Stride Gaming — Update 19 September 2016

Stride’s management team is among the most experienced in the industry. The acquisitions of Tarco and 8Ball fit well with its stated strategy and are highly complementary to the existing real money gaming (RMG) online bingo business (74% of FY16e NGR). Prior to these deals, Stride had made one acquisition since listing in May 2015: the $21.2m (£14.6m) acquisition of InfiApps (plus earn-out), a mobile social gaming company that also diversified it internationally (some 70% of its revenues coming from North America). Despite being announced simultaneously, the Tarco and 8Ball acquisitions represent two distinct deals. Both completed on 31 August (with trading in the 12.0m new placing shares having commenced on 24 August).

By way of a recap, Stride’s growth strategy has six core pillars:

Tarco has an estimated 3% share of the UK online bingo market with 22 B2C brands (including Moon Bingo and Robin Hood Bingo), four B2B brands and c 63,000 monthly active players. It operates on the Dragonfish (888) platform. The deal also brings in Netboost Media, a data-driven marketing business that serviced the Tarco brands (with c 60 employees, based in Israel). Tarco/Netboost earned £2.54m of EBITDA on £17.40m of NGR in the 12 months to May 2016 (up from £2.26m and £15.87m, respectively, in calendar 2015).

Stride has paid an initial £16.0m for the Tarco assets (£7.7m in cash, £8.3m via the issue of 3.2m new shares) and £2.2m cash for Netboost. It will also pay the Tarco vendors an earn-out of up to £22m (51% cash/49% shares) based on the EBITDA for the 12 months to December 2017 (at a 7.5x multiple, implying 2017 EBITDA of £5.0m to achieve the maximum). The deal constituted a related party transaction since the Tarco and Netboost vendors included GAL Holdings (a 33% shareholder in Stride prior to the deal/placing, whose shareholders include Boyd and Sims).

8Ball has an estimated 2% share of the UK online bingo market with over 60,000 active players and 74 brands – many more than any other operator. This multi-brand strategy enables it to re-market to players who churn and it often captures them on one of its alternative brands. It operates at the lower end of the market and achieves very low cost per acquisition (CPA) through its proprietary business intelligence platform, which is highly ranked for SEO (Booty Bingo is currently number three of all non ad-supported sites in Google search). Based in Cheshire, 8Ball has 30 employees, and the operations director will stay with Stride for at least two years post completion. It operates a multi-platform strategy, with brands hosted on the Dragonfish (888), Virtue Fusion (Playtech) and Cozy Games platforms. 8Ball earned £2.00m of EBITDA on £9.64m of NGR in the 12 months to May 2016 (up from £1.51m and £8.24m respectively in calendar 2015 helped, we believe, by some bolt-on acquisitions).

Stride has paid an initial £12.0m in cash to acquire 8Ball, which is debt-free; the vendors are the management team. An earn-out of up to £18.0m (a mix of cash and shares) is payable based on the performance of the business in the 12 months to end-August 2017. The earn-out is based on 6.0x EBITDA, implying FY17 EBITDA of £5.0m to achieve the maximum. The terms of the deal are equivalent to 6x adjusted EBITDA. The first £3m of the contingent consideration will be satisfied in ordinary shares, with the balance satisfied via a mixture of cash and shares at a ratio of 40/60.

The completed deals have the immediate impact of creating a step change in Stride’s position within the UK online bingo market. Gambling Compliance estimates that the UK online bingo-led market will be worth c £600m in 2016 (out of a total UK online gambling market of just over £3bn). Stride expects its market share to have doubled from 5% to 10% with the acquisitions. Its multi-brand strategy means that it has a much larger share by brand: it now operates just over 100 brands (having added 96), about a quarter of the estimated c 400 active bingo brands in the UK.

On a pro forma basis, Stride’s NGR for the 12 months to May 2016 would have been £71.8m and EBITDA would have been £16.6m. Exhibit 3 also shows the extent to which Tarco’s margin in particular is below that of Stride, indicating scope for improvement.

Stride has indicated that it expects to achieve cost synergies of £2.3m post the earn-out period, from marketing (greater media buying power and shared marketing teams), administration and distribution. We expect it to continue to operate on a multi-platform basis, and indeed we believe it is now the biggest third-party operator on the Dragonfish platform by number of brands, but cross-sell to churning customers is likely to favour brands on its own platform.

Stride believes that it can obtain revenue synergies of about £3.0m post earn-out by improving player lifetime value (LTV), yield per player per month and the net cash hold. Stride’s LTV and yield (Exhibit 4) are much higher that either Tarco and 8Ball and while we believe this partly reflects the different customer mix, we also believe that Stride has better engagement, customer service and remarketing capabilities and should be able to close the gap somewhat.

The three businesses will remain separate during the earn-out period, although some cost and revenue synergies will still flow from the group’s greater scale and cross-fertilisation of best practice. In particular, we believe that marketing towards customers who leave the Tarco or 8Ball brands is likely to direct them towards Stride’s own brands on its proprietary platforms, where margins are higher. While the deferred consideration provides a strong carrot, we also believe there are sensible measures in place to ensure, for example, that marketing and other costs are positioned to deliver ambitious medium-term profit goals rather than short-term earn-out targets.

