Stride Gaming — Update 2 December 2015

Founded in February 2012, Stride Gaming is a multi-brand, bingo-led, online gaming operator with its own proprietary software platforms. It only operates in regulated RMG markets, mainly serving the UK. At the end of July 2015, the company acquired social gaming company InfiApps, an already profitable company in an attractive complementary vertical with c 70% of its revenues arising in North America. Stride is run by an extremely experienced management team with headquarters in London and c 200 employees.

Despite only being incorporated in 2012, Stride Gaming is already profitable and growing strongly. The company has seen a strong appreciation in its share price since its May 2015 listing, rising from 132p to 272.5p, driven by a combination of an oversubscribed initial offering and strong trading that beat early guidance. Its FY16e EV/EBITDA is 12.6x, falling to 11.1x in FY17e. This places it towards the top end of the range of online gambling companies, but we believe this is justified given its strong growth potential and our likely conservative forecasts, which we believe could benefit further from a number of factors:

Stride’s management has signalled its intention to initiate a progressive dividend policy – we expect this could begin in FY17, widening the potential shareholder base.

Stride’s maiden full year financials revealed that the company has made significant operational and financial progress. FY15 revenues were £27.8m (FY14 pro forma £20.2m), despite including only one month of InfiApps. With a full year’s contribution from InfiApps, we expect FY16 revenues of £45.0m, rising to £48.8m in FY17. Online bingo is an extremely cash-generative business that benefits from high levels of operational leverage, particularly for operators with their own software platform. As a result, we expect operating cash flow to rise from £4.6m in FY15 to £12.1m in FY17, taking the company from a net debt position of £3.1m in FY15 to an estimated net cash position of £9.0m in FY17.

There are approximately 400 online bingo operators in the UK and it is a highly competitive market. However, the introduction of the UK POC tax in December 2014 is putting pressure on sub-scale operators unable to absorb the additional regulatory financial burden. As a larger operator with its own proprietary software platforms, Stride is well placed to weather the additional burden. In common with other RMG gambling operators, Stride would be affected by any change in the regulatory environment in the markets in which it operates.

Stride Gaming is a multi-brand, online, bingo-led real money and social gaming operator, which benefits from its own proprietary software platforms and a highly experienced management team. Founded in 2012, Stride has grown aggressively over the last three years via a mixture of organic growth and M&A. Its bingo real money gaming (RMG) business operates from the fully regulated markets of Alderney and the UK, while also holding an Italian gaming licence and a 25% interest in a Spanish online bingo operator QSB (branded as Bingosoft). Stride’s recently acquired (end July 2015) social gaming business, InfiApps, adds an international dimension to its revenues, with 69% of InfiApps’ 2014 revenues coming from North America and the balance coming from the rest of the world. The company intends to continue its growth via a mixture of organic and M&A activity, both in existing markets and abroad.

Stride Gaming develops and markets online gaming products in real money gambling and social forms. The company targets the softer end of the gaming market where players tend to play for entertainment and fun rather than in the hope of winning significant cash prizes. To that end there is significant overlap between the real money and social forms of the game, the primary distinction being that social games lack the ability to ‘cash out’ winnings. As a result, social games are not subject to the regulatory and licensing restrictions to which real money games must adhere, including prohibition in some countries. This means that social games can be freely distributed and marketed globally.

Stride is a bingo-led business. In practice, this means its websites are a mixture of bingo (Kitty Bingo, Lucky Pants Bingo, King Jackpot, Bingo Extra, Jackpot Café, Jackpot Liner), slots (Magical Vegas, Big Top Casino, Spin and Win) and social casinos (Slot Bonanza).

Stride’s main operating company Daub Alderney developed its proprietary platform in 2011 and began trading in 2012, leading with the Spin and Win website, which featured a mix of slots games, side games and table games as its first offering. Its first bingo offering, Kitty Bingo, launched in September 2012, quickly followed by Lucky Pants Bingo (ranked number one in Google mobile bingo searches) in January 2013. In September 2014 the group acquired a number of brands (Jackpot Liner, Jackpot Café and King Jackpot) and their supporting software platform from Top Table Entertainment for £12.5m. Daub incorporated a 100%-owned subsidiary, SRG Services, a company incorporated in Mauritius, to carry out the administrative services for Daub Group’s online gaming operations. Marketing services company Spacebar Media was acquired in February 2015 for £6m for its marketing services capabilities and to provide additional software development expertise. A pre-IPO restructuring brought all of the group’s companies under the Stride Gaming banner. The company successfully listed in May 2015, raising £11.2m to fund further potential acquisition opportunities. The group’s final and most significant acquisition was that of Israeli social gaming business InfiApps in July 2015 for $22m (£14.5m) with a potential maximum consideration of $40m. With games including Slot Bonanza, InfiApps has achieved more than 5m downloads since its 2012 launch.

Online gambling is growing strongly around the world. H2GC, a leading industry consultancy, estimates that the online gaming market (including online lotteries) was worth €32bn in 2014, up from €29bn the previous year. Online gambling is expected to grow to €53bn by 2020, taking it from 8.7% to 12.3% of the total gambling market.

