Evolution Gaming
Their Moat Isn't Just Wide... It's a Mathematical Certainty
*Disclaimer 1: All Money Related Figures are in Euros unless otherwise stated.
*Disclaimer 2: I am long Evolution Gaming (EVVTY) at an average price of 112 USD.
What does Evolution Gaming do?
Evolution Gaming is a Swedish Company that innovates, develops, and produces content for online casinos on a business-to-business basis. Their content is played through the interface of a casino operator who deals with the authentication of the player, player account management, and user interface. Evolution’s customers include the majority of the largest online gaming operators in Europe and North America, as well as a growing number of land-based casinos that have begun to offer games online.
Before I discuss more about evolution gaming’s operations, please familiarize yourself with how online casino’s work by reading my summary below and/or watching the provided video: 21 After DD On 19 - Don't Miss It!😎 #casino #blackjack #casinogame (youtube.com)
Online casino games involve a real dealer interacting with players via live video stream. The dealer manages the game, shuffles the cards, spins the roulette wheel, and deals with bets in real time. Players participate remotely from their computers or mobile devices.
Game Variety: Live dealer games cover various popular casino classics, including:
Blackjack: Play against the dealer, aiming for a hand value as close to 21 as possible without exceeding it.
Roulette: Bet on where the ball will land on the spinning roulette wheel.
Baccarat: A card game where players bet on the outcome (player, banker, or tie).
Poker: Variants like Texas Hold’em, Omaha, and Seven-Card Stud.
Other Table Games: Some casinos offer additional games like Sic Bo, Casino Hold’em, and more.
Interaction: Players can chat with the dealer and other players during the game. The live stream provides an immersive experience, making it feel like you’re at a physical casino.
Fairness and Security: Reputable live dealer casinos hold valid licenses from regulatory bodies. These licenses ensure fairness, security, and adherence to industry standards. Playing on licensed sites provides peace of mind for players.
Creating an Account and Depositing: To participate, players need to create an account on a live dealer casino platform. After registration, they can deposit funds using various payment methods.
Bonuses: Many live dealer casinos offer bonuses, such as welcome bonuses, free spins, or cashback. Players can claim these to enhance their gaming experience.
Requesting Payouts: When you win, you can request a payout. The casino processes withdrawals based on their policies.
Evolution sets up live streaming studios with tables to play games like and employs professionals good at dealing, with characteristics of an entertainer for live streaming. Casino operators will then pay Evolution Gaming either a fixed fee or a percentage of their winnings to be able to rent out their dealers and live tables. Evolution Gaming also pays the costs associated with running the live steam. The casino operator is responsible for paying out winnings to players who win. Therefore, the casino operator is either paying a fixed cost or a portion of their winnings in exchange for evolution gaming dealing with all the costs and technical expertise needed to run a live casino. In addition, Evolution Gaming also provides new and innovative games for their casino operators.
Industry Trend:
According to online surveys conducted by Statista, global online casino gambling revenue grew by an average of 28% in the past five years before reaching $95bn in 2023. Statista expects the entire online gambling market to continue seeing double-digit revenue growth in the following years and hit a $117.6bn value by 2025.[1]
According to Evolution’s management, their goal is not to just grow with the online casino market, but to grow faster than the online casino industry, which is exactly what they’ve done over the past five years.
According to another estimate done by Grand View Research, the online gambling market is expected to grow at a compound annual growth rate (CAGR) of 11.7% from 2023 to 2030[2].
Evolution Gaming’s Shareholder Return Policy:
To distribute a minimum dividend of 50% of net profit over time. Evolution also has been engaged in share buybacks since 2022, but share buybacks are not a written down policy like dividends currently are.
Evolution Gaming’s Story:
I believe that Evolutions growth will continue due the following reasons:
1. Because it is a growing industry, I expect to see Evolution’s revenue grow at least as fast as the online casino market.
