Stride Gaming — Update 6 December 2016

Founded in February 2012, Stride Gaming is a soft gaming multi-brand, bingo-led, online gaming operator with its own proprietary software platforms. Its real money gambling operations are UK focused and fully regulated. Its strategy is to grow both organically and by acquisition. In July 2015 it acquired social gaming company InfiApps, which took it into an attractive complementary vertical and diversified it geographically. In August 2016 Stride acquired Tarco and 8Ball, which doubled its share of the UK online bingo-led market from 5% to 10%. Stride continues to look for accretive acquisition opportunities including those that would take it into other soft gaming verticals. Stride is run by an extremely experienced management team, with headquarters in London and c 300 employees.

Stride’s shares are at the lower end of their recent range, providing an excellent opportunity for investors to take another look. Sector sentiment has been affected by a government review into betting shop gaming machines (which does not affect Stride) and possible restrictions on pre-watershed TV advertising (which may even benefit it competitively, as almost all of its marketing is online). Its calendarised 2017 EV/EBITDA is now only 7.1x, below the historic average and slightly below the peer group. We consider that it merits a healthy premium given its pure online regulated status, well above average growth and continued potential to increase market share. A share price of 320p, for example, 38% above the current level, would still only be a 2017e EV/EBITDA of 10x.

Stride had already reported that FY16 EBITDA would be “not less than £12.3m” and thus results were in line with expectations, although net cash of £11.3m was well ahead of forecasts (our estimate £4.0m) due to the timing of the Tarco/8Ball acquisition on the last day of the financial year. The 30% real money gambling (RMG) revenue growth rate was an excellent result, well ahead of the market, but social gaming’s flat revenues reflected some balancing of priorities between marketing and profit during the earn-out period (social EBITDA increased by 17% pro forma to £4.1m, while RMG EBITDA rose 32% to £8.2m). Our unchanged FY17 forecast is for a 59% increase in EBITDA (including Tarco and 8Ball) and 11% increase in adjusted EPS, with underlying RMG revenue growth a very healthy 18%. The main synergies from Tarco and 8Ball come in FY18, offsetting cost pressures from the extension of the POC gaming tax to free play to produce 5% EPS growth. The business is financially very strong, with over 90% EBITDA/ cash conversion; we expect net cash to increase to £15.5m at end FY17 in the absence of further likely acquisitions.

Stride’s real money gambling business is fully regulated and licensed in the UK and Alderney but it is affected by changes in tax or licensing conditions, in common with other operators. POC is to be extended to ‘free play’ from August 2017 (applied to gross rather than net RMG revenues) and this is already in our numbers, although not yet clear exactly how this will be implemented or what the effect will be. There is also some risk that the UK government could place tighter restrictions on TV bingo advertising, but virtually all Stride’s marketing is online. Stride operates in highly competitive markets, but we believe it is very well placed in the UK, with larger multi-product operators focusing more on sports and casino and smaller operators squeezed by POC. It has its own proprietary software platforms but also depends on third-party providers such as Dragonfish (888) for its Tarco and 8Ball brands. Stride is not materially affected by currency movements aside from the translation of its US-based InfiApps business (c 15% of FY17e revenues).

Stride Gaming is a multi-brand, online bingo-led real money and social gaming operator with a highly experienced management team. Stride has grown aggressively over the last four years via a mixture of organic growth and M&A. It is now the fourth-largest UK bingo-led operator and aims to become number three in the next two years. Its soft gaming female-led focus differentiates it from male-led sports and casino operators, with a largely recreational player base and strong growth in revenues from mobile devices (now over 50%). We expect Stride to continue its above-average growth via a mixture of organic and M&A activity, both in existing markets and abroad. This could include expansion into complementary verticals such as lotteries and scratch-cards, as well as possible white-labelling (B2B) to leverage its proprietary platforms.

Stride’s FY16 revenue split was 73% bingo-led real money gaming (RMG) and 27% social gaming but the acquisitions of Tarco and 8Ball have shifted the mix towards RMG, which we expect to account for 85% in FY17. Within this, revenues on Stride’s proprietary platforms are c 47% and on third party platforms, 38%. FY16 adjusted EBITDA split 67/33 between RMG and social and this moves to 78/22 on our FY17 forecasts. Virtually all (98%) of Stride’s RMG revenues arise in the UK, where all its marketing is focused, while social gaming derives c 65% of its revenues from the US.

