Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

{audio:0:15:05} We would like to better understand what is going on there and what the implications are of getting players and gamers from China?

{audio:0:15:36} When they refer to unregulated markets, you can include Germany from 1st of July as well as Canada, LATAM, all of Africa, Finland and Russia. The Chinese share is very small. The reason for that is because in Asia, when you try to launch a live casino or any gambling product, you need to give out very low rates. You have to do that because otherwise the operators cannot be profitable due to the transaction cost they have for each deposit or pay out, which is extremely high because quite often they have to do things in cash.

{audio:0:16:40} When Evolution entered the Asian market, I had a meeting with them in Malta where I offered to work together with Asia Gaming to distribute their live casino. I explained that we would purchase their game at 5.5% and resell, but the 5.5% was theirs and they would fall under our contracts. They would not be contractual with anyone else in China, in order to effectively hide them from illegal gambling. They declined because they were only willing to sell at 8% or 9%. I told them it would be impossible to make any money. After that they made inroads. First, they put a guy in Manila, then grew a team there. They do well in Asia but not as big as you would think.

{audio:0:17:43} In China specifically they wouldn't be that big because they do not have the required CDN they need. Asia Gaming were successful because they had a CDN in China, which is highly illegal.

{audio:0:18:10} A CDN is a content delivery network. For anyone playing online games in Asia on an illegal site, they need to have a proper stream which is fast enough to play a live casino. That works in Europe where you can even use the cloud, but a cloud solution does not work in China. Many companies place servers in Taiwan to service China from there, but it is not strong enough. That is what we did at Asia Gaming, which is a technical part I was not directly involved with. I know we had servers inside China, which is impossible for Evolution to do. It is too risky and they do not have the right connections to do it. All these factors make China a small market for them.

{audio:0:19:19} The two reasons are the pricing or commercial side of the business, plus they also lack the technical access to get to the market with a viable CDN?

{audio:0:19:32} Exactly, and the third part is that operators in China have no licenses whatsoever. Several of them have a PAGCOR license from Manila, but most of the big ones in China have none. Evolution are not able to give their software solution to anyone who is completely unlicensed. There are some ways around this which Evolution and every game provider in the world do. They have one contractual partner with the ability to resell games to whoever they choose. But then you have to lower rates because that partner takes a cut in between and also has to make money.

{audio:0:20:33} That also tells me it will not be a massive market for them. I know they are working with three or four partners based out of Manila. These guys could hold an Isle of Man license, an MGA license from Malta or a PAGCOR. That is fine for Evolution but they have to close their eyes and pretend these partners do not resell to anyone, but they do. There is much less risk in other markets such as South Korea and Thailand. All of East Asia is fine because they have the payment solutions in place which means the money can go back to Evolution.

{audio:0:21:33} Only China is a huge risk. At Asia Gaming, every single thing was in cash. I personally went to Macau to pick up a duffel bag each quarter which contained my salary. This is not something which Evolution can handle.

{audio:0:21:57} For the time being, Evolution is setting up a different company by partnering with aggregators or distributors who resell the game to unlicensed operators; is that currently how they are making money from China?

{audio:0:22:23} Yes, but as I said the Chinese part is insignificant. If you want to measure your future risk, I would say that China is the only risk. Everyone I used to work with from Asia Gaming have disappeared. I do not know where they are and cannot contact them. They are no longer in Hong Kong where we all used to be. They had to go underground because China were shutting everything down. They did this by stopping the payment flow, without which there is no product.

{audio:0:23:10} From your point of view, the risk here is that Evolution see no real cash coming from China, plus they have the risk of being sanctioned from China?

{audio:0:23:29} There would not be any sanctions towards them as a game provider. What is illegal in China is to run a B2C operation where you accept money directly from a player. It is also illegal for a player to play on an online casino. Evolution are not breaking any Chinese laws by doing what they do, but again China is a very small portion of the unregulated market.

{audio:0:24:08} Is there a similar risk in other Asian markets? Worst case scenario is that Evolution lose whatever revenues they make from that market, or could it go beyond that in terms of sanctions in other markets?

{audio:0:24:30} The risk is absolutely only in China. The second riskiest market is South Korea and Evolution are doing well there. As an investor, the number one risk factor is unregulated markets. For all the others which are fairly big, such as Thailand for example, there is no risk.

