Description

Jumbo Interactive Ltd (ASX: JIN)

Elevator pitch:  Focused and founder led, JIN is a high quality, highly cash generative business operating in the online lottery industry in Australia, an attractive vertical with a favorable duopolistic market structure and long growth runway due to a mix shift away from off-line channels and foray overseas.  We believe the stock can deliver a total IRR in the mid-teens in our base case, with the opportunity for the stock to roughly double over the next 3 years in our upside scenario based on JIN successfully growing its nascent SaaS/Managed Services offering.  We see limited downside at this levels due to the defensive nature of the business, high and resilient margins, strong cash generation and upcoming positive catalysts.

Business description: Established in 1995 by CEO Mike Veverka (ownership: c.15%), JIN is an authorized reseller of official digital Australian lottery tickets via its proprietary mobile app (c.65% of TTV) and Oz Lotteries website (c.35%), with a c.20% share of online lottery sales.  Lotteries operators are licensed at a state or territory level, with key operators including JIN, The Lottery Corporation (ASX: TLC) and Lotterywest (government-owned entity).  Jumbo is diversifying their lottery retailing business (80%+ of EBITDA) by leveraging their lottery platform into higher margin SaaS and Managed Services for charity, school and local lotteries in Australia, U.K. and Canada.

JIN operates 3 divisions:

• Lottery retailing - Jumbo has a national agreement with TLC and Lotterywest in Western Australia to distribute lottery products online. Key products are Powerball (c.50% of TTV) and Oz Lotto and Saturday Lotto (each c20%). L-T revenue growth: +6-8%; FY23 EBITDA margin: 30.1%.  JIN pays a variable % of TTV to TLC and Lotterywest and charges customer a service fee. 
• SaaS - JIN licenses its ‘Powered by Jumbo’ digital lottery platform to government and charity lottery operators. FY23 EBITDA margin: 65.3%
• Managed Services – JIN provides lottery platform and lottery management services, including payment processing, to charities that are looking to establish and run a lottery program.  JIN has been growing this business both organically and via acquisitions by acquiring Gatherwell (Dec ’19 - £17m – U.K.)  Stride (Jun ‘22 - $12m - Canada) and StarVale (Nov ’22 - £23m – U.K.). FY23 EBITDA margin: 42.9%.  Margins should go up as the business scales and businesses acquired are fully integrated (one integrated platform, shared tech support and larger marketing budget).  

Industry overview:  

The lottery market in Australia has proven to be both consistent and highly resilient over the past three decades: 

Source: JIN and TLC investor presentations

In addition, the share of tickets sold online has continued to increase due to customer preferences and convenience, with the trend accelerating during COVID-19 due to lockdowns benefiting online channels and high levels of government stimulus boosting TTV.  While online share gains have slowed post CV-19, we expect online sales penetration to continue to grow, with share of online lottery sales as high as 60-70% in some countries.

Source: JIN investor presentations

Source: JIN investor presentations

Discussion points

• Yearly lottery sales are dispropertionaly driven by the number of large jackpots, which are inherently difficult to predict and can greatly vary year to year.  Larger jackpots tend to capture the interest of consumers that play the lottery on a less frequent basis and see regular players spend more.  Conversely, the absence of well published large cash prizes sees engagement and value per transaction drop.  As such, lottery sales are difficult to model and can create volatility in the stock as lottery TTVs are closely tracked by analysts.  However we believe the combination of inflecting lottery volumes after a difficult FY23/1H24 and recent changes made to Powerball and Oz Lottery to increase the size of jackpots bode well for JIN.  See next section for detail.

