Description

BACKGROUND

Everi is a diverse gaming supplier operating 2 core business segments (Gaming and FinTech) with a presence in over 840 casinos across 37 US states and 9 Canadian provinces. 

Games Segment (~55% of Revenue and EBITDA): leading designer and supplier of gaming machines and systems 

• 90% of revenues generated via leasing or sale of slot machines with remaining 10% coming from a NY Lottery contract, gaming systems sales, and interactive revenues.
  
• The company entered the slots business in 2014 via the acquisition of Multimedia Games (MG) which provided Cl. II games in tribal casinos. Over the past several years the company went on to enter the Cl. III market and commercial casinos as well. Roughly 2/3 of the installed base is now in tribal casinos. 
  
• The company entered premium game installations 6 yrs ago and has grown the installed base to 3.4k units (~25% of its total installed base)
  
• Everi also produces the top slot tournament system in the industry (TournEvent) with more than 5k active units in North America across 425+ casinos.

FinTech Segment (~45% of Revenue and EBITDA): leading provider of casino floor kiosks/ATMs and related products and services such as compliance/audit, online payment processing, and check verification. Revenues are generated primarily from fee surcharges for ATM transactions, cash advance transactions, and check warranties. 

• EVRI has significant scale, processing over 110m financial transactions annually totaling ~$29bn 
  
• They are the market leader in the cash access business with over 70% market share. 
  
• In mid-March the company announced a small bolt-on acquisition of a leading provider of loyalty solutions in the gaming industry (Atrient)

INVESTMENT THESIS

High quality business: significant amount of recurring revenue with sticky customer base and operating in 2 industries with high barriers to entry

High recurring revenues: Roughly 75% of revenues are highly recurring. In its gaming operations business (~35% of total revenues) EVRI has a large installed base of machines in which the company earns daily leasing fees and participates in unit revenue with the casinos. On the FinTech side, cash access contracts (~32% of revenues) typically last 3-5yrs and are based on the underlying dollar transaction amounts at casinos and the contracts are nearly always renewed. FinTech equipment (Kiosks/ATMs/cage dispensing units, cash recyclers) generates ongoing software/maintenance revenues (~8% of revenues).

High barriers to entry: Casinos (and all related activity therein, including cash access) are highly regulated and the licensing process is onerous given it needs to take place on a state by state basis. The company has 673 gaming licenses and 34 money transmitter licenses.

High customer retention: The cash access business has a 92% customer renewal rate

Strong gaming growth trajectory: (1) share gains as casinos are diversifying their floor space away from larger suppliers, (2) new gaming cabinets are performing well and driving up yield for the installed base (which in turn bolsters market share capture), (3) premium/WAP units increasing as % of total installed base

1. Smaller suppliers gaining share

A wave of gaming supplier consolidation 6-7 years ago (SGMS/WMS/Bally Tech, GTech/IGT, Aristocrat/VGT, among others) led to significant market share concentration wherein the top 4 companies accounted for roughly 93% of ship share in 2013. There has been an inflection point since then as seen in the charts below which shows replacement ship share over time – the top 4 (Aristocrat, SGMS, IGT, Konami) have seen declining share (left chart) to the benefit of smaller suppliers which have seen share increase (right chart). Smaller manufacturer share was 30% at 2018 end vs. 20% at 2017 end.

This share gain is on top of already existing industry tailwinds as casino operators began reinvesting in their gaming floors again beginning in 2017 resulting in increased replacement unit sales market wide over the past few years. Industry data implies replacement sales improved 5-6% y/y in late 2018 and operator surveys suggest a replacement rate of ~8% for FY’19 which is among the fastest rates over the past decade. Accordingly, EVRI’s gaming units sold grew at a 23.5% CAGR from 2016-2018 far outpacing overall industry sales growth. 

EVRI market share stands at ~4% (~38k units out of ~1mm total gaming machines in NA) currently with the goal to get to double-digit share in the next few years. This is a differentiating factor within the space as it’s not feasible for top suppliers to organically double their installed base.

2. New gaming cabinets are performing well = higher unit yield and higher ship share 

Daily win per unit (DWPU) inflected this year as unit performance is improving following capital investments in new cabinets and games to update the installed base. DWPU has increased y/y for 6 straight quarters now and ticked notably higher in 1H’19. EVRI’s slot product line has been significantly expanded and some of its latest offerings have been among the top performing gaming units industry-wide. There’s still a pipeline of titles that have yet to hit the market so expect growth to continue.

3. Premium/WAP units increasing as % of total installed base 

Premium units are now ~25% of the installed base and these have been upgraded as well – 17% of premium units are older cabinets as of 2Q’19 vs. 53% at FY’17 end. Of the 3.4k premium units ~23% are wide-area progressive (WAP) units vs. 14% at 1Q’18 (WAP are typically highest yielding units)

FinTech’s consistent growth is underappreciated by the market. New innovations in pipeline will drive continued strong growth trajectory.  

Top line growth in the segment has consistently been in the HSD/LDD range. The core cash access business has now had 19 consecutive quarters of growth in same-store transactions and dollars processed. Total dollar amount processed increased 10.2% y/y in 1H'19 and 11.7% in FY'18. Segment revenues have grown at a~12% CAGR since FY'16. Revenue growth drivers are broad based including: new customer wins, new property openings, entrance into new markets, introduction of new product extensions, and increasing equipment sales/maintenance. Revenue should be able to grow in low to mid-teens CAGR over the next few years with much of this growth falling to EBITDA and FCF given very high incremental margins for most of this business and low capex needs.

