Evolution: A Force in the Live Casino Market (EVO)
There are certain companies that we come across as we are seeking winners that are simply cut from a different cloth. These companies usually have capital light business models that are highly scalable, generate high returns on invested capital and have competent management with significant stock ownership that aligns them with their fellow shareholders. Enter Evolution (EVO), a publicly traded live casino supplier listed on the Stockholm exchange.
What does Evolution do & is it in my circle of competence?
Live Casino solutions are the specialty of Evolution (EVO), an online casino supplier that caters to the Business-to-Business (B2B) market. The company has over 700 clients worldwide and offers them a complete package of Live Casino services, from development and production to marketing and licensing. Live Casino games are hosted by a game presenter (i.e., dealer) who operates a casino gaming table that is streamed live via video. The players can place their bets on their devices (computers, smartphones, tablets, etc.) (Sanchez, 2021).
The content can only be played through the interface of a games operator who adds various aspects of the gaming experience such as player authentication and account management. Evolutions customers are the largest online gaming operators in Europe and North America as well as land based casino’s that are beginning to offer games online. (Evolution Annual Report, 2022)
The company has livestreaming online casino studios in various regulated locations such as Riga, Latvia, Tbilisi, Georgia, and Fort Mriehel, Malta, New Jersey and Vancouver, Canada. It also runs on-premises studios on land-based casinos in Belgium, Romania, Spain, and the UK. (Sanchez, 2021).
Evolution has a large variety of games on their platform. The majority of Evolution’s revenues consist of commission fees for both live and RNG casino. Commission is calculated as a percentage of the operators’ winnings generated via the company’s casino offering. Typically EVO will earn between 10% — 20% on the gross revenue generated by the operators. (Evolution Annual Report, 2022)
EVO also generates revenue from what they call dedicated table fees, which are monthly service charges that the operators pay to EVO to provide dedicated tables to their users. This is used for more customized tables that the operators need. Finally, there is a small amount of revenue generated for setup fees included in the launch of a new casino offering. (Evolution Annual Report, 2022)
Although this is a technology company, the business model is easy to understand and how EVO generates revenue is not complicated. Next, I’ll discuss if EVO meets the criteria for being a good business.
Is it a good business?
Going back to my framework from my first post, we need to determine if the company has a long-term competitive advantage that it can sustain.
Growth
The business has had explosive growth in revenue, EBITDA and cash flow since its IPO in 2015. As seen by the 5-year financial development below, EVO is generated revenue is $1.4 billion in 2022, up from $245 million in 2018.
This growth can be attributed to a few factors:
- Market regulation is surprisingly another growth factor. In the gambling market, as more regulation occurs the engagement and gross revenue actually increase.
- The smoothness and reliability of the gameplay. Online casino players are a tricky bunch; they need to be able to trust the online casino and know if something goes wrong, they can get their money back.
- The development of engaging new games for players to enjoy; this includes the classic casino games as well new engaging games. They have even gone as far as to think about the coolest way for a player to roll dice.
- Online business also provide a scale advantage due to their inherent network effects. As more games are introduced, more players are engaged creating a flywheel effect turbocharging growth.
The other innovation that the company has created that will propel growth further is what the company is calling One Stop Shop (OSS). “This is a single platform for unified integration of Evolution, NetEnt, Red Tiger, Big Time Gaming, Ezugi and Nolimit City games.” — (Evolution, 2022). Think of this similar to how you would think of the Netflix or Xbox live home screen where you have all the entertainment at your fingertips in a nice organized central platform. My opinion is this will continue to make the product more sticky and help them retain customers over the long-term strengthening the network effects moat.
Based on the total addressable market, market estimates from H2GC state that, “the total global gaming market land-based and online had an estimated value of EUR 438 billion (375) in 2022, measured in gross gaming revenues.” — (H2GC, 2022). 77% of the gross revenue was generated from land-based casinos and CAGR from 2018–2022 for live casino was 21.5% so it appears this growth can continue for the company.
Competition
There are two main competitors who compete with EVO; Playtech, which is publicly listed on the London Stock Exchange and Asia Gaming, which is a large private company in Asia. From what I’ve heard, Asia Gaming has about 3–4x the revenue that Evolution currently has, which tells you what the demand for the online casino market suppliers is like. Of course, there are a number of smaller companies operating slots in Europe and Asia as well and other land based Casino’s who may attempt to get involved in the future.
Being a technology company, the CEO, Martin Carlesund has stated that “While barriers to entry are relatively low, the barriers to success are considerably high.” What he’s getting at, is it’s not a very easy businesses to be successful in. It’s not just enough to make great games, you need to hire armies of teams to operate the games while complying with regulations. Evolution has an entire team simply dedicated to monitoring online chat as an example.
Cost Structure & Profitability
The largest costs as seen above are for personnel costs related to dealers (85–90%) at the studios spread mainly across Europe and North America. The Evolution Academy is located at the production studios and is set up like a real live casino studio, which provides training in a realistic setting. The training time period for a new game presenter is about 100 hours per employee, after which a 3-month trainee period begins. (Evolution, 2022).
Other operating costs are related to IT and product development with depreciation and amortization being a non-cash expense this leads to a a high cash conversion rate and a return on invested capital of 27.5% since 2015 (Sanchez, 2021).
