Placing a Bet on iGaming
Secular Growth, Consolidation, & Attractive Valuation
In this report, I review the U.S. casino industry’s digital transformation, the growth opportunity ahead, and the forces driving increased consolidation in the sector. And I profile three iGaming companies that I believe are likely takeover targets – and may pay off handsomely for investors.
But first: what is iGaming, anyway?
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A Brief Overview of iGaming
iGaming, or “internet gaming,” digitizes the traditional casino, creating an online gambling experience offered through computers and mobile devices. iGaming products include conventional casino games like slots, poker, electronic table games, and live dealer table games. Online sports betting is an entirely different beast and does not fall under the umbrella of iGaming.
The history of online gambling is as old as the internet, so I will keep it to the essential details. In the United States, legal gambling has historically been limited to land-based casino operators. Digital offerings were restricted to simulated games that offered no prospect for real money winnings.
There are a few key pieces of legislation that established this precedent:
The Federal Wire Act (1961) prohibited the transmission of wagers across state lines.
In 2011, the Department of Justice issued a legal opinion that the Wire Act only applies to sports betting, and not other forms of online gaming.
The Professional and Amateur Sports Protection Act (“PASPA”; 1992) restricted legal sports betting to all but a handful of states.
The Unlawful Internet Gambling Enforcement Act (2006) prohibited transactions from banks to online gambling sites unless explicitly legalized by state law.
After the 2011 Department of Justice ruling on the Wire Act, individual states had a pathway to legalize intrastate iGaming operations (although the convoluted legal precedent dissuaded most states from doing so). Intrastate iGaming was subsequently legalized by Delaware in 2012, New Jersey in 2013, and Pennsylvania in 2017.
The fate of online wagering was significantly altered in 2018 when the Supreme Court overturned PASPA, reversing a federal ban on sports betting that prevented states from legalizing, regulating, and taxing the activity.
Today, states are free to determine their fate regarding all forms of online gaming. Since the Supreme Court’s ruling, West Virginia, Michigan, and Connecticut have legalized iGaming.
Status of iGaming and Sports Betting Legislation by State
As the above map demonstrates, the legalization pathway for iGaming has lagged behind sports betting. MGM Resorts CEO Bill Hornbuckle predicts a natural progression from sports betting to iGaming:
Ultimately, you're now looking at a couple of dozen states that have sports betting. iGaming is one more step in all of this progression…once you're in the business, once you get confidence around the business' ability to control responsible gaming and other social issues that come up, you gain that confidence. And you're more excited to continue to go and to progress.
I believe there is another reason that iGaming legalization will catch up with sports betting: money.
On January 22, 2021, Michigan launched online sports betting and iGaming. With nearly a full year of data, and 14 active sportsbooks and iGaming operators in the state, Michigan provides an apples-to-apples comparison of the financial potential for both industries.
iGaming Generated 90% of Profit and 96% of Tax Revenue
In Michigan, iGaming provided 9x the gross profit and 25x the tax revenue of internet sports betting. It’s true that of the six legal iGaming states, Michigan showed the greatest discrepancy. But the trend is consistent across state lines: one study calculated that U.S. iGaming revenue surpassed U.S. online sportsbook revenue in 2021, despite sports betting being legal in five times as many states. As iGaming generates outsized tax receipts in legal states like Michigan, I predict more states will “follow the money” and pass iGaming legislation.
“The real value to this business and the economic opportunity is in iGaming. Sports betting is going to create and has created a great deal of momentum…but I think iGaming becomes the economic secret to this business.”
“The convergence of land-based and digital continues to gain momentum.”
"This is [likely] the beginning of the consolidation wave."
iGaming consolidation momentum has gradually been building since the repeal of PASPA. There are three broad categories of buyers: land-based casinos, sportsbooks, and traditional gaming suppliers. I will walk through the rationale for each of them and provide a few recent examples.
Land-based casinos realize that iGaming will be a primary driver of future topline growth. The casino industry in its entirety is expected to grow roughly in line with the economy (4% per year). On the other hand, Goldman Sachs forecasts iGaming will grow at a 27% CAGR for the next decade.
Additionally, bringing iGaming technology in-house can boost efficiencies and profitability. iGaming does not require a physical presence, limiting capital requirements and increasing returns on investment.