Stride (originally Daub Alderney) developed its proprietary platform in 2011 and began trading in 2012, initially with Spin and Win and then, in September 2012 with its first bingo offering, Kitty Bingo. In September 2014 it acquired a number of brands and their software platform from Top Table Entertainment (TTE) for £12.5m. In February 2015 it acquired marketing services company Spacebar Media for £6m. A pre-IPO restructuring brought the three businesses together under the Stride Gaming banner and it listed in May 2015, raising £11.2m to fund further acquisition opportunities. Since then it has made three further acquisitions: InfiApps (social gaming) and the Tarco assets, Netboost marketing operation and 8Ball in RMG online bingo.

Stride’s management team has a considerable depth of online bingo industry experience and an excellent track record. CEO Eitan Boyd founded the B2B Globalcom bingo network (later renamed Dragonfish) in 2002, which was sold to 888 Holdings for $42m in 2007. It continues to be one of the largest pooled player bingo networks in the world. Following the successful sale of Globalcom, Eitan went on to launch Wink Bingo, a B2C bingo operator, which was also sold to 888 in 2009, for £60m. COO Darren Sims was also instrumental in the sale of Globalcom to 888 and was integral to its post-acquisition integration as 888’s VP of Bingo. He rejoined Eitan at Spacebar Media just before the sale of Wink Bingo to 888.

Ronen Kannor, CFO, joined Stride’s senior management team in October 2014. He has more than 13 years’ experience in financial management roles in the real estate and business intelligence sectors. Non-executive chairman Nigel Payne has more than 20 years’ experience as a director of both publicly listed and private companies, including being CFO and then CEO of Sportingbet between 2001 and 2006, when it was one of the world’s largest online gambling companies. Biographies are on page 12.

Stride’s strategy is “to maximise shareholder value by achieving growth through organic and acquisitive means. We aim to deliver organic growth by enhancing our proprietary platforms, systems and knowledge and strategic acquisitions will allow the company to enter new verticals and/or provide scale to existing verticals”.

Stride Gaming is headquartered in London, UK and holds gambling licences in the UK and Alderney. It has almost 300 employees in offices in the UK (London and Chester), Mauritius, Israel, South Africa and Guernsey. It operates its own proprietary platforms, both RMG and social, desktop and mobile (eg a TTE mobile platform was launched in FY16). It also develops its own content – both RMG and social – although it also licences popular games from providers such as Net Entertainment. Tarco and 8Ball are hosted on third-party platforms (888’s Dragonfish, Cozy Games and Playtech’s Virtue Fusion). However, Stride manages all its own marketing and business intelligence; analytics are very important for maximising player engagement and monetisation.

Online bingo is a multi-player pool-based game and thus a gaming risk-free business for the operator (who takes a share of the pot). On average 65-70% of players are female and there is a strong community and chat element. In between games customers play side games – usually slots – and this is where the bingo-led operator makes the bulk of revenues, typically 70-80%.

The UK Gambling Commission’s latest statistics show that online bingo generated £152.7m of gross gaming revenue in the year to March 2016, out of a total online gambling market of £4.47bn. This is the pure bingo figure. Gambling Compliance (2015 Report) expects the total bingo-led segment to total c £600m in 2016, which tallies in that it implies that casino games account for 75% of the bingo-led market. Gambling Compliance estimates that the UK bingo-led market has grown at a CAGR of c 7.5% between 2011 and 2016 and we believe that rate is being sustained despite the maturity of the sector, due to the shift to online and mobile. For example, industry leader Jackpotjoy increased UK RMG revenues by 10% in the six months to June 2016 and Gala Bingo by 12% in the nine months to June 2016 (7% in Q3 FY16).

Stride’s revenue growth has been well ahead of the market average at 31% in FY16 and 30% pro forma in FY15. Its estimated market share was 5% before the Tarco/8Ball acquisitions and 10% after. We described the acquisitions in detail in our Update report dated 19 September. They added 96 brands, taking its total to 105 and giving it c 25% of the estimated c 400 active bingo-led brands in the UK market. We believe Stride will reduce the number somewhat to streamline the back-end operation, and a selection of Stride’s brands is illustrated in Exhibit 6.