- As I have shown in the chart, Evolution Gaming’s profit and revenue has grown much faster than the online casino industry. While the online casino market has grown at 28% in the last five years, Evolution Gaming has grown their revenue at 37% and their earnings per share at 43% in the same period. This demonstrates a competent and shareholder friendly management team.
2. I expect to see the online casino market continue to take market share from traditional casinos.
-H2 Gambling Capital, a company that specializes in providing data and market intelligence on the global gambling industry, states that the share of online casinos amounted to 23 percent of the total casino market in 2023. The share of live casino, the area that evolution gaming specializes in, is just 5% of the total casino market [3]. If online gambling continues to grow faster than land-based gambling, online casinos will continue to take market share.
1. I expect to see Evolution continue to develop innovative games that players enjoy playing which means they keep coming back to casino operators to play the newest games. This also means that casino operators maintain their relationship with Evolution Gaming and are more than happy to pay them for their services.
- Given that Evolution Gaming has incredible operating margins that are greater than 60%, competitors like Sisal, Galaxy Gaming, and any other future competitors will try to make a run at Evolution Gaming’s market share. If successful, they could shrink Evolution’s operating margins. However, I expect to see Evolution’s business moat prove resilient. I will discuss this more in depth later.
2. I expect to see Evolution continue growing and expanding its operations in both mature markets like the U.S. and Europe and in developing markets such as parts of Asia.
-Evolution endeavors to be the most reliable live casino provider in the market and holds all the licenses and certifications needed to operate where available. Here are all the regulated markets that it currently operates in, and I expect their presence to grow globally:
Europe
Alderney, Armenia, Belgium, Belarus, Bosnia, Bulgaria, Denmark, Estonia, Finland, Georgia, Gibraltar, Greece, Croatia, Ireland, Isle of Man, Italy, Latvia, Lithuania, Malta, Netherlands, North Macedonia, Norway, Portugal, Romania, Switzerland, Serbia, Slovakia, Spain, Sweden, Czech Republic, Germany, Hungary, Austria, United Kingdom, Malta
Americas
Argentina, Bahamas, Colombia, Curaçao, Dominican Republic, Canada, Mexico, Peru, Paraguay, USA (Connecticut, Delaware, Michigan, New Jersey, Oklahoma, Pennsylvania, West Virginia), Venezuela
Africa
South Africa, Uganda, Congo, Lesotho
Asia & Pacific
Philippines
-Currently, Evolution Gaming has 19,221 employees and they have 1600 live streaming tables. These are two metrics I will be looking at in the future since growth in market share will necessitate more employees and tables.
If any of the four points listed above fail to remain true for the next several years, then it would be a reason to reevaluate the investment thesis.
The Nature of Evolution Gaming’s Moat
For those who don’t know, the term “moat,” popularized by Warren Buffett, refers to a business's ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share. The question with Evolution Gaming is can they maintain their relationship with existing casinos, create relationships with new customers, and still maintain their 60% plus operating margins?
Based on my analysis, Evolution gaming has a mathematical moat. I will walk you through how I came to this conclusion by showing you the math behind a game like blackjack.
NOTE: If you are not interested in going through the math, I will simply state the conclusion here: For a casino to be more profitable operating on their own compared to partnering with Evolution Gaming, they would need players to bet €3,386.63 per hour at each table.
MATH BEGINS______________________________________________________________
The Probabilities:
· Casino wins: 49.1% of the time
· Player wins: 42.22% of the time
· Player and Casino tie: 8.48% of the time
The Casino’s Spread: 49.1% - 42.22% = 6.88%
Hands Played Per Hour
Let’s say that in one hour, 70 hands are played which is one hand every 51 seconds. This is how the probabilities convert to hands won/lost.
Casino wins: 0.491*70 = 34.37 hands
Player wins: 0.4222*70 = 29.55 hands
Player and Casino tie: 0.0848*70 = 5.936 hands
* The net wins for a casino in an hour is 34.37 hands – 29.55 hands = 4.816 hands
Interpretation: A casino must pay for the cost of running the table with just 4.82 hands.
