Value Investors Club / EVERI HOLDINGS INC (EVRI)

Description

Bc of formatting issues, here is a link to the pdf of the idea.

https://www.dropbox.com/s/2f4ud5zvh2b063c/EVRI_Writeup_Final.pdf?dl=0

Short business description:

Everi Holdings, Inc. (EVRI) is a leading provider of gaming equipment and cash access services to the

global casino gaming industry. Through its Games segment, Everi designs, supplies and services video and mechanical reel gaming

machines and related system software for tribal and commercial casino operators. Revenues within the Games segment are

generated either through a lease (Gaming Operations) in which Everi receives a percentage of daily machine net win or a daily fixed

fee, or through a one-time outright sale. As of 9/30/18, 33% of EVRI’s slot machine installed base was located in commercial casinos

and 67% were located in tribal casinos. Everi’s FinTech offerings provide casino customers with an integrated suite of cash access

services and related products, including the management and oversight of Automated Teller Machine (ATM) and other cash access

transactions; compliance, audit and data solutions; technology to improve credit decision making and cashier operations; and online

payment processing solutions. Over the 12-month period ended 9/30/18, Everi processed approximately 105 million cash access

transactions totaling $27 billion. Everi entered the Games segment in 2014 through the acquisition of Multimedia Games. The

company was founded in 2004 and is headquartered in Las Vegas, NV.

Reasons to Own Evri:

• Highly recurring revenue business: Contracts in the FinTech business generally last from 3-5 years and are based on the

underlying transactions at the casino. In the Games business, a portion of EVRI’s revenue is generated from revenue sharing

arrangements originating from its installed base of units already on the casino floor. In total 78% of revenue is recurring in

nature leading to consistent revenue and profit streams.

• Gaining market share due to secular trends: The slot manufacturing industry experienced significant consolidation in 2013-

2014. Since that time, casino operators have been moving to allocate floorspace away from the big 4 suppliers leading to a

significant tailwind for smaller competitors such as EVRI.

• Highly regulated business increases barriers to entry: Casinos are regulated by regulatory bodies at the state level. The process

of applying for licenses is cumbersome and must be replicated multiple times to have a product that can compete on a national

level with EVRI’s financial technology or slot machine products.

• Trading at significant discount to sum of the parts: Everi’s is currently comprised of two distinct business segments. Its Fintech

segment is a capital light, growing, transaction-based business. While not a direct comparable, public payment processors trade

at an average of approximately 11.5x 2019 EBITDA. A discount to these broader competitors is appropriate, however, currently

it is too wide. The average of EVRI’s gaming equipment suppliers, who benefit from a highly recurring revenue stream, trade at

an average of 7.3x 2019 EBITDA. EVRI currently is trading at 6.0x 2019E EBITDA leading to a significant sum of the parts

valuation discount.

• FCF profile set to expand significantly: The existing CEO of EVRI took over in 2016 after a failed merger by his predecessor. Over

the past two years he has allocated capital into R&D and a significant capital refreshment cycle in order to increase the quality

of slot machines on the floor. As these replacement capital expenditures are reduced over the next two years, Everi’s free cash

flow profile is set to increase significantly and reach approximately 17% based on our forecasts for 2020.

• Strong leadership team: Michael Rumbolz, the current CEO, has led numerous businesses in the gaming segment including both

financial technology products and gaming equipment suppliers. Background checks indicate he is very well connected in the

gaming industry and used to be Chairman of the Nevada Gaming Control Board. Through our interactions with the business

group heads, we believe the management team is strong at this level as well.

Exhibit 1: Highly Recurring Revenue Business

Everi operates under three primary revenue models. The first is through leasing its

slot machines to the casino for placement on the floor. Under the terms of this

arrangement Everi enters into a revenue share model with the casino in which it

collects a fee of 20% of the winnings originating from the installed machine. As of

September 30, 2018 Everi’s installed base was composed of 14,116 units, of which

9,478 (67%) were Class II tribal units and 4,638 (33%) were Class III units. Nearly

30% of the total installed base is secured by a long-term placement arrangement

with significant term remaining. The second revenue model is to sell machines

outright to the casino. Over the past 12 months, Everi sold 4,262 units,

representing a CAGR of 16% over the 2015 figure of 2,798. The average selling

price over the last twelve months was $17,489. The third business model pertains

to the FinTech business in which Everi charges casino customers a transaction fee

each time a casino patron uses the company’s cash access services or the casino

uses its compliance services. Casinos enter into 3-5 year agreements with Everi for

such services.