“The folks you mentioned who use other people's technology generally pay between 10% and 12%. We don't. When this all settles in, we have margins that exceed 30%, hopefully, it will be partially because of that. And so that's interesting and exciting to us, and it makes the business more sustainable.”
Recent Precedent Transactions
March 2022: Pala Interactive / Boyd Gaming (BYD) – $170mm (Investor Presentation); EV / 2021 EBITDA: 34x
April 2021: Gamesys (LSE: GYS) / Bally’s (BALY) – $3.0bn (Investor Presentation); EV / LTM EBITDA: 12x
It’s no surprise that the internet sportsbook darlings (e.g., DraftKings and FanDuel) are investing heavily into iGaming. Sportsbooks operators recognize that iGaming customers are more profitable and require less promotional spending than sportsbook customers. iGaming also has fewer seasonal ebbs and flows as it’s not dependent on a particular sports season or event. Finally, there is huge value and cross synergies in having a “full suite” of gambling products.
Recent Precedent Transaction
August 2021: Golden Nugget Online Gaming (GNOG) / DraftKings (DKNG) – $2.0bn (Investor Presentation); EV / LTM EBITDA: NM
October 2019: The Stars Group (TSG) / Flutter Entertainment (LSE: FLTR) – $11.5bn (Investor Presentation); EV / LTM EBITDA: 18x
Traditional gaming suppliers
Through decades of innovation in support of land-based casinos, gaming suppliers have built a wealth of content, offered through electronic gaming machines (e.g., slot machines), table games, and other products and services. But most suppliers lack the technology and expertise to transition that content to the internet. Acquisitions are a valuable tool through which gaming suppliers can accelerate the transition of their physical products to the digital realm.
Recent Precedent Transaction
April 2022: iSoftBet / International Game Technology (IGT) – $175mm (Press Release); EV / 2021 EBITDA: 20x
A final impetus for increased consolidation is the recent industry-wide draw-down in valuation. After the initial market euphoria following PASPA’s repeal, coupled with the broader bull market in 2020 and 2021, the air has come out of valuations for most iGaming and internet sportsbooks companies. When valuations come down, expectations between buyers and sellers start to converge.
“There’s been a 50% to 80% correction on the (stock) price of the online gaming companies. In my opinion, it was long overdue. It will also probably lead to some business combinations.”
iGaming Takeover Targets
Prices as of 4/13/2022. Financial statistics per S&P Capital IQ.
Galaxy Gaming (GLXZ) – $4.95
This specialty gaming microcap has leaned into iGaming and is performing admirably. I believe a sale to a strategic at a substantial premium may be in the cards.
GLXZ generates ~40% of its revenue from iGaming, with the remainder from land-based specialty table games. From a strategic acquirer’s perspective, the Company was significantly de-risked after litigation with its former founder was resolved in 2021. The emergence of an activist investor may be the catalyst for a sale.
Activist investor Tice Brown has established a 6% position in GLXZ. On April 1st, he filed a 13D with notice to nominate himself to the Company’s Board and introduced a proposal to declassify the Board. Brown’s chief concerns revolve around option grant dilution and the potential for a premature sale of GLXZ at a price below intrinsic value. Brown established his position in the range of $3.75 – $4.70 / share. If this turns into a public battle, a strategic acquirer may catch wind and take the whole thing private. Regardless, Brown is a shrewd investor, and his declassification proposal is good for governance.
According to the latest proxy, Directors and Executive Officers collectively own 22.5% of GLXZ. In addition to potentially benefiting from employment opportunities at a larger company, the executives would be in line for a substantial windfall in the event of an all-cash sale. Alternatively, perhaps the executives could be convinced to roll their equity in a sale, aligning incentives and lowering the cash bill for a buyer.
Litigation with former CEO and Chairman Robert Saucier was resolved in 2021, ending GLXZ’s association with its founder, who has faced some questions regarding his background. The litigation was a significant overhang on the Company and served as a deterrent to a sale, as few buyers would want to get their hands dirty with substantial unresolved litigation.
PLAYSTUDIOS (MYPS) – $5.49
This social gaming developer has endured a choppy entry into public markets, but its Chairman has been scooping up shares. I believe MYPS’ popular games and loyalty program would fit nicely in the portfolio of a traditional casino operator like MGM Resorts (MGM).
