Description

Thesis:

We believe Evolution is an attractive long because it is the dominant provider of live casino content for online gaming operators globally with a wide moat and a multi-decadal secular growth runway ahead as online gaming grows to become a larger portion of the global gaming TAM, yet is trading near an all-time-low P/E valuation after a recent sell-off, creating an attractive entry point and a 65-80% upside / 20%+ IRR opportunity.   

85% of Evolution's revenue is generated from live casino and is the focus of the investment case. 15% of revenue that is generated from RNG slots does not grow nor move the needle so we do not focus on it here. Live casino is a great category and is the fastest growing vertical in the gaming landscape that is a primary beneficiary of the secular shift from land-based to online gaming. Online gaming (includes live casino, RNG slot games, digital poker, etc.) is about 15% penetrated into the ~$250bn global gross gaming revenue (GGR) TAM (land-based casinos represent the other 85%). Live casino is roughly 30% penetrated into online gaming, so is 4-5% penetrated into the overall global GGR TAM today. Live casino is an immersive player experience that enables play and interaction with real dealers on blackjack, roulette, craps games, etc., live, through mobile or PC devices. Live casino offers more interesting and entertaining game variants compared to in-person games on casino floors, which when coupled with the convenience of being able to play from virtually anywhere with an internet connection (assuming your local geography allows online play), is expanding the overall GGR TAM by bringing in new players and increasing the frequency of existing player activity. We believe the live casino category can increase its penetration into the global GGR TAM by 2-3x over the long-term to 15-20% of global GGR, driven by online gaming increasing to 40%+ of global GGR and live increasing penetration into online to 40-50% as more geographies legalize online gaming and more players become attracted to the live category.

Evolution is widely recognized as the best B2B provider of live casino games and dominates with 75-80% market share by revenue globally, supplying B2C operators such as Flutter / Draftkings / etc. with live casino content for players to play on their websites. From a high level, we believe Evolution is a very high quality business. EVO grows topline 20%+, has 70% EBITDA margins and 50% FCF margins, 100%+ tangible ROICs / 30%+ ROICs including intangibles, revenue is nearly 100% usage-based / recurring, we estimate customer retention rates are >95%, and new game development is creating new revenue streams which benefits growth and widens EVO's moat (e.g. entry into new categories such as game shows and online lottery as well as creation of unique variants on existing games that drives differentiation and player engagement). For a more detailed description of Evolution's business and background, please refer to Ed Young's (MS Gaming Analyst) initiation report (Ed is the best analyst on the name; we recommend doing an intro call with him if interested in the name). 

When we first looked at Evolution in 2020, we initially struggled to understand what if anything that EVO does is difficult to replicate. However, after extensive calls with formers, competitors, customers, and management over the last several years, we believe EVO does in fact have a wide and sustainable competitive advantage, driven by two key reinforcing factors:

1. EVO’s significant scale (4-10x+ larger than their nearest competitors enabling significantly higher R&D spending on game creation and tech development) creates a flywheel effect of product innovation that is difficult for competitors to match (EVO is releasing 100+ games in 2023 vs. its nearest competitor Playtech 20-25; new game releases drive player activity). Because EVO has so many resources, it can test and perfect its games more than anyone else, which enables the Company to have the best and most entertaining games that generate the highest player volumes and in turn the most revenue for operator customers. This is best evidenced by the average revenue generated per game of EVO vs. peers; talking directly to peers Playtech and Pragmatic Play, they admit EVO generates 2-3x or more revenue per game on a like-for-like basis on average (there isn't one thing we can point to for why; it's a combination of 50+ "small details" that all add up to a better game and player experience; we recommend talking to formers to understand this point).
2. The unit economics of the industry supports a winner-take-most structure, which reduces the risk of competitive encroachment. EVO typically charges operator customers a 10-15% take rate on GGR; a competitor looking to gain share can come in and offer a 50% discount, or a 7.5% take rate (or more if they wanted), but unless that competitor's games can generate at least 85% of the revenue per game that EVO can generate, the operator would make less money, so is instead incentivized to stay with Evolution despite the higher take rate (e.g. the math is if EVO can generate $100 of GGR on a game less 15% EVO take rate = $85 of net gaming revenue to the operator, since competitors can only generate the equivalent of $33-50 of revenue per game on average across their portfolio relative to EVO due to the inferiority of their games, the operator would make only $31-46 of NGR by favoring a competitor's game placement over EVO's, not even close to what EVO can bring in). Competitive advantage point 1 makes it hard for competitors to generate enough revenue per game to overcome competitive advantage point 2, hence the reinforcing effect which we find attractive.    