{audio:0:25:01} Operating in unregulated markets and offering games where it is illegal to gamble is one thing but are there money laundering activities which could be worse?

{audio:0:25:25} No, it would not be. A very big market for Evolution and probably the majority of that 60% is Turkey. Evolution, NetEnt and B2C operators such as Betsson who are on the Swedish stock exchange, openly admit they have business in Turkey on a B2B level. Evolution have taken one step away from that by offering their games to a B2C in a completely separate company and then they go with it, and most often there is even one company in between. Evolution does the exact same thing for Turkey, by offering their game to an aggregator who then resells to Turkey and the aggregator will hold an MGA license.

{audio:0:26:29} The risk could be that Turkey decides to be much stricter with online gambling, but historically they have never been and gambling grows tremendously as Turks love live casino. Out of the entire online casino cohort, 80% is live casino, whereas in regulated markets such as the UK and Sweden, a company like LeoVegasmakes 15% of their casino revenues from live.

{audio:0:27:22} If Turkey decides to either become regulated or put taxation on it, that will take down revenues. They could also be much harder with online gambling and try to protect with VPN and IP, so that is more of a risk factor than anything else.

{audio:0:27:51} What is your view on the government's stand on this? They are aware it is happening but are not stricter with it. Will they eventually regulate or become stricter and do they have a way to technically enforce it or will they always get away with it?

{audio:0:28:18} For now, they will not try too hard to make operators go out of business. They lack the resources and technical parts. Unless there is proper regulation in place, an operator who has no license in Sweden can still accept Swedish players. They simply use a VPN and off you go. It is the same in Turkey and that part will not stop. They will look into regulation because they realize if they legalize it, they take a huge chunk in taxation from companies which will reduce their business. On the 1stof July regulation comes into place in Germany.

{audio:0:29:16} Live casino has been banned, but even when that happened, very few Evolution partners shut things down on the 15thOctober last year when other operators did. From 1st of July there will no more live casino in Germany, so the entire market disappears for Evolution. This can also happen in other markets, perhaps not as extreme, but once taxation regulations come into place, operators and game providers lose money. A company like Evolution has to choose sides.

{audio:0:30:16} Either they serve their regulated market or the unregulated, and because Evolution is so big, they can only choose regulated. The unregulated market will go to other live casino providers who do not have the stature of Evolution. These things will be difficult for them.

{audio:0:30:41} Is regulation a net negative as it shrinks the market rather than growing it?

{audio:0:30:48} Yes, the immediate effect is very high. When regulation came into place in Sweden it slaughtered all the share prices. They lost 50% to 60% of their revenues overnight and we saw the same thing in Germany. I have two clients in Germany. One went with the regulation, which means they took down the max bet to €1, and they lost 50% of their casino business overnight. They shut down Evolution on their site. I have another client who does not follow the regulation, and they increased by 1,000% and were simply laughing. But with regulation coming in place, they will have to either shut down or become an affiliate. For a game provider it is simply a loss.

{audio:0:31:53} Can regulation grow the market when players opt for virtual VPN instead?

{audio:0:32:05} It depends on the regulation. In Germany it will not grow the market because the regulation is so strict it makes no sense. Taxation is 5.3% on the bet amount, so the actual tax in Germany is over 60%. They have a €1 max bet and nobody will place a €1 bet on blackjack when, in the best-case scenario, they can win €2.50; that is a terrible product. Regulation and taxation like that simply kills the market totally and that is what we will see in Germany. I don't believe any other markets will follow that route because Germany has an election later this year, without which the law would have never been passed. It is simply political and hopefully won't occur again.

{audio:0:33:19} Does reasonable taxation also lead to a negative mid and long term for the market or is it only a short term hit and over time it grows the market?

{audio:0:33:36} Sweden is a perfect example of that; it was a short-term hit, but mid and long term, the market grew. The numbers are skewed because they changed the regulation during the pandemic due to increased gambling. They made adjustments which affected the casino market, but if that did not happen, it would keep growing. Long term it is most often a positive, but it is important for investors to look at the taxation in each market and what the actual impact will be. You will only ever hear positives from game providers. They have to say they love regulation and paying taxes, but in reality, they all want to say Germany is making a huge mistake and they will all lose. A publicly listed company like Evolution cannot say that. It is vital to read what the taxation is about and how game play is affected.

