RP iGaming Index: Ice floes ahead

A tough September for igaming-exposed stocks saw only four companies make gains. Regulus Partners’ Paul Leyland looks at the underlying drivers and more closely at 888’s performance during the period

The hype-correction pattern of the spring and summer continued through September, with gambling stocks mostly under pressure during the period, albeit against a backdrop of a relatively volatile market.

Overall, the index fell by 10.8%, bringing the cumulative decline since inception to 13%, US hype notwithstanding (see Chart 1 below).

During the month only four stocks recorded gains, while 28 stocks fell. Within that, only two stocks reported double digit gains: Kambi (+18%) and Nektan (+19%, albeit tiny). Fully 14 stocks (or nearly half the index) reported double-digit declines in the one-month period (for a full list of the 35 Index components see last month's edition).

Q3 has therefore been a tough period for online gambling exposed stocks, continuing a trend emerging at the end of Q2 (see Chart 2).

We discussed what we believed to be the underlying drivers of this in the last edition, but they are worth summarising here. First, the usual market problem (especially in gambling) of reality failing to meet the hype – and there was a lot of hype in May.

Second, lower macro growth than has hitherto been almost effortlessly delivered, especially in mature markets, is starting to make itself felt in quarterly results.

Third, regulatory pressures are ever present, with a balance of short-term negativity offsetting longer term hopes during the period (especially for 888 – see below).

Finally, our thesis that listed stocks, for the most part, are not as well equipped to capitalise on growth than some of their private peers (NB, this is emphatically not a result of being listed, in our view, more due to when and how most listed stocks gained critical mass around half a generation ago).

We believe that all of these issues remain present in September’s performance. However, markets tend to look ‘short term forward’ unless there is a massive macro trend to play (such as electric cars or online retailing, which is not so obvious – or liquid – in the fragmented world of gambling).

Here we would flag a potential iceberg (or more accurately ice drift) which the market may be (slowly) cottoning onto: the double whammy of Q4 betting comps and Sweden ‘re-regulating’ in Q119.

Everybody knows (or should do) that sports betting is a volatile business, and some of the revenue ups are as undeserved from an underlying trading perspective as the downs.

However, this does not stop companies crowing over good fortune and playing up their operational prowess while also seeking to downplay the bad. This is human nature, but the result is often dangerously misleading.

Q417 provided the strongest set of European online sports betting margins in living memory (certainly for a full period), and did so against particularly weak comps.

The result was a truly exceptional end to the year for exposed companies from an both absolute result and YoY growth perspective. However, it also masked an underlying slowdown which appeared to start in Q216 (in more mature markets at least, according to our analysis).

Q118 therefore had an excuse for underperformance: the consumer ‘hangover’. Q2 and Q3 had the World Cup. So what will Q4 have? In short, horrible comps set against a mature market macro slowdown, which will also mark year end for most companies.

So if investors have been disappointed by what has been achieved so far, then this could be substantially magnified in the coming months.

For context, 11 of the 35 stocks have material exposure to the Q4 sports betting comps issue, or 31% by number of stocks. Although on a market cap-adjusted basis, this is 62% of the index – a big weighting that could mean a big swing (see Chart 2 below)

Tellingly this mix was a 70% weighting at the beginning of the index period, suggesting some price movement targeted around sports betting already, although this could be more cooling US ardour and unexciting World Cup related than forward-looking so far.

The second near-term issue that investors might start to think more clearly about is Swedish regulation from Q1 next year. Many stakeholders talk about ‘re-regulation’ (a term the author adopted as an analyst over a decade ago to downplay the even more misleading chatter about ‘deregulation’).

The Swedish market might be being ‘re-regulated’ in that regulation is being replaced, but for all the exposed listed operators, they will be domestically regulated in what is often a core market for the first time. From a commercial perspective, that is not ‘re-regulation’. It is regulation, pure and simple.

There has been some noise about ‘re-regulation’ growing the Swedish market, but we do not buy this at all due to the lack of any material impediments to current market growth in Sweden.

There have been no significant advertising, product or payment restrictions which ‘re-regulation’ will (positively) address.

Instead there will be a 19% GGR tax (roughly approximate to profit margins) and a greater degree of social responsibility scrutiny, possibly impacting both advertising and product. The regime will also allow two highly successful domestic monopolies to compete online more effectively.

Sweden could therefore start the new year with revenue from listed operators being squeezed as well as profits being significantly impacted.

From an index perspective, 10 stocks would see Sweden as a ‘core market’, or 33% of the index by number of constituents, 25% by weighted market cap. Again, a potentially material emerging issue to be added to wider pressures, in our view.

Stock in focus: 888
Perhaps the most dramatic stock during the period was 888, which reported H1 results on 27 September. Despite an attempted focus on reported revenue (flattered by US dollar weakness), constant currency results for the group were poor, with revenue declining (investors tend to look through window dressing very quickly).

The eye-catching reason was the UK, where regulatory-led changes resulted in (worse than feared) double-digit declines in revenue, although performance in other markets also lagged market growth, according to our estimates and analysis.

In more general terms, we believe 888 encapsulates a number of issues facing the listed online sector. First, it was built for a dot.com desktop world which is now fast disappearing both from a regulatory and consumer-technology perspective, especially in key mature markets.

Second, it was excellent at servicing high-spending customers, which are under pressure in some jurisdictions from a regulatory perspective and, as early adopters, are not the growth engine they once were (mass market requirements are very different, in our view).

Third, exposure to substantially all (Western) markets means that regulation happens to existing revenue streams far more often than regulation opening an opportunity.

Finally, in trying to see strategic value on a sensible basis, we see 888 in danger of being left behind in the US by more opportunistic/optimistic/aggressive peers, despite being the only online-specific operator present in all three live online states at the beginning of the post PASPA hype.

888 provides one more useful lesson in this period – a 16% fall on the day of the results might have been the most eye-catching move within the index during September, but its performance over the month was far less unusual that that big swing might suggest.

Six stocks actually had a worse September performance than 888, just in less eye-catching gaps.

Underperforming 888’s 16% September fall (essentially all in one day) were: Stars (-18%), Scientific Games (-18%), GVC (-17%), GiG (-19%) and Gaming Realms (-27%). Sometimes the market can get over a correction more easily than a slide.

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.