Investor Dialogue: Evolution Gaming Short Report

Why is this interview interesting?

Investor Dialogues is a new format at In Practise. We invite 3-5 professional investors from our audience to participate in a recorded discussion on a specific company. Each participant is anonymised and named analyst 1-X in the transcript.

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Evolution Gaming

Why is this company interesting?

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.

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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.

Clearly, the first place to start is on the short report. What were your original views when you read the report?

Analyst 1: I would say, I definitely did not anticipate that the stock would fall anywhere near 30% or 40%. I thought that there were some things in that that were a bit sensational and they discredited it a little bit. For example, the things about the customers with the cash and the agents, was ridiculous. But there were some technical things that I wasn’t too sure about, that I didn’t think I could, necessarily, answer. I certainly didn’t want to dismiss it and, actually, I had a joint call with a company and another analyst, shortly after, to go through some of the technical points. We’ve since talked to other people, as well, so we can go through some of the things that we found. I’m sure all of us have found similar things.

Do you want to start on those technical points?

Analyst 1: We’d known that you could access it through a VPN, virtual private network, and that they couldn’t necessarily see where the originating IP address was from. Some of the points in there, where it talked about being able to access it from different roundabout countries, was something that we had to explore more with them.

I think one of the other big points that came out of it was that their relationship with the regulators is not so adversarial. It’s not as if they raise a flag and, oh my god, the regulator is going to come and shut you down. From everything that I’ve read and learned, David Rebuck, from the New Jersey regulators – one of the most respected regulators in the world – they’ve already opined on this stuff about gray markets and it’s not going to affect your ability to get a New Jersey license. I think all the top 20 casino suppliers, in New Jersey, use aggregators, so that was another thing that was a big deal in the report. It’s not such a big deal on our due diligence.

In a nutshell, those are some of the points. They work very closely with their regulators; they are talking to them all the time and they know them very well. It took them two years to get that New Jersey license, so there are no surprises from New Jersey.

The other thing that I heard was that New Jersey gets these kind of complaints all the time and they understand that there are ulterior motives as to why people do this. It’s a tough business; people are trying to get edges over everyone else. There are companies that maintain their New Jersey license that have more gray market exposure, or tougher backgrounds, than EVO – DraftKings, Bet365 – so I don’t think that’s an issue with them.

The technical stuff about the blocking was interesting because the company use the analogy that they are like a bouncer at a bar. When you first come in, they check you, but once you’re inside, you’re not checked. They said they could trace everything that these guys did to put this report together and they went over some pretty extreme hurdles to get through EVO’s defenses. They used a certain cover and, once they were inside, they dropped it. It would be like you got into a bar with an illegal license and then when you were inside, you switched and used your regular one, which nobody would do.

I’ve also learned that, even if you get in on a VPN, your experience inside sucks. You can’t really move well between games and there is continuous geo-blocking that goes on when you are in the lobby and you move from game to game; it’s a very unstable connection. Could it happen that somebody from Iran gets in through all kinds of technical manipulation? It’s possible, but it’s not very likely and they wouldn’t have a very good experience. It might be that you would be able to get in once and that’s it.

There seems to be two different things here, from the report. One argument was that there are players from sanctioned or black listed countries using it. The other argument is that they are selling – or effectively reselling – content to illegal markets, which seems to be two different things. Obviously, one of you is in Singapore and closer to the action, than us, in terms of the APAC market. What are your views on those two questions?

Analyst 2: On the sanction market part, I thought that was a part of the report that was a bit ludicrous. Why would EVO risk the US, which is this huge pot of gold? I wrote about it in my blog. It would be kind of like running through traffic to pick up a penny, and there’s a pot of gold sitting on the sidewalk. It doesn’t make any sense and I think they’ve clarified, pretty strongly, that they do block anything from a sanctioned country.

I think the part that surprised me, as was just mentioned, is that I thought VPN was the way that everybody accessed everything in Asia. If you look at the amount of money that comes into Asia and you look at the largest countries in Asia – Indonesia, China, Philippines – it’s all illegal; you are not meant to gamble online there. A lot of India is turning black. There are a number of states that are now outright banning it. I always thought it had to be through a VPN and that EVO had that plausible deniability. But that report did show that it was, actually, quite easy to access EVO games without a VPN. Even sitting in Singapore, you can access EVO games, without needing a VPN; you just don’t say you’re from Singapore.

That was a little bit surprising to me and that’s where it caused me concern. At least for me, they no longer have that plausible deniability.

The customers are playing via these operators with licenses in Malta or PAGCOR. EVO is selling them the content and saying, I’ve done my bouncer job. That then gets resold.

Analyst 1: We should say, this is an industry problem; it is not just an EVO thing.

Analyst 2: Absolutely. Maybe I am getting too far ahead, but how do they report those numbers of the revenues coming from different regions? They know where the IP addresses are coming from; that’s how they track it. They know where the money is coming from and there is very little to be hiding behind there.

The reality becomes, how much can they control it? The key point, that gave me a lot of comfort, is that there is only so much they, as a supplier, can tell their regulated clients what to do. I am regulated, in Singapore, as somebody who manages money for people. My suppliers don’t really tell me what to do; it would be weird. Why are you telling me what to do? I will talk to my regulators. For EVO, it is a very plausible defense to say, look, I can only tell my clients so much. In the end, they have a relationship with the regulator; the regulator knows what’s going on. Who I am to go and sit in my clients’ offices and police them?

Do you think they know the IPs?

Analyst 3: Yes.

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