We expect Stride to continue to gain market share in FY17, with proforma revenue growth of c 18%. Larger multi-product competitors such as GVC have tended to prioritise marketing spend on their betting and casino operations while smaller competitors have had margins squeezed since the introduction of the POC gaming tax in December 2014. Additionally Sun Bingo and Mecca (Rank) have both lost market share over the last year due to platform migrations.

We believe that Stride’s outperformance is all about effective marketing and player engagement. It has a recreational customer base with the average customer spending about £25 a week for 20 weeks. It works hard to offer attractive content and functionality backed by sophisticated data analytics eg predictive modelling and personalised game recommendation. It aims to maximise its share of player wallet by adopting a multi-brand approach, to re-engage players who are looking for a change eg after a poor run of results.

Stride entered the social gaming market with the acquisition of Israel-based InfiApps at the end of July 2015. Founded in 2012, InfiApps was already a profitable, internationally focused business which had achieved over five million downloads of its social casino app Slot Bonanza. InfiApps diversified Stride both by product and geographically (most revenues are international including 65% from the USA). It also brought in an experienced app development team. The business model is freemium-based, although there is also some in-app advertising. About 2-3% of players are converted into paying customers, making in-app purchases, and their average FY16 deposit size was $24.50 (up 44%).

Stride’s social gaming revenues were £12.8m in FY16 and thus it is a very small player in the $3.7bn social casino market. Mobile is driving market growth, which is forecast to be c12% in 2016 (2015: 19%, Exhibit 7). Social casino is a sub-set of the wider social gaming market, which is forecast to be worth $17.4bn by 2019 (source: Transparency Market Research). InfiApp’s management is part-way through its two-year earn-out period (which runs to July 2017) and focused mainly on player engagement and monetisation in FY16, with daily average revenue per paying user (ARPPU) up 22% to $35. This produced a 17% increase in EBITDA to £4.1m on a 1.8% increase in revenues (see ‘Financials’).

Stride has proprietary platforms for both real money and social gaming and has indicated that it could license its platform to other operators on a B2B basis. We assume that this might be in slightly adjacent areas to minimise competitive conflicts.

Stride has a toe in the Spanish and Italian online casino and bingo markets via a 24% investment in a small operator, QSB Gaming, licensed in Alderney. The fair value increased from £1 to £0.81m at 31 August (total implied value £3.4m) as the business is doing well, but is recorded as an ‘available for sale’ investment as Stride has no significant influence. Stride also has a dormant Italian licence and could enter that market at some stage, although it is very competitive.

Regulatory risks: Stride’s RMG business is fully regulated, but there is no licensing framework for social gaming and a small risk that social casinos, in particular, could come under closer regulatory scrutiny in its main market, the US, or elsewhere. Licence conditions and tax rates can and do change in the UK, for example HMRC is currently consulting on the precise way that POC will be extended to free play from August 2017, which is likely to change game play and impact margins (we allow for a four point increase). On 24 October, the government (DCMS) announced a review of gaming machines and social responsibility; while mainly focusing on FOBT machines in betting shops and betting adverts on television it is possible that it could put some restrictions on bingo TV advertising (currently permitted before the 9pm watershed). This would affect all operators and indeed Stride might benefit slightly as it does relatively little TV brand advertising.

Competition: Stride operates in highly competitive markets and some competitors are much larger than itself with much bigger marketing budgets. However, Stride’s management is extremely experienced and has built a strong brand presence.

Economy: Gambling has historically proved resistant to economic slowdowns, but not immune, although the structural growth in online gambling outweighed economic pressures in the last major slowdown of 2007-08.

Acquisitions: With acquisitions forming a large part of the growth strategy, the ability to find and successfully integrate attractively valued targets is a key sensitivity. In its FY16 results statement, management notes the “while we are pleased with the integration of InfiApps…balancing longer term benefits against shorter term performance targets needs to be managed carefully and presents certain challenges to maximise the performance of the business in the earn-out period.” Tarco, Netboost and 8Ball could present similar challenges. They will remain separate during their earn-out periods (although some cost and revenue synergies will flow from the group’s greater scale and cross-fertilisation of best practice) but we 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.