How much does it cost to run an online casino table?
Despite being an efficient online casino operator, it costs Evolution Gaming $46.60 Euros to operate an online table, so it’s reasonable to assume that any new competitors will have to pay at least $46.60 to compete with Evolution Gaming.
At what point should a casino operate their own online casino?
Unfortunately, I do not know the details of the contracts between Evolution Gaming and regular casinos. However, let’s assume an 80/20 split where regular casinos pay Evolution Gaming 20% of their profits for Evolution running the online tables.
Things we established:
· The Casino’s Spread: 6.88%
· The cost to run a table per hour: €46.60.
· The Casino and Evolution has a 80/20 profit split.
The casino’s profitability equation if they decide to partner with Evolution Gaming:
The casino’s hourly profitability equation if they decide to NOT partner with Evolution Gaming:
The graph shows that if a casino decided to do an online casino without evolution gaming’s help, they would need players to bet €677.33 per hour just to break even. However, to be more profitable operating on their own compared to partnering with evolution gaming, they would need players to bet a combined total of €3,386.63 per hour at each table.
MATH ENDS________________________________________________________________
Now that I’ve explained the math behind Evolution’s moat, I’m going to tell you a story just to reinforce just how wide the moat is.
Imagine you are the Chief Operating Officer at Caesar’s Palace. Given that you’re the COO, you’re very good at managing all the people/things that create the casino experience. This includes the drinks, the dealers, the food, the hotel, the resort, and physical security. Despite running a successful casino, you see the writing on the wall that is the continued market share growth of online casinos, and you realize that you must break into this business to guarantee Caesar’s future existence.
This means that you must transform the casino experience and establish security online, which is completely different compared to what you are used to dealing with.
The Casino Experience:
· You’ll have to develop fun games that your users enjoy. If you don’t, users can easily click onto another online casino. Therefore, they no longer must walk several blocks to get to a competitor.
· You’ll need great programmers, hardware technicians, and user experience designers to ensure that the games are developed properly and visually appealing and that the live stream is high-quality and compatible with a plethora of different devices.
· You must have a variety of dealers that can speak different languages since people from different countries will log into your casino. On top of that, they’ll have to be trained to deal and interact with a livestream.
· You’ll have to create the casino experience while complying with all the regulations of the various countries that your online casino operates in.
· You’ll need graphic designers to ensure that the online casino mimics the aesthetics of a real casino.
The Security:
· Big burly guys who toss out card counters are no longer adequate security. You’ll have to figure out how to stop card counters who are behind their laptop and phone.
· You’ll also need to implement some digital security to prevent hackers from stealing user data or hijacking a live stream.
Even if you’re successful with all the above, you’ll be trying to grow and market your online casino while Evolution Gaming is doing everything to kill your business.
Brick and Mortar Casinos who are thinking about doing their own online casino without Evolution Gaming:
Everything above sounds daunting, and if you’re not successful, your career would be at stake. You realize that partnering with Evolution Gaming to help set up and operate an online casino is a possible solution. They’ve done it for 18 years and have been incredibly successful. You crunch the numbers and realize that you would have to get players to bet an astonishing €3,386.63 per table per hour for it to even make sense to go at it alone. As a result, you make the clearly rational decision to partner with Evolution Gaming and profit share.
By the way, the story I just told isn’t a fairytale, it actually happened: Evolution and Caesars Digital sign strategic agreement to expand partnership throughout North America - Evolution .
Segments of Growth:
A company grows future earnings in three ways:
1. Reinvest profits back into the business to expand operations (this is capital expenditures).
2. Improve operational efficiency to increase profit margins.
3. Benefit from increased customer demand (organic growth).
The chart below analyzes the first point. Here we are looking at how much the company has invested in the past and what rate of return they received on their investment
Their capital expenditures have been choppy, but their ROIC has been increasing since the 2020 low. In the first quarter this year, they received a 6.71% ROIC which puts them on track for a 26.84% return in 2024. Overall, their historic ROIC is impressive.