When we look at EVO's forward revenue growth opportunities, we see solid growth maintaining across geographies. Europe (33% of revenue) is the most mature market but is still growing healthily in the mid-teens. Asia (~40% of revenue) is the largest gaming market globally with a 3bn+ population and penchant for gambling; much is done offline today but as 4G and 5G mobile devices proliferate and per capita wealth increases, penetration of online gaming will continue increasing. We think the Asia geography can grow at a 40%+ CAGR the next several years. North America is 12% of revenue and we believe can grow at a 25%+ CAGR the next several years as existing legalized states mature and new states legalize. LatAm (8% of revenue) is an exciting new continent that is in the early stages of regulating and we believe can grow 40%+ the next several years as live casino gains more adoption. Rest of World (3% of revenue; contains Africa and Oceana) is flattish as EVO isn't focusing on these geos. 

Lastly, we believe EVO's management are excellent operators and have a strong track record of success. Martin Carlesund (CEO) is a workhorse and drives the organization forward at a fast pace of innovation. Todd Haushalter (Chief Product Officer) is widely recognized in the gaming industry as one of if not the most brilliant minds in game design. He is the creative engine at Evolution and is a huge asset. We like that there is significant insider ownership (~15% of the company) that aligns management and the board with shareholders.

Our main knock on EVO is its revenue diversification strategy into RNG slots (purchased NetEnt and several other small RNG studios over the last several years). So far the RNG strategy has not worked as this revenue stream is roughly flattish as EVO is having to re-architect the NetEnt platform and invest more in game development, not to mention the RNG category is significantly more fragmented with significantly lower barriers to entry and lower take rates. We view RNG as a call option that if it can grow, great, but if not it isn't significant at only 15% of revenue and doesn't really matter for the investment case. 

Valuation:  

We think EVO can grow total revenue at a low 20s CAGR through 2026 and modestly expand margins into the low 70s, culminating in €8.50 of 2026 EPS, materially ahead of consensus. EVO has historically traded at a trough P/E of high-teens and peak of over 40x with an average (ex-2021 when market valuations were nonsensical) of high 20s. Using the lower-end of EVO's historical P/E range to account for slower growth prospectively than historically simply due to law of large numbers and growth dilution from now having RNG revenue, at 20-22x P/E on 2026 EPS of €8.50 we get a price target of SEK 2,100-2,250 including dividends received for 65-80% upside and a low-mid 20s IRR over 2.5 years through 12/31/25.

In a downside case where competition is more successful at taking market share and if we assume the live category slows by more than we expect due to prolonged weakness in global macro conditions (GGR is historically not very cyclical but ultimately it is a discretionary spend so it exhibits some cyclicality), we get to €5.50 in 2025 EPS * 17x (assuming the multiple de-rates to its all-time-low) = SEK 1,110 for only 10-15% downside.  

Given the multiple compression EVO has seen YTD (now trading at 20x 2024 consensus P/E), we believe EVO is an attractive and asymmetric investment opportunity at current levels (a high quality 20%+ EPS grower with 70% EBITDA margins and relatively low cyclicality trading at 20x P/E). 

Risks:

Regulatory. This is the most debated topic on EVO and one where we believe we have a differential view that makes us comfortable with the position. 40% of EVO's revenue comes from "regulated" markets where online gaming is explicitly legalized and overseen by regulators. 60% of EVO's revenue comes from "unregulated" markets where online gaming is not overseen by regulators and there are no laws in place stipulating whether online gaming is explicitly legal or illegal. EVO does not generate revenue from geographies that are "black markets" where there are laws in place that explicitly ban online gaming (e.g. Australia, or New York State) or are U.N. sactioned countries (e.g. Iran). The debate in the stock lies in investors' opinions around EVO's unregulated exposure.

