32Red — Kindred spirits

In line with expectations, 32Red’s FY16 results were characterised by 28% revenue growth and continued EBITDA margin expansion (from 10.8% to 17.0%). The company has also reported Q117 NGR growth of 20% and our 2017 and 2018 forecasts remain largely unchanged. We forecast 22% revenue growth in 2017 and an EBITDA margin of 20.4%.

Within the context of an enlarged group, we believe there is clear upside to these figures, as the company will be able to leverage Kindred’s network, products and platform capabilities.

32Red Casino increased 2016 NGR by 16%, with mobile revenues accounting for 57% of the total (vs 44% in 2015). Growth has been driven by targeted returns-driven marketing, both online and offline, and we forecast 22.3% revenue growth in 2017 and 15.4% in 2018.

2016 Roxy Palace revenues were £10.6m (below our forecast of £12.0m). Now that the business has been integrated, we expect marketing to continue and we forecast 8% growth in 2017 and 2018. Roxy Palace has a slightly more recreational and international customer base than 32Red and many of its geographies are similar to Kindred.

After three years of investment in Italy, NGR grew 33% to £2.3m, with a move into profit in H216, in line with management expectations. To date, the main limitation has been the narrow product range supplied by Microgaming and, although 32Red Italy is poised to benefit from a recent renegotiation, we would expect a migration to Kindred to further benefit the business.

Our standalone forecasts for Italy revenues are £3m in 2017 and £4m in 2018.

Other products comprise online sports betting, bingo and poker games. Revenues increased by 60% to £3.8m, below our £4.5m target due to the well-publicised industry-wide punter-friendly sports results in late 2016. We forecast revenues of £6m in 2017 and £7.6m in 2018.

32Red reported a full year EBITDA of £10.56m, representing a margin of 17.0%. This was marginally higher than our forecast of 16.9%, and a 620bp increase from the prior year.

Online gaming is characterised by high operational leverage, and 32Red’s successful returns-driven marketing has led to sustained underlying margin expansion. As the business continues to scale, we forecast EBITDA margins of 20.4% in 2017.

32Red operates largely in regulated environments and therefore margins have been affected by the UK’s 15% POCT. Our forecasts also include the additional taxation of freeplay bets, commencing in August 2017.

Founded in 1997, Kindred Group is one of the world’s largest online gaming companies, with 16.5 million customers in over 100 countries. It is licensed in Australia and 11 EU states and its 13 consumer brands include Unibet, Stan James Online, Maria Casino, iGame and Bingo.com. The company’s headquarters are in Malta and it has over 1,100 employees.

Kindred is listed on the Nasdaq Stockholm Large Cap List, with a market cap of approximately £1.7bn.

Leveraging a strong balance sheet, Kindred has been a leading consolidator in the fragmented European online gambling market. Since 2005, it has acquired and successfully integrated eleven companies, strengthening its position in regulated or soon-to-be regulated countries. Most recently, Kindred acquired Stan James Online, an online UK sports-betting business in 2015.

On 23 February 2017, Kindred announced an all-cash offer for 32Red at a price of 196p per share, a premium of 39.5% to the prior three months’ weighted average closing price. The first closing date is on 24 March 2017 and final consideration is expected to be paid in May. After completion, 32Red’s shares will be delisted from AIM.

The acquisition of 32Red is consistent with Kindred Group’s strategy and marks a meaningful entry into the UK online casino market. According to H2 Gambling Capital, the UK online gaming market is expected to grow from £5.9bn in 2015 to £10.5bn in 2021.

32Red believes it is the 11th most recognised UK online casino brand despite only having a 3-4% market share. 2016 saw a 26% increase in total marketing spend and recent initiatives include an exclusive licence to promote ITV flagship brands featuring Ant and Dec, and British Horse racing sponsorship agreements with racehorses and brand ambassadors.

32Red derives over 90% of its net gaming revenue (NGR) from online casino, with online sports, bingo and games accounting for the rest. Approximately 77% of revenues come from regulated markets, mainly the UK and Italy.

On 2016 reported figures, 32Red would comprise approximately 10% of the enlarged group’s revenues, with UK casino representing the most significant contribution.

32Red’s 2016 EBITDA margin of 17.0% is lower than Kindred’s 22.2%. This is due to 32Red’s predominately regulated and taxed revenues. UK point of consumption tax (POCT) is 15% and costs are expected to rise further in August, with the introduction of taxation on freeplay.

Importantly, however, 32Red’s successful focus on ROI marketing is expected to contribute to significant margin expansion, despite the increase in taxation.

32Red’s management role in the enlarged group remains unclear, although Kindred Group has typically encouraged acquired management teams to remain active within the business.

32Red is a high-growth, cash generative business and Kindred expects the deal to be earnings accretive within the first financial year. The UK online casino market is very fragmented, and benefits of the enlarged group include access to Kindred’s extended range of content, as well as a larger marketing budget.

Kindred has previously migrated other acquired businesses onto its own company platform (eg iGame has successfully migrated and Stan James Online is due to migrate in 2017). Currently, 32Red outsources its platform capability to Microgaming (gaming) and Kambi (sports). Given 32Red’s predominately gaming focus, its main technical and content provider is Microgaming, with whom it has recently agreed a new five-year contract, with improved commercial terms and flexibility to add other suppliers’ games.

Following the deal, Microgaming will remain 32Red’s key content provider, but a Kindred platform will facilitate supplementary content from other providers.

The acquisition of 32Red significantly enhances the enlarged Kindred Group’s regulated exposure. 77% of 32Red’s revenues are derived from regulated markets, mainly from the UK and Italy. This compares to 35% of Kindred’s revenues. Kindred has stated that the acquisition will lead to 39% of revenues being regulated, but this figure appears rather conservative, given 32Red’s current revenue mix.

In other “soon-to-be regulated” markets, Kindred faces a number of regulatory hurdles. A major rationale for the 32Red deal is to reduce dependency on markets such as the Netherlands and Sweden, where the group currently generates approximately 40% of its revenues. The Dutch re-regulation is expected in 2018 and there is potential for future Swedish re-regulation. We note that Roxy Palace (£10.6m revenues in 2016) includes a slightly more international player base, and has a small share in Sweden and Holland.

32Red is 77% regulated, growing strongly and highly cash generative, as evidenced by its historically generous dividend policy. Now 32Red is trading ex-dividend, the acquisition price of 196p per share equates to a valuation of 10.2x 2017 EV/EBITDA, which is at a premium to the peer group average of 7.8x. Given its brand strength and track record, this acquisition multiple appears appropriate.