scenario 3: Shareholders vote down the deal and let the stock take care of itself

The world’s largest online poker company’s cross-selling efforts into casino and sports were delayed (not failed) with a sports full product launch in 1H16 vs 3Q15 and Casino in 1Q16. Overall, the core poker business remains healthy with stable rev/EBITDA contribution and 3Q constant currency deposit growth of 4.5%. While European (80% of players) purchasing power remains soft (FX vs USD) and will for another quarter, we don’t expect this to affect 2016 or beyond and believe that Amaya’s adjusted poker strategy will increase play and stability.

During the 3Q, as product delays were announced, management reduced 2015 EBITDA midpoint to C$562m (down 10% from prior guidance and 9% below consensus), but then on Jan 20, Amaya preannounced with 4Q15 financial commentary highlighting that results will come in at the upper range. When it releases 4Q results, we expect the company to give color around casino and sports (including the recently launched Spin & Bet), which will help solidify its growth initiatives.

We believe analysts cut too far. We remain believers and expect the company to generate $2 of FCF and $2.18 of EPS, which implies a 10% FCF Yield and 8.5x PE multiple. We value the company at C$33 and US$24 (given current FX) and believe investors should hold out for more than the C$21 potential offer price.