• What is the terminal value of a reseller and do these businesses deserve low multiples?  JIN operates under license agreements in a heavily regulated industry and as such, is dependent on these licenses being renewed.  Given the uncertainty, it can be argued JIN should trade at a low multiple due to its questionable terminal value.  This came into play in 2020 when the TLC agreement came up for renewal and investors were worried the agreement would either not be renewed or licensing fees increased.  While the contract was renewed for 10 years to August 2030, TLC did increase fees (“Pursuant to the Reseller Agreements with TLC dated 25 August 2020, a ‘stepped-up’ service fee is payable in the subscription cost of the tickets purchased at 1.5% FY2021, 2.5% FY2022, 3.5% FY2023, and 4.65% FY2024 and thereafter”).  We believe the risk of the TLC licence not being renewed is very low.  JIN has had a 20-year uninterrupted relationship with TLC/Tabcorp and TLC agreed to new long dated deal with JIN.  We believe JIN is well entrenched in an industry that has high barrier to entry, offers a robust and reliable solution ($50m+ spent to build the platform and years of marketing to build the brand) that provides a seamless experience (takes minutes to sign-up and play, it is fully secured and JIN takes care of the payment processing), has a trusted brand and local digital marketing expertise.  Regarding the fee increase, we believe the previous fee was just too low and TLC essentially played catch-up with the new agreement.  We believe the gradual increase in take-rate has now brought TLC margin in-line with that of the industry (online is usually 3x more profitable than off-line, margins we believe TLC has now achiewed under the new few structure).  Lastly, both TLC and JIN have enacted ticket price increases, which should more than offset the headwind for JIN from the last contractual fee increase this year. See next section for detail.

Why now?

• Lottery volumes are rebounding this year after a run of unfavorable jackpots in FY23 (see table below) and difficult comps vs. strong growth during Covid-19.  Powerball currently has a record A$200m jackpot, the biggest lottery prize in Australian history, and player engagement across all products are up after a slow start to the FY.  

TTV growth (source: TLC investor presentation):

• TLC (and lotterywest) enacted a 10c base price increase on Powerball tickets in May ’23.  In addition to this, JIN increased its online price by 10c, for a c18% total price increase online. TLC price increase took the base price ticket from from $1.10 to $1.20 , with larger price increases passed in WA.  In addition to the Powerball 10c service fee increase, JIN also increased ticket prices by 5c for all other games.  The Powerball price increase from TLC (first in 5 years) is expected to deliver larger jackpots as a result of increased prize reserves.  This will benefit JIN TTV and margins and we don't expect the new higher prices will impact demand for JIN.   

• In addition to the price increases discussed above, TLC recently made changes to Oz Lotto to also increase the size of jackpots (i.e., fewer but larger jackpots) and change draw dates to avoid clashing with larger Powerball jackpots.  These changes should drive renewed interest and engagement around this product which has suffered from the popularity of the Powerball.

• The SaaS and managed services opportunity offers a longer-term growth option that is currently not backed into the stock price.  We believe JIN has optionality to accelerate growth with SaaS and Managed Services (a $3bn and $5bn TAM, respectively) and continue to diversify away from the core Australian lottery business.  With its M&A strategy now in place and beachheads established in Canada and the U.K., JIN can continue to self-fund acquisitions via FCF generation/modest leverage (JIN has no debt left from prior acquisitions – the $15m of debt used to fund StarVale acquisition was fully repaid by Jun ‘23).  We expect this opportunity to drive growth and add a higher margin revenue stream to the mix, with the opportunity to grow the business overseas.  While we don't expect this be an overnight success (and we actually want JIN to carefully expand into these new verticals - the track record for Australian bueinsses expanding overseas is not exactly stellar) we don't believe this scenario is baked into consensus expectations - see our bull case below.  JIN commented the acquired businesses should be fully integrated this year, with margins improving post integration.  JIN is now accredited in British Columbia and is awaiting approval in Ontario, for a full coverage of key Canadian states.

• Current valuation multiplies are attractive given the growth profile and quality of the business.  We believe the de-rating experience in ’22-’23 reflects the de-rate in the tech sector in general rather than anything structurally wrong with company (other than the poor jackpot run in FY23 that was well telegraphed and transient in nature). Given the catalysts in place (uptick in volume + price + growth in SaaS/Managed Services), we don’t see any reasons for JIN to re-rate and revert to his long-term average over our investment period.

Forward EV/EBITDA

Expected Return and Risk-reward

Catalyst

 - Impact of price increases on TTV and margin (1H24 earnings)

- Improvement in lottery TTV in the back-half of FY24 with color provided during 1H24 earnings

- Growth in SaaS/Managed Services along with develiry of synergies and improvement in margins