{audio:0:34:52} How big is the Chinese market compared to Europe?

{audio:0:35:09} When I was there, China was as big as the entire regulated market in the world. It is impossible to get your head around how big it is, but again it is not realistic for Evolution.

{audio:0:35:38} Can Evolution change their commercial strategy or how do they move forward given the market is massive and they can get large revenues from China?

{audio:0:36:05} It is impossible this year or next year because the Chinese government is clamping down on transactions. Currently, the market is almost dead. The risk is too high and very often you will not get paid for your services. I do not believe Evolution will push more into China but this could change because everything is run by the Party in China. If they suddenly decided to ease up on the rules, the market could open, but until that time, Evolution will look for income elsewhere.

{audio:0:36:53} How does Evolution compare to Asia Gaming in other markets?

{audio:0:37:03} They are well-positioned because they have a superior offering. They are miles ahead of everyone else, which means every market they enter, they are immediate market leaders. In markets like the US where they are only tapping into now, the more States that allow live casino the more revenue they will make, which is why they purchased Ezugi who has Golden Nugget.

{audio:0:37:58} Why is their total offering so good and how do they manage to serve those games to Asian players and be so successful?

{audio:0:38:17} They did their research and saw what Asia Gaming did. In Asia the number one game is baccarat, which is easy for a live casino provider as it has unlimited players on one table. Blackjack has a maximum of seven players so you need hundreds of tables in Yerevan and Riga. With baccarat, only a small studio is required or it can even be run from existing studios. They can also get Asian dealers and it is therefore a cheap product to offer. They can also offer separate pricing for the Asian market.

{audio:0:39:17} For blackjack tables you pay 10%, roulette tables 8%, but baccarat is only 5%. Asian operators get 95% of revenue from baccarat so they can still maintain their margins. It works in that sense because they are lucky with the game type Asians prefer playing.

{audio:0:39:49} Baccarat is a regional game and not proprietary to Evolution so could someone offer the exact game and compete with Evolution and drive prices down?

{audio:0:40:51} Baccarat is the same and has no variations. It would make no difference if competitors offered another baccarat because Evolution has grown into a strong brand in Asia. Operators and players prefer Evolution who are well-known. Asian players can visit the Evolution website and see the company is listed on the stock exchange and have multiple licenses.

{audio:0:41:45} They need to trust the game provider so they know they would not be cheated. Another small competitor called Lotus Gaming has no licenses, so how will their games be fair?

{audio:0:42:22} Playtech used to be massive in Asia but were not willing to go down to 6% or 7% for the slot games and also priced themselves too high on live casino. Today they are almost out of the market. Playtech's Asian business is going down the drain and that began three or four years ago. Another unlisted Western company, called Microgaming, are absolutely massive because they adjusted their prices. They realized they could no longer sell for 9% and had to go down to 6%.

{audio:0:43:23} Some unregulated markets have such a large piece of the business that they still allow for those games to be operated. You can deliver through VPN networks but how does the cash flow at the aggregator level? Evolution does not need to bother about cash flow but how do you ensure an aggregator's cash flow channel does not stop and the regulator does not crack down on that?

{audio:0:44:33} They choose their aggregators carefully to ensure there is not too much risk. There will always be a percentage of cash they should be collecting that they will never see. They have a contract stating they will be paid based on the GGR generated from the game, but if the aggregator is never paid, eventually they will go out of business. Every now and then Evolution write that off, so that does hurt their margin slightly, but Evolution has little business in China and their other markets are fine. I see that as a short-term risk.

{audio:0:45:42} Outside of China there are no cash flow problems. When betting in Turkey, do you go through the cash channel or the banking channel?

{audio:0:46:12} Turkey is not a cash market and there are many solutions to payments. Of course, there are high transaction costs but that is for the operator, not Evolution. That will be part of the negotiation of what fee Evolution takes from a Turkish operator. They handle it via temporary credit cards and underground payments. When it comes to making money, there are endless creative solutions.

{audio:0:47:03} If the crackdown happens at source, will that kill the business?

{audio:0:47:11} True, but there are so many creative ways that there will always be a crackdown, but then something else pops up. A good example in Europe is Norway, where they are constantly trying to shut down payment solutions. It works for a week, the market goes down slightly, then a new payment provider pops up and off you go again.