Currency: Most of Stride’s revenues are generated in sterling and to a lesser extent the US dollars. With operations in Mauritius, Israel, South Africa and Guernsey Stride has a small net currency exposure, mainly against the US dollar and Israeli shekel, but it is not material.

Stride came to AIM via a placing of 8.5m shares at 132p in May 2015. With a small free float the shares rose strongly to over £3 by September 2015, before running into some profit taking. A placing of 12.0m new shares at 225p in August 2016 (as part-consideration for Tarco and 8Ball) increased the free float and improved liquidity.

Gaming companies are generally valued on an EV/EBITDA basis and Exhibit 9 shows Stride’s rating on a calendarised basis versus the UK-listed peer group. Its FY17 P/E is only 10.2x versus the peer group average of 12.2x while its (calendarised) EV/EBITDA is 7.1x versus the average of 7.7x. Yet a number of the peers have large low-growth land-based operations (Ladbrokes Coral, William Hill, Rank Group) which typically attract a lower rating. Stride is a fully regulated pure online operation delivering above average growth and cash generation and with continued potential to increase market share. Its underlying FY16 performance was excellent and forecasts have been maintained (after significant upgrades in September). Thus its discount appears unjustified and indeed we believe it should trade at a healthy premium. A share price of 320p, for example, 35% above the current level, would still only be a 2017e EV/EBITDA of 10x.

Stride needs to demonstrate the successful integration of Tarco and 8Ball over the coming months, particularly given its comments about the challenge of managing InfiApps during its earn-out period. However, Tarco and 8Ball are an exact fit with the rest of the group and its track record with previous acquisitions such as TTE is very positive. Evidence of its step change in scale as FY17 progresses, and potential for further expansion in a consolidating market, should be a catalyst for significant multiple expansion.

Exhibit 10 analyses the FY16 results and our forecasts down to the EBITDA level while Exhibit 11 shows our overall numbers. Part of the reported growth in FY16 came from the full year effect of InfiApps (only in for one month of FY15). Stride also provided FY15 pro forma results, adjusted for InfiApps and also for the full year effect of POC (only in for nine-months of FY15).

Reported revenue and adjusted EBITDA increased by 72% and 68% to £47.8m and £12.3m respectively; pro forma increases were 22% and 27%, an excellent performance. The results were in line with our estimates but Stride’s 19 September trading update had reported that adjusted EBITDA would be “not less than £12.3m” and thus there was perhaps a small element of disappointment at the lack of a beat. Adjusted (diluted) EPS increased by 45% to 20.3p (our estimate 19.6p) which represented a pro forma increase of 6%.

FY16 RMG revenue increased by 31% (both reported and like-for-like). There was a 37% increase in funded players (to 71,220) and 7% increase in yield per player to £120 per month (£27.70 per week). On average a player stays for 18-20 weeks, generating a lifetime value of £507 in FY16 (up 5%). Stride does not disclose the cost of acquiring players, which is competitively sensitive, but we believe it is around £100 ie the gross profit per player is over £400. The FY16 RMG adjusted EBITDA was £8.2m, 17% up on FY15 (reported) and 33% on a pro forma (adjusting for POC). The margin was very similar on a pro forma basis at 23.5% (FY15P: 23.2%). Gaming tax (POC) is 15% of UK NGR and we estimate that FY16 marketing costs were c 25% of revenue, with total distribution costs at c 36% of and admin costs at c 26%.

InfiApps focused more on profitability than revenues in FY16, increasing the level of player engagement and monetisation. The daily ARPPU increased by 22% to $35 yet pro forma revenues only increased by 1.8% and constant currency revenues slipped 6%, implying that player numbers were down. However, proforma EBITDA increased by 17% to £4.1m, a margin of 32% (FY15P: 28%) and compared with the £14.6m initial acquisition cost (plus earn-out) the business will have been usefully accretive. Distribution costs are higher in social than in RMG (we estimate c 45%) since platforms such as the iOS App Store and Google Play charge c 30% of revenues for hosting. The admin ratio is broadly similar but of course social gaming revenues do not bear the 15% POC gaming tax.