The company is very profitable to go along with the growth sporting EBITDA margins of nearly 70%, its quite an incredible business. The company is earning a ROIC of 27.5% since the IPO in 2015 and I expect the high ROIC to continue in the next 5–10 years. As you can see above, the board has proposed a dividend of about 50% of their earnings. This is a very common theme among Swedish publicly traded companies, but given the high ROIC I’d prefer management to retain that capital and continue to invest in the business.
The growing customer base & dependency
Evolution as of 2022 has over 700 customers comprised of online operators and land based casino’s. Typically customers will sign 3-year deals with Evolution, which provides a bit of predictability to the revenue once these contracts are signed.
As can be seen from the above, Evolution is dependent on it’s top 5 customers for about 30% of their revenue and the top customer accounts for 14% of their revenue.
There are two ways to look at this; 1) as an investor you may proceed with caution when you see this due to the fact that if one major customer moves away from EVO, this would have a material impact on revenue. 2) the other way to look at this, is online and land based operators are finding it very difficult to actually create their own games and functionality to compete with EVO, and thus are increasing their spend with them over time. I’ll let you the investor decide how you feel about this, but I lean towards EVO’s competitive moat growing.
What is the quality of management & do they have skin in the game?
“Jens Von Bahr and Fredrik Österberg founded the company in 2006. They remain on the board and control ~13% of the outstanding shares. One of the early backers was Richard Livingstone, a British gaming company operator/investor. Richard’s brother Ian sits on the board and controls ~10% of the shares.” — Sanchez, E. (2021)
Based on the above its clear that management has high insider ownership indicating there is a high likelihood that their interests are more aligned with shareholders.
Positives of management are as follows:
- Management has maintained a clean balance sheet with no debt.
- Management has done a great job creating new games and improving system availability time.
- As revenue has grown, the margins have also grown showing that management has a very good business model. Typically businesses who have high gross margins near the beginning, continue to keep those.
Negatives about management are as follows:
- Management did a poor job with shareholder communication after a short seller report was released in 2022 (more on that in the risks section below).
- As stated above, the dividend policy is not good in my opinion. If you are earnings 27.5% ROIC, the best approach is to retain the capital and reinvest. If you want to return capital to shareholders, I’d prefer a stock buyback.
- The company acquired NetEnt AB in November of 2020. To do this they had to issue roughly 30 million shares. Although it was a good acquisition, I wish they would have not diluted shareholders and used a combination of cash and debt instead.
Overall management is doing a good job and we’ll see how they continue to run the business going forward.
What is the valuation?
Valuation is always the fun part we can all debate about, but here’s my attempt at a simple discounted cash flow model over the next 5 years:
In 2027 I have estimated EVO will generate about $2.1 billion EUR of unlevered free cash flow, assuming EBIT grows at a annual rate of 30% for the next 5 years. I think this is extremely realistic for the company and they could even exceed that. This is implying about a 50% upside from today’s price to my estimate of intrinsic value or a IRR of 29%, which would be a great result.
I’m curious if you agree with the assessment above or not and if you look at the valuation a different way. Feel free to drop a comment if so as I’d love to hear your feedback.
What are the risks?
We can’t have a discussion about a potential investment without talking about the risks of course and there are a few I’d like to highlight:
- Competition and the nature of capital markets — EVO is currently generating EBITDA margins of about 70%. Competitors are 100% seeing this and want part of the market and there will be competing products coming for EVO now and in the future. If EVO is unable to continue to offer players and operators the best games and platforms, then the estimated future cash flows would be be impacted.
- Regulation — even though I think this will turn out to be a positive in the long-term, EVO does generate about 60% of its revenue’s from unregulated markets, which is what we call the grey zone. It’s not illegal, it’s just such a new market for online casino's that there has not been formal regulation created. My guess is governments globally will be looking to increase their tax revenues and will regulate online gambling in their countries, states, provinces, etc.
- There was a short-seller report released by a secretive short-seller indicating two important points. One being that the unregulated revenue, which is 62% should not be valued the same as regulated revenue and if there is ever a clamp down in North America or Asia on online gambling, the EBIT multiple could be impacted. The other is risk mentioned in the report revolved around individuals logging on using a VPN from black listed countries and the platform could be a hot-bed for illegal cryptocurrency transactions.
I think when reports like this come out, you have to take them very seriously and look into the details, even if you think they might be false. They help your analysis and potentially point you to things you might have missed in your research. On the unregulated revenue point, I don’t consider this one a huge risk, will some markets make it unprofitable or even illegal to engage in the online casino business? Probably, but I think over time governments will want their tax cut of this large market and EVO could still thrive in a higher tax environment. The 2nd point from the short seller report I think is concerning, if there was ever to be illegal crypto transactions occurring or black listed country participants involved on the platform that could cause huge reputational damage and permanently impair the business model. The operators are technically the ones who need to authenticate the players, but I think EVO needs to do its part, as they can see all the data from the players on their platform.
I hope you all enjoyed this look into Evolution and would love to hear your thoughts in the comments below on if you found this useful, if I missed anything and if you’d like to read more posts like this in the future.
References
Sanchez, E. (2021). Shree Viswanathan shares his latest writeup, “Evolution: The Leader in live Casino” — SVN Capital. SVN Capital. https://www.svncapital.com/news/evolution
Evolution 2022 Annual Report https://mb.cision.com/Main/12069/3735605/1921487.pdf
