Despite the threat of government intervention and regulation, the sector has strong prospects and is an obvious area for investors to consider, according to Edison Investment Research.
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Already game over or a clear investment opportunity?
Online gaming is a lucrative sector, which generated £40 billion of gross gaming revenues (GGR) last year. Although the threat of government intervention and regulation seems to be increasing, investors are aware of the sector's strong prospects and it is an obvious area for them to consider, with stocks capable of delivering diversification and scale the best option.
A significant market
The global gaming and betting market's GGR have grown at a 2.3% CAGR between 2012 and 2018 to c £347 billion, and the sector has an average dividend yield of 6.0%. Online gaming comprises 11% of total global gaming and the global online gaming market has grown at a c 10% CAGR over the past ten years, amounting to c £40 billion GGR in 2018. Data intelligence consultancy H2Gambling Capital estimates online growth of 7% CAGR to 2023 which would raise the online share of global gaming to c 14%, far surpassing the expected growth for the land-based market at c 2%.
A key driver for online gaming growth has been increased mobile penetration rates. H2GC estimates that global mobile usage for online gaming will rise from c 41% (2018) to over 50% by 2022. Another important factor on online gaming growth has been the widespread introduction of local regulations for online gaming.
Regulation on the rise
The online gaming sector has been increasingly restricted by many governments, aiming to control the market size, the number of participants and to curb the level of illegal gambling. In fact, several countries have banned gambling completely.
However, there is a wide range of regulatory frameworks in place. These frameworks range from what is known as black to white. 'Black' refers to the explicitly prohibited, while 'white' refers to licensed markets that are fully open to commercial operators, known as 'regulated' markets. In addition, there is what is known as 'grey' frameworks. This refers to many jurisdictions that have yet to legislate for online products and the framework remains ambiguous.
Clearly increased regulation is likely to cause a stifling of growth in the sector, with fewer people playing and less money to be made due to rising gaming taxes, consumer protection initiatives and advertising restrictions. In those 'black' countries where online gambling is completely illegal, such as Turkey, and which impose heavy bans on e-gaming, like Poland, we can see a much smaller market size compared to certain 'white' markets (£200 million and £300 million market size for Turkey and Poland respectively).
However, in these 'white' countries there does not seem to be a significant drop in activity, partly because there has been a clear trend towards updating regulations to make them appropriate for online and mobile gambling. With this in mind, while regulation brings its own challenges, generally this 'white' regulation does create more opportunities for operators to enter markets.
An example of this is the UK market. This is one of the many regulated online gaming markets and is the largest globally, estimated to be about £6.4 billion (2018).
Its gambling market is fully regulated and had a GGR of £14.5 billion for the 12 months to September 2018. Some £5.6 billion of this came from the online gaming market, 39% of the total.
However, despite many entrants being attracted by the UK's permissive white regulation, the regulatory environment is becoming increasingly challenging and legislative burdens, including additional social responsibility measures, advertising restrictions and ID checking have led to higher taxation and a slump in the overall growth of online gaming.
|Name||Quoted Currency||Market Cap (m)||EV/EBITDA (x) FY19||EV/EBITDA (x) FY20||P/E (x) FY19||P/E (x) FY20||Dividend yield (%) FY19|
|888 Holdings (LSE:888)||GBp||595||7.1||6.5||13.7||12.4||5.8|
|Flutter Entertainment (LSE:FLTR)||GBp||5384||14.8||13.1||22.3||19.6||2.7|
|GVC Holdings (LSE:GVC)||GBp||3645||8.4||7.2||10.6||8.5||5.6|
|JPJ Group (LSE:JPJ)||GBp||512||7.9||4.5||7||5.8||5.5|
|Rank Group (LSE:RNK)||GBp||600||5.2||5||10.8||10.3||4.9|
|The Stars Group (TSE:TSGI)||CAD||6335||9.8||9||9.1||7.7||N/A|
|William Hill (LSE:WMH)||GBp||1405||7.1||6.2||16||11.8||5.2|
It seems clear that a further increase in regulations on a regulated 'white' market would not be positive. Indeed, the US showed that removing harsh restrictions can be very beneficial.
The repeal of PASPA, a federal law that banned sports betting in all but four states, allowed the nation to become the world's largest sports-betting opportunity.
At present, however, states are allowed to decide whether or not to legalise and regulate sports betting.
Consequently, it is estimated that the first seven states could be generating $1.4 billion of GGR by 2021, and a further wave of states could add an additional $7.5 billion of GGR in the following three years.
'Grey' markets are more cash generative but can be volatile. This is because in these jurisdictions (such as China, Japan and Austria), the sudden enforcement of IP blocking can negatively affect share prices, such as happened in 2017 with bet-at-home.com (XETRA:ACX) (Poland) and Playtech (LSE:PTEC) (Malaysia).
Bigger is better
The sector's growth has sparked continued consolidation. In the past 18 months M&A has picked up significantly with deals ranging from £15 million (BetBright acquired by 888 Holdings (LSE:888)) to $17.3 billion (Caesars merger with Eldorado resorts). The idea here is essentially 'bigger is better'.
M&A allows operators to shift their business mix away from stagnating markets, like the UK market, and into more lucrative ones, such as the US. Moreover, by increasing their size, operators gain access to proprietary technology and diversification, both in terms of product mix and geographic exposure.
Of course, a strong balance sheet is required to deal with not only M&A, but also in order to stand tall in the face of regulatory shocks. In our view, the technologically advanced, diversified players are the best positioned and we would expect smaller operators to either be gradually subsumed or exit the market altogether.
Clear investment potential
Risks to forecasts remain high within the sector with government intervention leading to higher costs and lower revenues, particularly evident in the UK over the past year (tightening of regulation has affected the share prices of almost all UK operators).
This increasing regulation is also raising barriers to entry. In particular, gaming taxes, consumer protection initiatives (such as self-exclusion, source of funds, KYC etc), AML enforcement measures and advertising restrictions have all been on the rise.
However, regardless of the regulatory hurdles, the online gaming market continues to be characterised by structural growth, with the overall online market expected to grow at c 7% per annum, attractive margins and strong free cash flow generation. Leading operators should continue to benefit from these dynamics, as their gains in market share should offset the general rising costs.
Additionally, selected local regulations have helped drive growth. Europe with a mixture of largely white and grey frameworks now comprises 54% of the total online market. Other regulated (white) European markets include Spain, Italy and Sweden.
Conclusion: Time to play your hand
Ultimately, the sector risk may be high due to the threat of government intervention, but diversified companies still have undemanding valuations and the most protected from individual country risk are the larger, more multifaceted players.
The best positioned are those with scale, diversity and the ability to continue consolidating. So overall, we believe that there is significant opportunity to find value in the sector.
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