Land-based real money gambling has long been a highly regulated industry, but many jurisdictions have yet to implement full licensing regimes. The regulatory environment varies between full regulation, no formal regulation (grey markets) and markets where online gambling is prohibited (black markets).

An increasing number of European countries are now either regulated or in the process of drawing up and approving regulation. These potentially offer new expansion opportunities for Stride. Although regulation imposes additional costs on operators, it generally allows more marketing, higher player trust and drives more unscrupulous operators out of the market.

Even in regulated markets, bingo is often recognised as ‘soft gambling’ and so carries fewer restrictions than sports betting or poker. For example, bingo is the only form of gambling where TV advertising is allowed prior to the 9pm watershed in the UK.

Bingo is the fourth largest vertical in the online gambling industry (after sports, casino and poker), estimated to be worth €1.8bn in 2014, with a growth rate greater than that of the wider gaming market at 10.1%. H2GC estimates that the market will be worth €2.3bn by 2018 and still growing at c 7% pa.

Europe is by far the largest bingo market led by the UK, where almost 2.5 million adults play online bingo (up from 1.1 million in 2008, a CAGR of c 20%) and 1.73 million play online slots (source: Kadence market research, May 2014). UK Gambling Compliance Research Services (GCRS) estimate that the UK market will be worth c £510m in 2015 (as at September 2014).

The online bingo-led market has distinct features that differentiate it from traditional online gambling products such as sports betting and poker. Most notably, it has a predominantly female demographic and a much more social ‘community’ angle. Stride’s management believes these distinctions mean that it can achieve a competitive advantage by having a specific focus on bingo. Stride is adopting a multi-brand strategy to maximise its share of wallet among bingo players. The advantage of a multi-brand approach is the ability to re-engage customers that are looking for a new brand. Often this can happen after a poor run of results (despite bingo being a game of pure chance), when a customer perceives their luck is out on a particular brand. While Stride already operates a number of brands, it intends to launch further brands and is likely to supplement these with acquisitions, which bring both additional brands and customer lists.

While players are attracted to the site to take part in bingo games, they are cross-sold side games, predominantly slots. From a commercial perspective, slots generally contribute as much as 50% of the net gaming revenue (NGR).

Although it is difficult to obtain precise data, we believe that Stride is now the sixth biggest bingo operator in the UK market. Of the top six, only Stride and Tombola can lay claim to owning their own proprietary software platforms. Indeed, Stride currently owns and develops two distinct bingo platforms. One is a fully responsive mobile-ready platform, which was self-developed. The second is a desktop download-only platform, which the company obtained as part of the Top Table Entertainment acquisition. Stride’s mobile-ready platform has demonstrated excellent performance in the mobile space, with 48.9% of revenues coming from mobile (19.7% in FY14). This is ahead of what we believe to be a 30% industry average. While the Top Table platform is desktop only, there is the potential to offer the Top Table brands in a mobile format. We believe this would support further growth in Stride’s mobile revenues.

The UK market has begun consolidating post the POC tax, but so far this has mainly focused on casino and sports betting (aside from the Intertain/Jackpotjoy deal). This creates the opportunity for more consolidation in the online bingo space. Details of recent deals are shown in Exhibit 4 below.

The market for social games is global and estimated to reach $17.4bn by 2019, up from $5.4bn in 2012, a CAGR of 16.1% (source: Transparency Market Research). Within this, Eilers Research estimates that the 2014 market for casino-style games was worth about $2.8bn; it is forecast to grow to $4.4bn by 2017. Key growth drivers include rising broadband penetration, growing trust in online e-commerce, the rapid growth in mobile devices and their sophistication. Having been originally dominated by Facebook, the mobile channel is expected to contribute all of the growth, with Facebook revenues expected to fall. Eilers estimates that mobile surpassed Facebook for the first time in 2014, accounting for 56% of social casino revenues, and that it will rise to 81% of social casino revenues by 2017.

Stride completed the acquisition of Israel-based InfiApps at the end of July 2015. Founded in 2012, InfiApps is a highly successful internationally focused social gaming company. InfiApps is already profitable and has achieved more than five million downloads of its social casino app Slot Bonanza, with a further c 100,000 installs every month and c 400,000 weekly active players. The social gaming business model is a freemium-based approach with in-app purchases that offer the player additional bonus features. We estimate that 1.5% of players are converted into paying customers. Revenue take among paying players is attractive at an average of $50 per week. While this is the primary revenue source, it is supplemented by additional in-app advertising revenues. Slot Bonanza is distributed via the iOS App Store, Google Play Store and Amazon Marketplace. These distribution platforms charge c 30% of revenues for hosting.

The InfiApps acquisition also gave Stride a high-quality app development team. Stride’s management intends to utilise this capability in the future to the benefit of its RMG brands. The InfiApps earnout incentivises its senior management to stay with the group for at least two years. Moreover, Stride’s management is working on a middle management long-term incentive plan to ensure that further members of the InfiApps team are leveraged to the long-term success of the business.

