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Paddington Bear tucks into JackpotJoy as a big short call

By Paddington Bear | Monday 20 March 2017

Disclosure: The author has a short position in one or more of the shares mentioned. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

There is split opinion on Standard & TSX listed JackpotJoy (JPJ) both from people I highly respect. On the one hand Odey (not Crispin) are buyers and own a significant stake, and on the other hand we have Marc Cohodes who presented the bear case at Grants Conference here. 

A very quick summary: Jackpot operates online bingo assets; it is the largest UK operator with a 22% share (according to Stride Gaming (with whom we may have some fun at a latter date)). (though Intertain claim a 27% share), (apologies for excessive use of parenthesis).

The bull case is that it owns a market leader with economies of scale and a network effect where revenues grow to circa £350 million with EBIT of £100 million. Put a 12x multiple on that, and assume debt has been paid down to a paltry £ 200 million and you then have a market cap of £1 billion, compared to today’s £425 million.

The simplified bear case is that this is company with a large debt burden and earnout structure having purchased “assets” which it may not fully own. Coupled with an interesting history there is a reasonable probability that the equity is worth less than the debt.

Intertain has crossed the Atlantic, is now listed in London under the name of JackPotJoy, and has recruited a new IR executive. Assumedly its plan is to entice British punters/investors to buy its stock. So this is a very good time to analyse the business.

To give you a very brief overview of how I frame my research I ask six key questions:

  • Are there any moral hazards to owning this stock?
  • Does the industry have attractive economic for an investor?
  • Does the business have a convincing strategy for converting industry economics into profit?
  • Does the company have the proven abilities to execute on converting profit into cash?
  • And does the equity benefit from the cash flow?
  • Are there any major red flags that should give an investor pause for thought?

Is there moral hazard?

This question is not necessarily about my own personal morality. It is about business risk. Whilst I believe that online gaming is immoral; that immorality (real of perceived) creates business risk.

You just have to look at how the real-world Bingo industry faired under tax changes and regulation changes and what happened to companies like Top Ten Holdings PLC.

The moral hazard here comes when you see that average UK disposable income is £201 pcm  and the average JackPotJoy bingoist spends circa $170CAD (or £100) per month gambling on its sites.

This is not the place for a moral crusade, or rant. Sufficed to say I can see why regulatory pressured could fall on this industry, and hence it probably is not an industry that warrants premium multiples.

Does the industry have attractive economics?

Whilst this is not necessarily “sine qua non” for investing, as a great company that is taking share in a declining industry can be a wonderful investment; I would, however, rather own a great business in a great industry!

I will again refer to Aubrey Sr on Bingo: Top Ten tried online bingo - but it found that it was a commodity industry. Revenue growth could only be achieved by advertising spend. There are no barriers to entry, anyone can set up a site, and the only differentiating factor is ad spend.

In addition to this I have noticed that many gaming companies have multitudes of sites. Whilst they claim that this is due to offering niche products to niche audiences I believe the reason to be something different.

It is something that we noticed in Adult Dating sites with failed operator Cupid PLC. Punters come along to a site to try their luck (sound familiar); but when, inevitably, luck is not on their side (whether it is because there is a motivation team or you are simply playing a game against an algorithm designed to take your money) punters become disappointed.

The simple fact of gaming is that the house ALWAYS wins. Thus the punter ALWAYS becomes disappointed. I mean eventually even the dumbest of individuals realises that the flow of money is one way. So they try another site.

This leads to a business that requires lots of marketing spend, and lots of development spend as new sites/skins/games need to be created to satisfy the whimsicality of the bingoist.

Can the business convert the industry economics into profit?

The problem with commodity businesses is that they can only ever eventually earn cost of capital (unless they can extract rent). And the problem with businesses like this where punters move from site to site trying their luck is that it becomes much more capital intensive than originally imagined.

However the bull case here does have merit.

There is a social element to bingo… okay in real life brick and mortar halls I believe it. But online? Why should bingo compete with Twitter or Facebook? The more convincing argument is that the company has gaming liquidity. Bigo is like a pari-mutuel. The more players the bigger the prize. This is why people don’t really play the health lottery, but instead the national lottery..

The company would point to retention rates and show you a chart to illustrate this

 The problem I have with this, is however threefold. 

Firstly it does not show customer numbers. We know that around 90% of revenues come from 10% of customers (for gambling as a whole

This means that a certain number of high rollers (who are presumably gambling as much as they can afford) represent 60-90% of revenues. This makes the company very sensitive to inflation of food, rent, and interest rates. As if you bingoist has his income crunched then so too must his gaming.

Secondly, this does not tell us the frequency of visits. A punter playing in 2010 may not return until 2014. Surely this is not a problem? Well yes it is; you can’t compare this to a software business or television subscription. Customers are not locked in, and have no switching costs.

Thus the only way to keep them coming back is to keep the RPT (return to player - percentage of gaming returned to punter) high, and also to keep advertising and marketing to them.

And thirdly, I find an 11% churn hard to imagine from a gambling site. Sky, for instance, has an approximate 10% churn. So there must be something here that I just don’t get. I will have to dig deeper.

Can the company covert profit into cash

So far this is difficult to tell. There is not much by way of financial data on JackPotJoy. We can go through the GameSys private company accounts (and we have, and found some strange things there which we will discuss at a later date)

Obviously the aforementioned fears regarding the business and capital intensity makes significant cash generation hard. However, there are other fears with JackPotJoy which make cash flows to the equity very difficult. One concern in particular is that it has recently had to borrow money at Libor+9 ! these sort of  rates are not frequently applied, and often only reserved for very special cases.

Another concern that investors should have is that they do not seem to really own the jackpotjoy asset. In the “Real Money Agreement”  More on that later.

In the meantime you may want to brush up on the forensic accounting element of this company by reading about its former incarnation (Intertain) here.

More to follow....

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