Evolution AB (OSTO:EVO, Financial) delivered a stellar performance in the third quarter with reported revenue soaring to 452.6 million euros ($456.96 million), paired with EBITDA of 318.6 million euros. This marked a notable 20% surge in top-line growth and an impressive 70.4% EBITDA margin. However, it is important to note the currency headwinds, with the euro's strengthening impacting top-line growth. Specifically, currency fluctuations are estimated to have caused a 6 to 8 percentage points drop in revenue growth compared to the prior-year quarter.
Still, with the current trajectory, Evolution is optimistic about finishing the year on a high, expecting to touch the upper limit of the forecasted 68% to 71% EBITDA margin.
Product innovations lead the way
The Swedish gaming company has truly outdone itself this quarter, releasing a higher number of games than any preceding quarter, encompassing 28 RNG titles and 8 live games. Standout titles included the vibrant "Funky Time" and new launches like the riveting "Red Door Roulette" and the nostalgic "Video Poker." As Evolution moves forward, it sees its ability to continuously innovate and cater to players' desires as a pivotal competitive edge.
Expanding horizons: Studio and regional growth
One of Evolution's strengths this quarter was its Live Casino sector, generating an impressive 385.8 million euros in revenue. However, this success also highlighted a supply-demand gap, indicating a need for a faster expansion pace. While there were setbacks with planned studio projects, the company remains undeterred. A new studio was inaugurated in Colombia following the third quarter and there are concrete plans for further expansion in Europe, North America and Latin America.
On the regional front, North America recorded 9% annual growth, with Asia and Latin America not far behind, boasting 35% and 39% growth respectively. Europe remained steady, marking a 10% increase.
Navigating challenges with an eye on the future
Despite the accolades, Evolution acknowledges the hurdles ahead. The company has experienced delays in studio projects and recognizes a pressing need to ramp up recruitment efforts. The prevailing macroeconomic climate poses its own challenges, but Evolution is determined to push boundaries and exceed market expectations. With a continuous focus on innovation and a commitment to incremental improvements, the company is steadfast in its mission to provide unmatched experiences for its players. Financially robust, Evolution is poised to continue its investment drive and aggressive growth. As 2023 draws to a close, there is palpable excitement for what the next chapter in 2024 will bring.
Tailwind from strong projected sectoral growth
According to ReasearchandMarkets.com, the global online gambling industry is anticipated to attain a valuation of $153.57 billion by 2030, reflecting a compound annual growth rate of 11.7% between 2023 and 2030. This upward trajectory can be ascribed to several elements, including the proliferation of smartphones and internet access, the adoption of freemium models and favorable cultural and regulatory shifts. Such a trend denotes a substantial growth opportunity for Evolution.
The global online casino landscape, comprising both live and RNG components, has been on an upward trajectory in recent years. Current forecasts highlight its potential to remain among the most rapidly advancing sectors in the gaming industry. Determined to lead this wave, Evolution is geared toward outpacing the overall growth of the global online casino sphere.
Several core factors are propelling this expansion. Foremost among these are technological innovations, exemplified by cutting-edge hardware and amplified bandwidth capacities. There is also a notable shift as traditional land-based casinos pivot to digital platforms, complemented by evolving market regulations. A telling sign of the changing times is the prevalence of mobile gaming. By the third quarter, a remarkable 68.4% (a slight increase from 67.5% previously) of the gross gaming revenue on Evolution's platform was attributed to mobile users.
While RNG continues to be a dominant force in the online casino realm, the rising significance of Live Casino cannot be overlooked. Many gaming operators now view the service not just as an addition, but as an integrated, strategic asset.
Positioned as a business-to-business entity, Evolution establishes partnerships with gaming operators, who subsequently manage direct relationships with the end users. While these operators may be licensed in specific jurisdictions, their operations span the globe, catering to a diverse and widespread audience.
Moats
The company also has a number of "moats," or competitive advantages, that support its growth.
