Stride Gaming — Update 23 May 2016

Stride Gaming came to market in May 2015 with a very clear strategy to take advantage of opportunities for organic and M&A-driven growth in bingo-led gambling, related soft gambling verticals and social gaming. Having completed two acquisitions in the bingo space before its listing, Stride extended into the social gaming vertical via the July 2015 purchase of Israel-based InfiApps. Stride hopes to benefit from a number of supporting factors in pursuing its stated objective, namely:

Stride reported excellent H116 interim results with revenues up 21% on a l-f-l basis. Direct year-on-year comparisons are difficult due to the acquisition of InfiApps in July 2015 and the introduction of the POCT gaming tax (15% of UK RMG revenues) in December 2014. Thus Stride has helpfully provided pro forma numbers (as if both InfiApps and POCT had been in place throughout H115). Both are shown in Exhibit 1, together with our detailed revenue and EBITDA forecasts.

Stride’s management has always stated that its intention was to initiate a progressive dividend policy when financially prudent to do so. While we had previously expected that this might happen in FY17, management announced that it would pay its maiden interim dividend on the back of these strong results. The inaugural payment of 1.1p per share will be paid in June 2016 and we expect it to be followed by a final payment of c 1.3p per share to give 2.4p for the year. We believe that the well covered nature of the dividend, together with management’s stated commitment to a progressive pay-out, widens the potential shareholder base and should be supportive of the share price.

While the growth in RMG bingo-led revenues is positive, we have marginally trimmed our overall FY16 revenue forecast (from £45.0m to £44.7m) due to a lower than expected revenue contribution from InfiApps. However, higher margins at InfiApps and a lower admin cost ratio means that we have upgraded our FY16 adjusted EBITDA forecast to £11.8m versus our previous £11.3m. We have slightly increased our FY17 revenue forecasts from £48.8m to £49.8m as we expect stronger growth in the bingo vertical (12%) and a resumption of growth in social gaming revenues (10-15%) as the aforementioned business improvements begin to affect the top line. We have upgraded our FY17 EBITDA forecast from £12.8m to £13.4m as a result of the operational leverage effect of stronger growth at the same time as continued cost discipline.

We show preliminary FY18 revenue and EBITDA estimates in Exhibit 1 and will introduce formal forecasts later this year. We expect 10% growth in bingo revenues and 8% growth in social gaming revenues to drive aggregate top-line growth of 9.5% to £54.5m. However, we would flag that FY18e is the first year when the extension of the UK POCT to free bets and bonus plays (proposed in the March 2016 Budget) will affect Stride’s financials. It is still unclear exactly how the tax will be applied. We believe that we have erred on the side of conservatism in charging 20% COS on RMG revenues, the effect of which is to lead to fairly flat EBITDA in FY18e (£13.5m versus £13.4m in FY17e). It remains to be seen how the tax will affect the marketing methods of Stride and its peers. It might be that companies innovate and find alternative marketing methods to mitigate the impact of the tax, offering the potential for our provisional EBITDA forecast to be revised upwards.

Funded players: the strong performance in bingo has been driven by a 92% increase in the number of funded RMG players, which rose from 31,600 in H115 to 60,561 in H116. Importantly, this was not achieved by diluting the quality of the player pool, as evidenced by the fact that yield per player was steady at £114 (2015: £113). This is testament to Stride’s commitment to disciplined marketing spend. Management only approves additional spend when it can see a visible return on expenditure. Further investment in business information (BI) was made during the period as the BI team was expanded from one to five people. This should allow Stride to invest even more in marketing in future with a high degree of confidence in its payback.

Stride’s underlying business is strongly cash generative with cash conversion at c80% of EBITDA. Net debt at 31 August 2015 was £3.1m (excluding £1.4m of player balances from cash of £7.4m). Cash generated from operations in H116 was £4.8m, while investing activities were £0.7m. As at 29 February 2016, there was a small net cash balance of £0.3m (excluding player balances of £1.6m) and we expect this to rise to £0.9m at August 2016, even allowing for an InfiApps earnout payment and payment of the maiden interim dividend (£0.6m). We expect net cash to increase to £7.0m by August 2017, with £8.0m of loans (7.5% interest rate) being paid off by 30 July 2017.

Stride’s management remains committed to its buy and build strategy. InfiApps was acquired in July 2015 for an initial consideration of $22m (plus an earnout of up to $18m) and was immediately earnings accretive, taking Stride into a complementary vertical and diversifying it geographically. While it has yet to complete a deal post the InfiApps acquisition, we believe that management has a number of possibilities in the pipeline, both within its core soft gaming verticals and in other complementary verticals such as scratch cards and lottery.

Any potential targets must be in verticals where Stride’s management can leverage its experience in soft gaming. We believe that it is Stride’s commitment to finding deals at attractive valuations that has somewhat delayed further announcements to date. However, we observe that there are visible deals in the market and believe that, together with the less obvious targets, further M&A is a matter of when, not if.

Exhibit 2 updates our peer group comparison for Stride Gaming. After a very strong post-IPO performance, Stride’s shares ran into profit-taking in Q415 (on very low volumes) and have moved sideways since the beginning of the year, partly on the absence of newsflow. However, the interim results confirm excellent progress and we consider that at the current share price Stride Gaming’s rating is undemanding given its profitability, strong execution to date (InfiApps is already earnings accretive) and buy and build growth prospects.

Gaming operators currently sit at a wide range of multiples dependent in part on their online/land-based mix (online generally more highly rated) and geographic spread (mix of regulated/
unregulated markets). Both 32Red and 888 Holdings are pure online gaming comparators; Stride’s rating is slightly higher than that of 32Red, but well below that of the rather larger 888. GVC is sports-led, although it does now have a large UK online bingo business with Foxy bingo; Rank too is a large UK online bingo operator with Mecca, but its land-based businesses continue to generate more than 85% of EBITDA. There are few social gaming comparators: the US-listed Zynga is highly rated (its EV/EBITDA is still 11.0x in 2018e) and King Digital was acquired by Activision in November 2015 for $5.9bn, an EV/EBITDA of just under 6x (but its revenues had been falling).