We materially increased our forecasts in our 19 September Update note to include Tarco/8Ball: we raised our FY17e EBITDA by 46% (to £19.5m) and diluted EPS by 14% (to 22.5p). We are not changing them at this stage, since November and December are important trading months; we believe we are the lower end of a market consensus EBITDA range of £19.5m to £20.2m. Overall we expect RMG revenues of £75.4m, including £33.4m from Tarco/8Ball, an approximate 18% like-for-like growth rate. Our forecast FY17 RMG EBITDA of £15.3m implies a 20.3% margin (FY16: 23.5%) since both Taro and 8Ball pay third-party platform fees and Tarco in particular was much less efficiently run (offering useful scope for improvement).

Our social gaming forecasts are also unchanged since we assume the improved player engagement will flow through to a cautious 5% revenue improvement in FY17, with the EBITDA margin dropping slightly (31.3% versus 32.0%) to allow for a little additional marketing.

Overall our FY17 forecasts are for 59% EBITDA growth and 11% adjusted EPS growth.

Prior to the acquisitions of Tarco and 8Ball we forecast virtually flat EBITDA in FY18 due to the extension of the POC gaming tax to ‘free play’ ie essentially taxing gross (pre-bonus) revenues rather than NGR. If we assume a 25% rate of bonusing this raises the effective rate on NGR to 20%, but we assume a small amount of mitigation and non-UK revenues and apply a 19% rate. The earn-out periods end in August 2017 (8Ball) and December 2017 (Tarco) and beyond this Stride believes that it can achieve £2.5m of cost synergies (across marketing, admin and distribution) and £3m of revenue synergies (increasing LTV, yield, cash hold and cross-selling lapsing Tarco/8Ball players onto its higher margin proprietary platform). Adding in c 8% growth in social gaming gives us overall revenue of £103m in FY18e (up 16%), EBITDA of £21.0m (up 8%) and adjusted EPS of 23.6p (up 5%) allowing for a modest increase in tax rate, to c 8%.

Stride generated £13.7m of operating cash flow (after tax) in FY16, an EBITDA conversion rate of 111%. The £22.2m cost of acquisitions was more than covered by £25.9m net proceeds from the August fund-raise (12.0m new shares at 225p/share) and year end net cash (after player balances and the £8m loan taken out to fund the InfiApps deal) was £11.3m (end FY15: net debt of £3.1m). On top of that Stride is holding £3m of cash in escrow for the Tarco earn-out. The total cash balance was £10.3m more that our £4.0m estimate, but working capital was favourably affected by the timing of the Tarco and 8Ball acquisitions on the last day of the financial year and adjusting for this, we believe the underlying position was as we expected.

Stride’s RMG business generally has very high cash conversion of c 100% while the social gaming rate is c 70%. Stride has already paid a £4.0m earn-out payment in respect of InfiApps but the payments for Tarco and 8Ball do not fall due until FY18 (and will be part settled in shares). With fairly modest capex requirements we expect net cash to increase to £15.5m by August 2017 (unchanged from our previous forecast). Net cash should continue to rise strongly in FY18 too, in the absence of further likely acquisitions.

Stride declared a final dividend of 1.4p, which when added to the 1.1p interim dividend makes a full year total of 2.5p (Edison estimate: 2.4p). It will be paid on 1 February 2017 to shareholders on the register on 5 January. The payout ratio is still relatively low (c 12% of adjusted earnings) as befits a growth company with plenty of opportunities to put cash towards acquisitions, but the board nevertheless has a stated objective of a progressive dividend policy.

Stride financed £8.0m of the InfiApps consideration in July 2015 by way of a shareholder loan bearing a 7.5% interest rate. Post year end, in November 2016 it refinanced it with an £8m loan facility with Barclays, which matures in four years’ time and only bears an interest rate of 3.6% plus LIBOR. We believe this demonstrates Stride’s credibility as a still relatively young company.

The £8.0m debt was only 7.5% of FY16 year-end grow assets of £105.7m, up from £48.7m at August 2015 due to the acquisitions (intangible assets increased from £36.4m to £73.6m). Year-end net assets were £69.2m, up from £30.8m.