First, Evolution boasts a rich portfolio of proprietary games, including exclusives like "Monopoly Live" and reinvented classics like "Lightning Roulette." These unique offerings establish a high barrier for rivals, who would need to license from Evolution to access such content. With a significant player base, Evolution gains cost-efficiencies, akin to the "Netflix advantage." Their commitment to innovation is evident, with 88 new games launched in 2022 and over 100 anticipated in 2023. Such persistent novelty ensures player engagement and expands their intellectual stronghold, making it hard for competitors to match their success.
Second, the company's substantial setup fees for dedicated tables, which can reach up to 50,000 euros, make for a significant initial investment for casino operators. These, combined with monthly fees and the typical three-year contract duration, bind operators closely to Evolution. The loss of access to games, physical infrastructure and popular dealers adds to the considerable costs of switching, further solidifying the company's partnership with its operators and discouraging them from considering alternatives.
Next, Evolution thrives on a potent network effect, fueled by player interaction, a diverse game range and market dominance. Its extensive game array draws both players and operators, resulting in an enriching casino experience. Social interactions are central to its model, enabling players to connect real-time, further intensifying the network advantage. The dominance of Evolution in player traffic accentuates its allure and loyalty within its ecosystem.
Finally, unlike traditional casinos bound by space, Evolution's digital operation allows unparalleled scalability. Its ability to host an ever-growing number of players without proportional cost increments results in heightened return on investment. Evolution has impressively doubled its revenue per live table since 2014. Its expansive network of 1,300-plus tables, which are available 24/7 in various languages, embodies commitment to optimal capacity utilization. During unpredictable scenarios, such as the Covid-19 pandemic, it ensured uninterrupted service. This scalability, coupled with its wide-reaching geographic presence, positions Evolution with a competitive edge that is tough for nascent competitors to match.
Risks to investment case
Like all companies, Evolution also has some headwinds to contend with.
First, Evolution faces considerable regulatory risk, being deeply intertwined with the intricate and fluctuating laws governing the gaming industry across multiple regions.
Additionally, the company's revenue largely hinges on its top five customers, who accounted for 30% of its 2022 revenue, up from 22% in 2021. The primary client alone represented 14% of the total revenue. Such dependence highlights the significance of these clients to Evolution's fiscal well-being. Any adverse shift in the business or a decision to transition to competitors could jeopardize Evolution's financial stability.
Valuation
Evolution seems undervalued based on a vast majority of valuation indicators. For instance, the GF Value Line suggests a fair price per share of 1,883.43 krona ($173.16), and thus being nearly 46% undervalued.
This is also in line with the discounted cash flow model, which suggests, using conservative growth estimates relative to historic actuals, that Evolution is around 42% undervalued.
Other valuation metrics also indicate that Evolution is undervalued. FCF- and Earnings Yields of 5.52% and 5.46%, respectively, are both higher than the 10-year Treasury yield, which is appealing.
The company also has a PEG ratio of 0.28, a price-to-free cash flow ratio of 18.41, a price-earnings ratio of 18.63 and a forward price-earnings ratio of 15.02. Combining these metrics with the fact that Evolution has a $19 billion market cap and has been growing its top and bottom lines by more than 50% over the past three years, the stock seems remarkably undervalued and current price levels should eventually yield a decent margin of safety for investors.
Investment case intact, yet Mr. Market can stay irrational in the short to long term
Evolution is recognized as a distinguished provider of online gaming solutions within the casino industry. Despite the stock's recent decline in performance, this can be attributed to broader challenges, including decreased consumer spending growth and specific legislative hurdles in the U.S. for online gaming. However, it is my assessment that the company's core competencies continue to be robust. I have not identified these challenges as having a considerable impact on the company and will continue to closely observe any emerging risks. Presently, with a forward price-earnings rato of approximately 15 and the forecasted 20% revenue growth for the upcoming year, Evolution appears to be undervalued. Other valuation metrics also suggest a decent margin of safety.
Upon the release of the results, the market reduced share values by 10%. There is a possibility that shares might further decline, reminiscent of the observation by economist John Maynard Keynes in the 1930s: "Markets can remain irrational longer than one can maintain solvency." This serves as a reminder of the unpredictability of Mr. Market. Nonetheless, based on various valuation metrics, Evolution currently seems to be attractively priced, suggesting a potentially opportune moment for investors to consider acquiring stakes in a business demonstrating growing competitive advantages.