MYPS’ stock price was cut in half after missing overly optimistic revenue and profit projections floated during the SPAC offering. But the underlying business is still performing, and several factors make MYPS a potential takeover target. Moreover, the Company is well-positioned to eventually take advantage of the real money online casino market, and any change in the Apple App Store commission fee structure would be a financial windfall.
Nearly a quarter of MYPS is owned by two public companies: MGM Resorts (13%) and Activision (10%). Strategic buyers often use “toehold” positions to reduce the cash consideration it would ultimately pay in a takeover. Also, if either Company sought to dispose of its stake, it could ignite a broader sale process.
MYPS has a close relationship with MGM. Beyond MGM’s 13% ownership, MYPS went public through a SPAC started by MGM Resorts’ former CEO and Chairman Jim Murren. Two of the six Directors at MYPS have ties to MGM: Murren and the current Chief Commercial Officer at MGM, Steven Zanella. Finally, MYPS’ in-house loyalty program has a partnership with MGM that drives significant volume:
The simple idea, and we've seen it in social gaming for now several years with PLAYSTUDIOS, where, although small in context of some of the competitive set, will drive over 1,000 rooms a night if we choose to open up that channel through social gaming, to our properties. That's a meaningful piece of business.
MYPS’ Founder, Chairman, and CEO Andrew Pascal has been buying aggressively in 2022, at prices ranging from $3.77 – $5.22. He owns ~10% of the Company.
Last week, an MYPS investor (and founder of Diamond Resorts) released an open letter criticizing management and calling for a change. The presence of an unhappy shareholder is often the catalyst for an eventual takeover bid.
Finally, MYPS announced it will tender for out-of-the-money outstanding warrants. An interesting decision that suggests the Company sees a scenario in which the warrants become exercisable, and the MYPS sees greater value in retiring the warrants today vs. suffering dilution in the future.
Playtech (LSE: PTEC) – 593.00 GBX
PTEC is trading 13% below a previous takeover bid, and other suitors are circling. I believe the Company will announce a sale in 2022 at a premium to the previous 680 pence per share bid.
After undergoing a simplification strategy and shedding non-core assets, PTEC announced a sale to an Australian gaming machine maker. But Asian-based shareholders built a blocking stake and voted down the sale. Now, a Hong Kong-based buyer, TT Bond Partners (“TTB”), is evaluating a takeover proposal with the backing of PTEC’s CEO. Under UK takeover regulation, TTB has until June 17th to announce its firm intention to make an offer, or TTB will be subject to a restricted period during which it cannot proceed with a transaction. Simultaneously, PTEC’s Board is evaluating other strategic options.
Often a telltale sign of an impending takeover, PTEC has embarked on a strategy to simplify its business, disposing of non-core assets to become a pure-play gambling technology company. The Company completed the disposition of its Casual and Social Gaming assets in January 2021. In July, the Company disclosed a $250mm offer for its financial trading division (Finalto) from Gopher Investments (an affiliate of 5% shareholder TTB). The offer trumped an earlier bid by a management-led consortium. An agreement was announced in September with Gopher Investments, and PTEC expects to complete the sale of Finalto in Q2 2022.
In October 2021, the Company announced an agreement to sell for 680 pence per share to Aristocrat Leisure (ASX: ALL). Days after announcing the agreement, Gopher Investments requested access to diligence information to explore a potential offer. Gopher later decided against submitting an offer, but a group of Asian-based shareholders subsequently built a stake in Playtech and struck down the sale in February 2022, blocking the acquisition by Aristocrat. On February 3rd, 2022, TT Bond Partners contacted PTEC regarding a potential takeover. On February 21st, it was disclosed that PTEC’s CEO and Director Mor Weizer, in conjunction with former PTEC CEO and Director Tom Hall, had approached TTB and indicated their interest in participating in the investor group, which was agreed to by TTB. PTEC has formed an independent committee to engage with TTB and evaluate other strategic alternatives.
This article is not investment advice. The statistics and analyses herein are the author’s opinion and should not be relied upon as fact. Do your own diligence before making any investment decisions. The author retains the right to buy, sell or otherwise transact in any security without prior notice.