Exhibit 2: Gaining Market Share due to Secular Trends:

During the 2013-2014 time frame, the gaming equipment supplier industry experienced significant consolidation. Notably, Scientific

Games purchased WMS and Bally Technologies, Gtech purchased IGT, Aristocrat purchased VGT and Bally Technologies purchased

Shuffle Master. This consolidation led to the top 4 equipment suppliers (Scientific Games, Aristocrat, IGT and Konami) controlling

93% of the shipments made in the industry during that time period. The basis behind the acquisitions was to cut costs by selling a

broader array of products through the same salesforce and grow the creative team creating the gaming content. Casinos have

responded to the increased consolidation by allocating additional floor space to non big-4 companies. Everi has been a beneficiary of

this ongoing trend.

Exhibit 3: Trading at a Significant Discount to Sum of the Parts

Everi currently trades at a significant discount to its sum-of-the-parts valuation. One of the fundamental issues weighing on EVRI’s

valuation is the lack of perceived synergies between the two operating units. One of the premises behind the acquisition of

Multimedia Games in 2014 was the significant synergies that could be created from the transaction. However, the divisions still

operate almost completely separately. Furthermore, while the two operating units share many common customers, they each sell to

very different client touchpoints.

Since Mr. Rumbolz took over as CEO in 2016, he has invested heavily to expand the types and number of games that Everi offers.

These expentitures have been a significant use of cash over the past two years and has been a prime contributor to the

undervaluation of the security. Even in the absence of M&A, we expect this cash flow to grow significantly in the following years

leading to a strong return for investors.

Another reason for the wide discount to fair value is due to the two businesses having very different financial characteristics. The

businesses have very different levels of capital intensity and growth profiles. Investors are thus having a hard time assigning the right

multiple to the company.

Exhibit 4: FCF Profile Set to Expand

Everi FCF profile is set to expand significantly as two underlying dynamics take place through 2020. The first originates from

management’s significant investment over the past two years in the Games segment. The Company has used the strong free cash

flow profile of the FinTech segment to invest in R&D and capex to drive better operational metrics in the Games segment which is

beginning to take hold and drive higher earnings power. The second impetus is the substantial reduction in capital expenditures. In

order to secure placement at one of its largest Indian Casino clients, management has paid placement fees over the past 3 years

amounting to approximately $28m. When these expenditures cease in 2020, the Company will have a 4 year horizon to realize

economic profits from its guaranteed installed base at this clients facilities. Furthermore, Everi has been investing significant capital

to replace existing, older units with the its newer machines that have been performing better. Management has indicated it is

around 60% of the way through this replacement and once completed it will free up $20m of spending from capital expenditures.

Below is a chart demonstrating the significant ramp of FCF through 2020E. If management hits these expectations, the Company is

currently trading at an approximately 17% FCF yield.

Exhibit 5: Private Market Value

As previously mentioned, during the 2013-2014 time frame, there was significant M&A in the space. The strategic merit behind

many of these deals was to realize cost synergies from duplicate spending (such as sales force) while retaining the creative talent to

continue to grow the gaming catalogue. As you can see below, the gaming transactions have been at a significant premium to where

EVRI currently trades.

Key Risks

• Macroeconomic: Demand for EVRI’s products is dependent on favorable industry conditions in the casino industry. To the

extent gaming revenues decline, this could have a negative effect on EVRI’s revenue and profits.

• Leverage: Everi is currently leveraged at 4.8x TEV / EBITDA and this is plainly too much for the company. The CEO has

suggested that if EVRI sold the Games division it could paydown all it s debt. However, in the absence of this, the company

must work to paydown debt with its expending future free cash flow. Management is currently allocating excess cash to

payign down the debt balance.

• Passage of regulatory change in Texas or at Indian Casinos: As of September 30, 2018, gaming operations units installed

with operators in Oklahoma comprised 48% of the total installed base. Gaming patrons residing in Texas generate a large

portion of Oklahoma operators’ gross gaming revenue. Thus, to the extent Texas were to pass legislation allowing for the

operation of regulated commercial gaming facilities within the state, it would have a material adverse impact on Oklahoma

tribal operators’ gross gaming revenues and, subsequently, Everi’s earnings potential. As of now there is no indiction this is

being considered.

• Non renewal of FinTech contracts: Everi’s standard cash access contract covers a term of three years. Thus, in an average

year, approximately one-third of the company’s cash access contracts come up for renewal. Although Everi has historically

had success renewing the large majority of its cash access contracts, we believe the loss of a contract, particularly one

involving a large multi-site operator, could adversely impact the company’s revenues and operating profits.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Potential sale or spin of the FinTech division

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			2018	2019
Price:	5.90	EPS	0	0
Shares Out. (in M):	72	P/E	0	0
Market Cap (in $M):	425	P/FCF	0	0
Net Debt (in $M):	1,056	EBIT	0	0
TEV (in $M):	1,481	TEV/EBIT	0	0