I mentioned this before, but I will display it down below. In recent years, their operating margins have been an impressive 60%+ and their net income margins have fluctuated in the mid to higher 50%s. Although impressive, I don’t expect them to be able to increase their margins given how absurd they already are.
Looking now at point #3, here’s Evolution Gaming’s historic organic growth.
Now you might wonder how one measures organic growth. What I did is I looked at the company’s growth in operating income year over year. I then asked myself, “How much of this growth can be justified based on their Capex and ROIC?”, “How much of this growth can be justified based on their change in operating margins?” If these two questions did not explain all the earnings growth, then the remaining growth must be organic. Since they are in the casino business, this organic growth means that more people are frequenting their existing tables and/or players are betting more money. Their organic growth is slowing but it remains resilient. I will continue to monitor as 2024 unfolds.
Here's the year over year earnings growth broken down by growth category:
As you can see, this company’s earnings growth is dominated by organic growth. This means that Evolution doesn’t have to pay for expensive capex projects to obtain earnings growth.
Valuation:
For the valuation, I will use a discount cash flow analysis will the following assumptions:
1. A constant 62% operating margin
2. A 15% tax rate, per EU regulation.
3. Based off industry growth trends, 11% organic growth until 2030. After 2030, I will assume a very conservative 3% growth in FCF in perpetuity.
4. Given that management wants to achieve a 15% earnings growth rate, I will assume that they will grow their capital expenditures by 17% until 2030.
5. A 24% return on their capital expenditures.
The above assumptions result in the following projected free cashflow in 1000s:
In addition to these future cash flows, Evolution has 1.85 billion Euros in current assets (974 million in cash) and only 1.1 billion Euros in liabilities. This is a phenomenal balance sheet which will improve the valuation.
Given these projections, here is the fair value per share at various discount rates in U.S. Dollar terms:
Given that the equity risk premium in the market is currently 4.4% [4] and the U.S. ten-year yield is at 4.5%, I would say that a discount rate between 9% and 10% is appropriate. This would give Evolution Gaming a fair value between $139.87 to $167 which implies at least 31% upside.
Currently, Evolution Gaming is trading at a 5.38% cash flow yield. Given their growth prospects, here is the future cash flow yield on money invested today at the end of each year:
Risks:
There are two risks that investors must be aware of:
1. Regulatory. Evolution Gaming is an international business, and not all countries that Evolution operates in regulate online gambling. Therefore, regulators in both regulated and unregulated countries may pass laws that restrict their citizens from participating in online gambling. Simultaneously, Evolution interprets local laws about gambling to the best of their ability. If they misinterpret the laws, they may face future legal consequences.
2. Cyber security. Evolution Gaming is an online business. Although standard cyber security precautions are taken, a cyber-attack would undermine the trust of players and result in greater scrutiny from regulators.
Conclusion:
Evolution Gaming is a fast-growing company in a fast-growing industry, trading well below its fair value. Its growth is not driven by expensive capital expenditures, but rather organic growth.
Its 60%+ operating margins and 50% payout policy speaks to management being competent and shareholder friendly.
The moat of the business is not simply a result of their technical expertise, but by the fact that it mathematically makes sense for casinos to partner with them.
Although there are some key risks associated with this investment, the growing shareholder returns and cheap valuation makes the risk adjusted returns attractive.
My Current Holdings
[1] Online Gambling Market Size & Trends Analysis Report, 2030 (grandviewresearch.com)
[2] Online Gambling Industry Doubled in Four Years and Hit 176M Users and $95B in Revenue in 2023 | News | FOCUS ON Business - Created by Pro Progressio
[3] H2 Gambling Capital’s Expanded Company Research Analysis Shows Year on Year Revenue Growth of 11% in Q2 2022 (h2gc.com)
[4] ERPbymonth.xlsx (live.com)