Evolution AB ($EVO; $EVVTY)
Some thoughts.
Evolution AB’s financials are stellar. Management is laser focused, and the company has been the dominant provider in this space for years. The valuation exercise and projections are straightforward to think about in a steady state.
The purpose of this post isn’t to explain the business qualities (e.g. moat, etc.). My thoughts aren’t too different from what has been explained in detail by other bulls elsewhere throughout the years and reflected in the business’s underlying performance.
Despite the clear signs of business quality, the stock trades at multi-year lows in both price and valuation. I think it’s clear that, outside of a few near-term hiccups, the key drag on the stock is regulatory risk. I’ll make that the focus of this post, primarily so I can look back at how I thought about it in a few years’ time.
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The misunderstanding of both the game theory of regulatory regimes and the nature/level of risk associated with regulation in iGaming has made this company fall out of favor, along with the general uncertainty regulation as a concept draws from investors. There are two key risks, neither of which are great enough to justify the discount in EVO’s valuation in my view:
The bulk of EVO’s revenues (60%) coming from unregulated markets.
Operators providing EVO games to jurisdictions in which they are not licensed to operate.
On number 1, there are a few potential outcomes in each unregulated market that I see:
Each market slowly adopts regulations for online gaming. In this situation, EVO would be the incumbent supplier of games and quickly adapt to new regulatory frameworks and make required investments.
The status quo remains.
Outright ban/implied ban on all online gaming activity, as we have seen in China.
The most likely outcome is either the first or second scenario. Online gaming is a massive industry in Asia and has operated for many years under the clear view of governments. Either governments are too busy with other things to care, or they do not care. If they cared enough to say that gambling should be banned, then they would not have allowed it to flourish at this rate for so long. So, the likely case is that unregulated markets continue to remain unregulated and, in a situation in which governments do decide to act, regulation is more likely than outright bans.
The Philippines, which just recently adopted regulations, provides a representative case study of the first scenario playing out: EVO has continued to operate in the market, has built out a new studio and has hired local employees — all of which is being done without much consternation and while complying properly with new laws. As unregulated revenues become regulated, it is fair to say that EVO’s sky-high margins would decrease. However, if you take bears at their word that unregulated revenues is a problem which is reflected in the low multiple at which EVO currently trades, then you can already start to see a situation where even though the margins from unregulated markets may decrease as they transition, the higher multiple on those now “better” revenue streams should have an offsetting effect.
In the second scenario, unregulated revenues would continue to drag the valuation of the company. However, these revenues would nonetheless come in and support continued buybacks and returns of capital to shareholders. Sure, we may not benefit from significant multiple appreciation in this scenario, but the value of the underlying cash flows would still be there.
The third scenario, as mentioned above, is unlikely. First, a ban of a highly active online market is not practicable outside of places like China where the government can and does implement totalitarian control over internet activity. Indeed, a ban in any another Asian country would result in a further entrenched black market and prevent that government from generating jobs and revenues — it is not a logical course of action, so I do not view it as the most likely route to be taken. I would also note that each jurisdiction acts independently — even if one jurisdiction takes the ban route, there is no reason to believe others would follow given that we’ve already seen the Philippines taking the other approach successfully so far. Further, given EVO’s global footprint, the loss of one market should not materially affect EVO’s long term revenue potential overall.
I think the likely path for EVO from here is that it will shake off its near term hiccups (cyberattacks, UK regulatory review, labor issues) and continue to grow revenues through a combination of entry into and maturation of new markets (e.g. United States) and benefits from the global tailwinds to online gaming activity.
It is reasonable that its status as a “sin” stock may mean that it won’t ever command an eye-watering multiple despite the amazing financial metrics; however, the combination of FCF generation, buybacks and a rerate closer to a more reasonable multiple as EVO’s revenue mix shifts more toward regulated should spell great returns from here.
Disclosure: I am long the stock. This is not investing advice.