{audio:0:47:55} The market is not going away so it is best to legalize it and take a share of revenues as taxation. What stops governments from doing that?

{audio:0:48:14} That is a very good question and one I have asked myself countless times. It should not be that difficult but it takes a long time. Most game companies are from Sweden, so they should have been early with taxation but it only came into place three years ago. Holland are going into taxation from 1st October but they have been talking about taxation and regulation for 10 years. It is unbelievable how slow it is, which I have no answer for. Everything the government does, as we see living in Spain, things simply do not work, and they cannot figure it out quickly.

{audio:0:49:04} Sometimes taxation kills the market as is expected to happen in Germany. In those markets currently going for taxation and regulation such as Sweden and Holland, are taxations more rational there and the market may dip but will grow long term?

{audio:0:49:30} Germany is the only example where we will see a killed market. The UK is becoming increasingly difficult but the market is still growing. I cannot think of any market which has been killed. It is only short-term loss of revenue, but mid and long term it grows even higher.

{audio:0:50:04} Will it be possible for German players to gamble through a VPN or any other way to bypass the restriction?

{audio:0:50:36} It is possible and will happen but Evolution cannot offer their games to these operators, because legislation in Germany stipulates the government can go after directors. This happened in France many years ago when then the CEO of Unibet spent three days in prison. Evolution will not dare; they will put a full block on Germany. Nobody in Germany will be able to play an Evolution game. It will only be game providers with a Curacao or Costa Rican license, who don't give a damn because they don't have to, or fully unlicensed ones from Asia for example. These games will come into the unregulated sites which still operate in Germany, but at huge risk. Evolution will not even think about it. They will simply let the market die.

{audio:0:51:48} How do you see Evolution doing in Europe because there is Microgaming, Playtech and Pragmatic Play?

{audio:0:52:12} I think they will continue being strong. Pragmatic will take some market share with their live casino which I know is gaining in popularity. Evolution is so far ahead and the games they keep building are fantastic. Todd, the head of product, is an absolutely brilliant guy. They will keep growing and maintain their market share. The market also continues to grow and their acquisitions of NetEnt and Red Tiger were appropriate. NetEnt were market leaders years ago but they lost that position simply because the games they kept churning out were terrible.

{audio:0:53:11} Now they can bring the best brains from Red Tiger as well as Nick, the founder of Big Time Gaming which they recently acquired, and Todd, to build fantastic RNG games. NetEnt's position with Red Tiger will strengthen and if Nick comes up with another Megaways, they will make tons of money. On the RNG part they have a lot to win and that will be interesting to watch.

{audio:0:53:48} How do you see the growth rate for Europe over the next five years? Is it already mature or is there room to grow at double digits?

{audio:0:54:02} It will be difficult to see double digit growth year on year, but it will keep growing. Gambling will always keep growing which makes it such a beautiful market in that sense. Last year was an exceptional year for casino due to the pandemic, so we will not see that type of growth, but it will maintain the levels we saw in 2018 and 2019; I see nothing stopping that.

{audio:0:54:42} How do you see the market in the US evolving?

{audio:0:54:52} My company is also entering the US market and that is by far the most interesting thing happening in the iGaming business. There are only four states which allow casino, but double-digit states allow sports. It makes no sense because it is still gambling, but after the pandemic, the US States are all in complete disaster and need more tax money coming in. I believe the states which allow sport will also approve casino. That will happen quickly in the coming years.

{audio:0:55:47} The states which forbid online sports and casino will also be quick to approve it. States like California will take longer but the current legislation in place makes it slightly difficult. In New Jersey, for example, you had to run servers from an actual casino and include a live casino. The beauty of being a game provider is that we do not have the costs that an operator does, who needs a huge chunk of money to obtain a license, whereas game provider have nothing at all.

{audio:0:56:48} It is simply paperwork which needs to be completed, which is a hassle but costs nothing. From a game provider perspective, it will keep going extremely well. The valuation of these companies in the US such as DraftKings and FanDuel is going through the roof; it is crazy. If Evolution would do more listing in the US, they would go up because the US is the future. I believe Evolution are spending a lot of time and money on lobbyists to speed up the process.

{audio:0:57:44} How do you size the market compared to Europe?