1. High contract renewal rate and good track record for competitive customer wins

The top 5 customer contracts for the business have all been recently renegotiated and renewed for multiple years. During the last contract renewal cycle 100% of the company’s top 40 customers stayed with them. EVRI has historically capture 60-80% share of new casino openings as well as 30+ competitive wins per year over the past few years. ATM transaction volume has grown at a ~11% CAGR over the past 2.5yrs and cash advance dollars processed has grown at a 14.3% CAGR – some of this is obviously due to economic tailwinds as casino GGRs have been increasing, but it also reflects the company's success in retaining customers and signing new ones.

2. Kiosk replacement cycle 

Kiosks are now at the cusp of a new replacement cycle – earlier this year the company estimated that ~70% of customer  kiosks are now greater than 3yrs old (of ~4k kiosks deployed in the market). 1Q’19 saw the company sell the highest number of kiosks in 14 quarters. Equipment revenues increased 50% y/y in 1H’19 (excluding impact of Atrient acquisition). A refresh cycle also drives higher maintenance and service revenues. 

3. Expanding products/verticals

The company’s product offering hasn’t remained static – new extensions and innovations that improve casino efficiency are regularly added which then leads to stickier customer relationships. The company added an AML compliance product last year and with the Atrient acquisition the company significantly expanded its foothold within the self-service loyalty market. Other recent product extensions include QuikTicket, RecyclerXchange/CageXchange (products that automate tasks and enhance controls to reduce cash handling), Jackpot Xpress (tablet based app that accelerates the slot jackpot payout process)

4. Digitization of wallet to connect the entire gaming ecosystem will be a long-term growth driver

The company is testing a digital wallet with 2 major customers currently. This would be a mobile app available to casino patrons that connects gaming, sports betting, cash access, loyalty programs, and retail. 

An omnichannel that interconnects the entire customer ecosystem of a casino is a hugely attractive value proposition for operators. 

It provides a better more convenient customer experience as cash access and loyalty rewards are more efficiently obtained. It would integrate funding/payments across online gaming, sports wagering, and non-gaming (retail, food & bev, hotel) which has the potential to drive higher overall spend. In general, increased customer touch points tends to drive higher transaction volume. 

It gives casino operators greater insight into guest activity/behavior which would drive more effective marketing and promotional spend. It also opens the door for new transaction types that can drive further revenue growth. Cash management is a burdensome part of running a casino floor and operators would be eager to bring more efficiency to this and lower operating costs. Feedback from the test phase has been positive so far with casinos noting improved efficiency after implementation.  

With its dominant position in the casino-based payments market EVRI is best situated to take advantage of this shift to digital as they can leverage their expansive land based footprint. With digitization comes the opportunity for price increases as EVRI has the potential to offer a much more compelling and comprehensive cash access product to its casino customers.

Free cash flow generation set to increase significantly which will drive deleveraging and help re-rate equity  

FCF will double to ~$50m in FY’19 and should double again in FY’20 to ~$100m bringing net leverage to 4.2x at year-end and 3.5x at FY’20 end. This is critical as high leverage has left many investors on the sidelines with this name. ~$100m of FCF next year implies a ~14% FCF yield. FCF increase driven by ongoing growth/share gains/innovations across the entire business as detailed earlier as well as a couple affecting capital needs in the Gaming segment:  

1. End of gaming investment cycle – new gaming units are performing well and driving up yield 

In the years following the MG acquisition EVRI made necessary strategic investments to differentiate its games offering and upgrade to more modern cabinets. The company is now on the cusp of realizing returns on these investments and as mentioned earlier is seeing a material increase in yield (daily win per unit) for its installed base. The percentage of the installed base that has been refreshed/upgraded has been steadily increasing q/q (just 17% of premium units are older cabinets now) and they are close to end of this investment cycle which should allow capex to tick down. 

2. Fall off of payments related to the Player Station Agreement. 

EVRI has paid placement fees over the past several years ($57m payments from FY’16 thru 2Q’19) to secure gaming equipment on the casino floor for one its largest tribal casino clients (Player Station Agreement). The company made its final payment under this agreement in July ($5.6m). Going forward the related placements will remain in the company’s installed base for at least another 4.5 years (i.e. thru end of 2024) without additional placement fees (which is valuable from earnings visibility/stability standpoint)

Potential for sale of company

In late May, Bloomberg reported that EVRI was exploring strategic alternatives including considering a sale, in whole or in part. Per the article, the company has been working with a financial advisor to solicit offers from potential buyers and has drawn interest from private equity firms. Given its leading market share and high FCF/asset-light business model the FinTech business would make an attractive PE target. This segment is particularly mispriced given it could realistically fetch a 10-11x EBITDA multiple in a sale (vs. EVRI’s FY’19 EV/EBITDA of 6.7x).

Valuation / Price Target 

Valuation is attractive with shares trading at 6.0x and 5.0x my FY’20/21 EBITDA estimates (14% and 19% FCF yield respectively). LTM leverage is high at 4.7x but expect this to fall rapidly given the FCF generation outlined earlier. 

At 7.0x FY’20E EBITDA shares are worth $13 (+47% 12-mth upside) which implies a ~10% forward FCF yield. There’s significantly more upside on a longer horizon as there’s a strong multi-year growth story with the name along with substantial deleveraging. Expect the company to de-lever ~2 turns by FY’21 bringing net leverage to 2.8x at which point the market will be more likely to shift to a FCF valuation and justify a higher EBITDA multiple. I think the company can generate at least $1.50 FCF/share in FY'21, which at an 8% yield equates to $18.75/share (+114% upside)

In a sale scenario (which is possible in the near-term) shares would be worth upwards of $16 (80%+ upside) assuming the Gaming business is valued at 8.0x and FinTech at 10.0x (conservative vs. historic transaction multiples). 

Catalyst

Earnings announcements show evidence of increased share capture, increasing free cash flow, lower leverage

Outcome of strategic review results in sale of company or one of the segments