Eitan Boyd, CEO has more than 15 years’ experience in the online bingo sector. He founded the B2B Globalcom bingo network (later renamed Dragonfish) in 2002, which he later 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.

Darren Sims, COO also has over a decade of online bingo experience. He was 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 Boyd 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 12 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. He previously held the CFO and CEO roles at Sportingbet. Sportingbet was one of the world’s largest online gambling companies and during his time there Nigel was involved in successfully executing a number of M&A transactions.

Gaming companies are generally valued on an EV/EBITDA basis. We have calendarised Stride’s results for the purposes of comparison in Exhibit 6 and believe 2016 (the first full year of InfiApps) is the most appropriate year on which to make valuation comparisons. Our constructed peer group includes a mix of online bingo and casino operators. We have also included two social gaming companies relevant to the InfiApps social gaming business.

Stride Gaming is already profitable and growing strongly. Its FY16e EV/EBITDA is 12.6x, falling to 11.1x in FY17e; on a calendarised basis the 2016 EV/EBITDA is 11.6x. This places it towards the top end of the range of the peer group. However, we believe this is justified given Stride’s proprietary platform, profitability and EPS growth. Stride’s EBITDA margin of 25% sits towards the top end of its peer group range of 20-25%. Furthermore, we believe our forecasts are conservative (see below) and are likely to be augmented by further attractively valued M&A and international expansion.

Despite being among the hottest stock market subsectors just three years ago, valuations of social gaming companies have come back a long way and 2016 valuations now lag those found in the real money space. This is partly because valuations among the bigger listed social gaming companies recognise the relatively short product lifecycle among ‘blockbuster’ titles that contribute a significant proportion of their revenues. Despite the fall in social gaming valuations, at 4x EV/EBITDA, Stride still achieved a purchase price for InfiApps that was at a significant discount to prevailing social gaming valuations. The King valuation is a takeout valuation, as it recently agreed to be taken over by video game giant Activision Blizzard.

Stride is a consumer marketing business with its own proprietary gaming platform. Its business model involves the use of effective online and offline marketing to acquire players at the lowest possible cost per customer. This is often done through the use of bonus offers, which provide the player with free introductory games. The company then uses a mix of attractive games and data analytics to maximise player lifetime values (LTVs). The spread between the cost of player acquisition (CPA) and the LTV is the customer yield which, when multiplied by the number of players, broadly represents Stride’s operating profit.

Stride has an August financial year end and recently reported its maiden full year numbers. FY15 revenues were £27.8m, up 227% y-o-y on a reported basis or 37% pro forma. With a full year’s contribution in FY16, we expect revenues of £45.0m, rising to £48.8m in FY17. Gross profits are calculated net of the 15% UK POC tax, paid on the real money portion of NGR. Distribution includes licensing, marketing, royalties and all payment processing costs. In our view, marketing is one of the company’s competitive strengths and although management does not disclose exact numbers, we believe that the company’s CPA compares favourably with industry averages.

We expect 8% growth in FY16 RMG revenues, ahead of the market growth rate. Our group revenue forecasts of £45.0m in FY16 and £48.8m in FY17 translate into EBITDA of £11.3m in FY16 (up 55%, including a full year of InfiApps) and £12.8m in FY17. We have allowed for a slight increase in the distribution cost ratio in FY16e, including InfiApps costs, and a broadly unchanged admin percentage, both declining slightly in FY17 as the group scales up. After net interest of £0.6m in FY16, our normalised PBT estimate is £10.1m (Exhibit 8). We assume a minimal tax rate on RMG profits (Guernsey base) and a 16% rate for the social gaming business.

Our reported PBT is after amortisation of earnouts and share-based payments (Exhibit 8). We have factored in our assumptions for the earnout, which are accounted for as contingent remuneration of £2.5m for this in FY16e and £0.5m in FY17e.

Online bingo is an extremely cash-generative business, consistent with which Stride has a cash conversion that benefits from high levels of operational leverage, particularly since it owns its own software platforms. The company’s cash conversion ratio was 105% in FY15 and we expect a normalised range in the region of 90-110% typical for online gambling companies. We expect operating cash flow to rise from £4.6m in FY15 to £12.1m in FY17 (Exhibit 8). Capex requirements are modest, but there are the aforementioned potential InfiApps earnout payments. The total amount payable could be as much as $18.8m (£12.4m) in total should InfiApps reach a level of performance consistent with its maximum earnout conditions, calculated on the basis of an EV/EBITDA of 4x.

Stride had a net debt position of £3.1m at end August 2015, largely due to the £8m loan the company took out to fund the InfiApps initial consideration. This loan has a two-year term and accrues interest at a rate of 7.5%. Given our expected increase in cash flow generation and in the absence of any M&A activity, we expect the company to move to a slight net cash position in FY16. With cash generation continuing to accelerate in FY17, we expect Stride to finish with a net cash position of £9.0m in FY17. Stride’s management has indicated that it may choose to repay the loan early, contingent on anticipated short-term M&A opportunities.

Balance sheet net assets were £30.8m at August 2015, mainly comprising of intangible assets (Exhibit 8).