{audio:0:57:55} I have no specific numbers to give you on that but there are reports coming out state by state. The casino numbers coming from New Jersey which were the first one years ago, were very low and people thought it was a bad market as nobody was making money. The New Jersey population has not grown that much but the online handle has been growing tremendously and continues to. It is not only sports, when a new state opens up, it starts at decent numbers, but as more operators come on board and spend a ton on marketing, the entire handle for both casino and sports goes up. The growth per opening state is much higher than any European market.

{audio:0:59:02} I had a very strategic question. When we speak to some of these operators, they don't like Evolution because they are taking too much from a take rate perspective. To me, to start an online to offline casino with the land and building is a far more difficult business and much more capital intensive as you rightly pointed out. It is also politically affiliated so you get a license if you have connections. Given this set up and all the fixed costs on live is on the offline side, this is more over the top and you are partnering with as many partners as possible and reaching customers over the top, chipping away share from a potential customer who would otherwise physically come to the casino. Evolution gets stronger as it grows but relationships become more difficult with operators?

{audio:1:00:32} Some operators feel that Evolution is taking too much and that is absolutely true, but again, there is no competition. If you want live casino on your site, you need Evolution, otherwise you can shut it down, that is how strong they are. Playtech is number two on live casino and are hated much more than Evolution, so in that regard they are fine. With land-based casinos going online, that is and will continue to benefit Evolution because they need a platform.

{audio:1:01:30} It can be anyone, and Evolution is connected to everyone. As long as a land-based casino chooses a platform provider other than Playtech, Evolution will be there and will be offered. Land-based casinos like Wynn were against online for many years. Stephen Wynn said it would never happen and that online would die, but today WynnBET are online because they have to be.

{audio:1:02:08} The balance of power seems to be shifting massively towards Evolution and while it is a good thing for them in the short term, do you see any risks over the long term? If 50% of the revenues shift online over time, does it cause a risk where offline players try create political barriers from a regulator perspective? Is that a risk we should be aware of or is that unlikely?

{audio:1:02:51} That is why the US have been so slow. The Indian tribes and land-based casinos have pushed hard with lobbyists to stop online in each state. But again, online is the future, nobody can deny that, and it is also what people want. They no longer want to go to a casino; that generation has passed. They will keep pushing to make it not happen, and in in certain US states that could be seen as a risk, but I will turn it around and say it is less risk than it was in the past.

{audio:1:03:51} During this hour I have mostly been saying good things about Evolution, but there is a risk that the expectations of the company to deliver are so high. In the last quarter they absolutely killed it and their stock price went up, but it has trickled down again. That can be temporary so if you are in it for the long haul, Evolution is a great place to put your money. Short term that would be my little risk flag because of expectations and the PE is super high.

{audio:1:04:41} Thanks for your time, it was very helpful.

{audio:1:04:57} No worries guys, it was enjoyable.

{audio:1:05:01} Needless to say you are very knowledgeable.

{audio:1:05:06} I invest a lot myself, not in Evolution due to the risk I mentioned. I am putting my money into Kambi.

{audio:1:05:19} We also have a position in Kambi.

{audio:1:05:30} Good, it keeps getting better over the past few weeks.

{audio:1:05:33} Thanks again and take care .

Evolution Gaming & Unregulated Asian Gaming Markets

Risks to Evolution Gaming in China and Turkey

Outlook on European, Asian, and US market growth 

Evolution Gaming

Evolution is a B2B live casino gaming operator which provides customers with professional croupier services via its online casino and gaming platform. (Live casino refers to a game where a game presenter runs a gaming table followed in real time via a video stream.) The company has a large addressable market. 

Live casino is the fastest-growing segment in online casino, with an annual growth rate of 31% from 2017 through 2021. Evolution dominates this space. Sales increased 90% in 2021 and are 6x greater than in 2017. The business has high and increasing margins; EBITDA margins were 68.9% in 2021 and management believes they hit 69%-71% in 2022. The business is capital-light with capex of less than 6% of sales in 2021. Evolution generates substantial free cash flow and has no net debt. 

Evolution Gaming & Unregulated Asian Gaming Markets

Former Managing Director at Ezugi, Hong Kong

inpractise.com/articles/evolution-gaming-and-asia-unregulated-gaming

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Evolution Gaming

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Executive Bio

Former Managing Director

Former Managing Director at Ezugi, Hong Kong

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