888 (888) – Gambling giant offers tempting odds with 40% discount

888 (888) – Gambling giant offers tempting odds with 40% discount

A pattern has emerged such that a group of companies with the following shared characteristics has become superficially cheap:

  • headquartered offshore
  • cash-rich
  • high-tech
  • Israeli-controlled
  • highly regulated activities

I am specifically thinking of XL Media (XLM), Plus500 (PLUS) and 888 (888).

These are all broadly engaged in online marketing and/or gambling and their official headquarters are in Jersey, Haifa and Gibraltar (respectively). Their share prices are all currently in severe downtrends, off their all-time highs by 58%, 35% and 40% (respectively).

Their businesses have been battered by regulations as governments around the world have taken action to protect their citizenry from what has traditionally been considered to be the vice of gambling and speculation.

Having read this far, it would be easy to write them off as uninvestible.

Indeed, I don’t think it would be unreasonable to simply write off all offshore businesses which are vulnerable to regulatory attack. After all, those are two very tricky risk factors, and perhaps they are particularly dangerous in combination.

Being offshore makes them more difficult to monitor, while the vulnerability to regulations can pose serious threats to their business models at any time. Legislative change is hard to predict, so these companies can be hit when you least expect it.

However, given that their share prices are already suffering from a loss of investor confidence, perhaps we are approaching the point when a bargain could be served up?

Indeed, I do think that one of these companies stands out at present: 888 (latest share price: 196p, market cap £714 million), which announced H1 results last week.

There are some simple reasons why I prefer 888 to the other two companies in this category:

  • Unlike XL Media, which acts behind the scenes, 888 has a B2C brand whose name is recognised by its thousands of customers around the world.
  • Unlike financial trading at Plus500, the services at 888 are explicitly marketed as entertainment and casino operations. Customers do not think they are going to be able to win. I prefer this from an ethical point of view. (Indeed, I have an 888 account where I occasionally play poker – not because I expect to win, but because it’s an enjoyable form of entertainment. This means that I don’t quit when I lose!)

As a result, I’m predisposed to view 888 as an interesting investment idea.

Quantitatively, the company has a super track record of growth.

Sales:

Adjusted operating profit:

Source: ShareScope.

The actual operating profit figures have been distorted by a few matters classified as exceptional.

For example, 888 recorded a massive provision last year for potential back payments of VAT in the unregulated German market. There was also a “payment in lieu of a fine” paid to the UK Gambling Commission.

H1 2018 has seen some more of these exceptional items, although their net effect has been to boost net income (thanks to a reduction in the provision for historical VAT).

So the accounts require some unpicking. Consider the following excerpt from the H1 results presentation:

Source: 888.

What I would do is deduct depreciation/amortisation and share benefit/finance charges from adjusted EBITDA, to get what I consider to be a fair representation of adjusted PBT. I think the exceptional items are quite irregular, and the revenue in respect of prior years relates only to the tax dispute, so I’m happy to exclude them both from the calculations.

The result is that I get an adjusted PBT of $33.5 million for H1 2017 (left-hand-side) and $37.4 million for H1 2018 (right-hand-side).

That’s solid progress for a period when adjusted revenues increased by only 1%. My adjusted PBT measure has improved at a much faster rate, i.e. by 12%.

Despite this reasonable outcome for the period, investors were disappointed by the overall picture and the shares sold off by some 15% on results day.

Net income of c. $73 million is forecast for the current financial year, improving to $77.5 million in FY 2019. If these forecasts are hit, they have the potential to make the current market capitalisation (equivalent to $930 million at latest exchange rates) seem rather harsh.

Fundamentally when the company is allowed to operate, I have little doubt that it is capable of executing. The latest H1 period showed that in “undisrupted markets” (i.e. markets where no new regulatory restrictions were imposed), it grew revenue by 18%. Casino activities (responsible for 60% of total revenues) increased by 30% in undisrupted markets and by 10% overall.

As it grows, underlying margins have the potential to improve, as you can tell from my PBT calculations above and from the company’s own view that its adjusted EBITDA improved by 10% despite the slow revenue growth.

More European markets will become regulated soon, such as Sweden and Netherlands. There are also major opportunities in the US, although the company has cautioned that it will take some time to expand in the new markets being opened up in various US states.

The dividend yield is better than 6% and with a stable management team, this share is definitely my favourite among the three bombed-out offshore gambling shares. Although whether I’m brave enough to put a few in my personal portfolio, I’ve not quite decided yet. It might be more profitable to play some poker!

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