Bearish investors and some sell side analysts (who in our opinion misunderstand this topic) take the view that unregulated exposure = bad and is a big risk for EVO's business; the risk being we could wake up one day and all of a sudden a piece of EVO's business could be gone because the unregulated market revenue went away. However, we believe this view fundamentally misunderstands what unregulated revenue even means and we encourage investors to do their own diligence and speak to formers, competitors, and regulators to better understand this key dynamic. Unregulated means there are no laws in place stipulating whether the activity can take place or not. There are many parallels to other industries with similar dynamics. Take Uber for example. In some geographies like NYC, Uber is regulated where drivers must have a specific license to operate in the geography. In many other geographies, Uber is unregulated, meaning they can operate how they choose without stipulations from regulators. Many countries have laws in place that make land-based casino gaming illegal but do not cover online gaming, which enables online activity to take place, and this has been the case for years. 

The risk with unregulated markets is that they can change – regulators in a geo can decide to legalize online gaming to collect tax revenue and monitor activity, which can cause temporary disruption to GGR while the regulatory process is sorted out, or they can decide to explicitly ban online gaming and make that geo black and the activity cease. However, an analysis of unregulated countries over the last two decades shows the trend is overwhelmingly toward unregulated markets either staying unregulated or turning to legalized regulated markets (there are only a few isolated occurances of markets turning black; Australia being one, the U.S. being another in the mid-2000s before turning white on a state by state basis beginning in 2013 with NJ). EVO's business in Asia is the biggest question mark for investors, as nearly all countries in the region are unregulated markets. However, when you drill down, this revenue is generated from a wide swath of countries from within the region with no material concentration. This is an important point that we think investors miss – how geographically diversified EVO is with no country making up more than ~5% of revenue (besides the U.S. but the U.S. is regulated state by state, so that limits exposure further). This means even if one or a few countries were to come out with unfavorable regulatory changes to turn white or black all at once in one year, EVO has enough other geographies growing independently that they can sustain overall growth (e.g. Germany turned from unregulated to regulated in 2021 and in the process of required operators to exit the market for a period of time. Germany was 7% of EVO's revenue and fell by 50% during this process. Despite this revenue hit, it was barely noticeable in the financials as EVO continued growing in other geos). We think the trend of unregulated markets likely staying unregulated or moving to regulated coupled with EVO's wide geographical diversity limits the regulatory risk the Company faces. 

Competition. Competitors have been trying to knock down EVO for years and many have failed while market share of the #2 and #3 players has been relatively stagnant. NetEnt tried standing up a live casino product for 7 years and finally shut it down in 2020 after not gaining any traction. Playtech has ~15% market share by revenue followed by Pragmatic Play with ~5% market share by revenue. These two are legitimate competitors but they largely copy EVO's games and lack quality innovation of their own to displace EVO in any material way. On Air Entertainment and a handful of other new entrants within the last 6-24 months are in various stages of building out studios in Europe and LatAm to try to break into the industry, but so far the market share of each of these players is <1% and we believe it will be difficult for them to scale outside of fringe tier 2 and tier 3 operators due to the competitive advantages of EVO we discussed.

There are also several B2C operators who are attempting to build out live casino products of their own, some for in-house use, and some for B2B white label use. That said, we believe the in-house use case will be isolated and not impactful (it's just hard for an operator to invest enough R&D to develop a competitive enough game that will only be used for their own website, whereas EVO and other third party competitors can amortize their R&D across all of their customers; the risk for an operator is if they favor their own in-house games or lower-quality competitors' games that players don't like, those players will leave and go to other operators' websites that have EVO's games), while we understand the B2B white label use case is going to be developed and rolled out slowly and incrementally (after already failing twice; this is the third try), so we do not expect any material impact to EVO from B2C operators trying to insource. 

Catalyst

Continued 20%+ topline growth driving 25% EPS compounding over the next several years.