In addition to the jump in market share from the Tarco and 8Ball acquisitions, we believe that Stride is growing is share organically. Stride’s trading update (19 September) reports that it expects its FY16 NGR to be “not less than £47m”. That implies FY16 growth in its RMG online bingo revenues of 31% on our estimates (with a near identical growth rate in both H1 and H2). By way of comparison industry leader Jackpot Joy (Intertain) has reported growth of 9% (H116); Gala Bingo 15% (six months to 9 April 2016) and 7% (Q3FY16), and Mecca (Rank Group) -2% (six months to June 2016). Mecca has been impacted by a platform transition as we believe has Sun Bingo (estimated 12% market share down from 14-15% in 2104).

We had previously forecast 12% growth in Stride’s RMG revenues for FY17 (Update report dated 23 May). However, we now expect it to achieve 20%, only partly due to the revenue synergies from 8Ball and Tarco and 8Ball which will flow much more strongly once their earn-out periods are completed (August 2017 and December 2017 respectively).

Exhibit 5 shows our updated forecasts, including Tarco and 8Ball which were acquired on the last day of FY16 and thus begin to contribute in FY17. Exhibit 6 shows the changes to our forecasts from those published in our Update report dated 23 May.

Stride has reported that it expects its FY16 results to be ahead of market expectations with NGR “not less than £47m” and adjusted EBITDA “not less than £12.3m” (Edison previous forecasts £44.7m and £11.8m respectively). This implies H216 EBITDA of c £6.7m versus £5.6m in H116 despite the fact that H2 would normally be seasonally weaker. Compared with H215, H216e EBITDA shows growth of 81%, but this includes a full six months of the InfiApps social gaming business versus only two weeks in H215. Our forecast FY16 normalised EPS of 19.6p is 11% above our previous estimate as we have slightly trimmed our interest and tax forecasts.

As noted above, we now expect 20% growth in Stride’s RMG revenues (previously 12%) in FY17. To this we add £33.4m from Tarco and 8Ball. Our total revenue forecast is £88.8m (last published £49.8m). Our new EBITDA forecast is £19.5m, up from £13.4m last published. For the purposes of the earn-out calculations we assume that most of the increase comes from Tarco and 8Ball – their combined EBITDA was £4.57m in the 12-months to May 2016 (Exhibit 3). In practice it is more meaningful to look at the group as a whole since the operations will essentially be integrated. We allow for the estimated distribution % to rise from 40% in FY16e to 44% in FY17e (higher marketing and Tarco and 8Ball platform fees) but a lower admin percentage (spread across a bigger group) to give EBITDA of £19.5m, a 22% margin (possibly slightly cautious since the pro forma group’s combined margin for the 12 months to May 2016 was 23%, Exhibit 3). Allowing for a slightly increased tax charge (c 7%) and increased weighted diluted share capital, our FY17 EPS rises by 14% to 22.5p. Our diluted shares calculation includes an estimated 3.9m new shares for the Tarco/8Ball earn-outs although these will only be issued in FY18.

We have not previously introduced formal FY18 estimates, but we published preliminary revenue and EBITDA estimates in our Update report dated 23 May. This flagged that we expected rather flat EBITDA in FY18, at about £13.5m (versus £13.4m in FY16e pre-deals) due to the extension of RGD (the UK POCT or remote gaming duty) to free bets, although HMRC is only now consulting on the precise method of calculation. With acquisition synergies coming through in FY18, we now expect an increase in EBITDA to £21.0m, although this still implies a lower margin (20.4% versus 22% in FY17e) as our assumed effective POCT rate increases to 19% (from 15%).

We previously forecast £0.9m of net cash at 31 August (excluding player balances). Stride received the £25.1m net proceeds of the share placing (12.0m new shares at 225p) on 24 August and settled the £21.8m cash component of the acquisition consideration on 31 August. Allowing for some acquisition costs we now forecast c £4.0m net cash at 31 August. Stride’s high level of cash conversion should flow through to rising net cash over the next two years and we forecast August 2017 net cash of £15.5m (previous forecast £7.0m). We have modelled £18.4m of contingent consideration payments (46% cash, 52% shares) versus the maximum £40m; higher payouts would only be triggered by higher EBITDA contributions than we have forecast. These are paid in FY18 but we still expect August 2018 net cash to rise to c £22m, in the absence of further likely acquisitions.

Our net cash is stated after an £8.0m loan from one of Stride’s shareholders (Poppy Investments), which carries a 7.5% interest rate, repayable on 30 July 2017. Stride is now in discussions with a first tier bank for a new four-year term facility, which we assume would bear a c 4% rate.

Exhibit 7 shows Stride’s rating on a calendarised basis versus the peer group. Its share price jumped from 242.5p to 272p on the trading update announcement and we have re-priced to reflect the increase. Despite this, on our upgraded forecasts its 2017 (calendarised) EV/EBITDA is still an undemanding 8.3x versus a peer group average of 8.4x and its P/E is only 11.9x versus the average of 13.2x. Stride still has a fairly short track record, but execution to date has been strong and management is highly ambitious. Assuming the Tarco and 8Ball businesses perform as we expect over the coming months, Stride’s step change in scale – and potential for further expansion within a consolidating market – should be rewarded with a premium rating.