Evolution AB Stock Analysis & Deep Dive

A live gaming operator from Sweden

Oct 16, 2023

Update Q3/2023 (29.10.2023)

Evolution continues to show strong numbers. Q3 sales grew 19.6% YoY and EPS grew 23%. In the comparable Jan-Sep period, sales grew by 26% and EPS by 27%. The strongest growth was in Asia at 35% and Latin America at 39%. Europe grew by 10%.

In the live casino business, customer demand exceeds supply. It takes about 18 months to set up a new studio, and in addition there are currently problems in hiring new croupiers. In Colombia, a studio was opened in Q3 and another in Europe is to follow this year. A total of 4 new studios are planned for next year.

RNG revenues are down 2% compared to Q3/22. Given the nearly 3Bn invested in acquisitions in this sector in recent years, one must wonder what management was thinking. With now almost 2.3Bn in goodwill at a market cap 17.6Bn, a lot of money seems to have flowed into overvalued companies.

In the conference call an evasive answer was given to the question about share buybacks. With currently 800m cash on the balance sheet, I think something should happen here.

With an EV/FCF of 16.4 Evolution is now priced even more attractive than before due to the drop in share price as a reaction to the Q3 numbers.

Intro

You don’t come across a company that grew its revenue in the last years by 49%, 53%, 90% and 36%. When you do however, it makes sense to dig a bit deeper and see if there might be an investment jewel hidden.

First I thought, that Evolution is just offering basic only gambling but I was surprised by the sophisticated live gaming component. Read on to learn more about a 20bn market cap company from Sweden of which you’ve probably never heard of.

The Company

Evolution was founded in 2006 and develops, produces, markets and licenses fully-integrated B2B Online Casino solutions to gaming operators. More than 700 online casino operators rely on Evolution. The largest customer contributes 14% of the revenue and the top 5 contribute 30% in total. Evolution employs over 17400 people in studios across Europe and North America and has more than 1300 live tables.

The Industry

Gaming is still a growing business. The global gaming market (lottery, casinos and gaming machines) was €438bn in 2022, of which 23% were online. Online gaming has shown tremendous growth with a CAGR of 19% in the past five years, compared to 2% for the overall market. The global casino market is split into 80% land based, 15% RNG and only 5% live casino.

The Business

Evolution provides fully integrated live casino solutions to a gaming operator (B2B), who then markets his product to the end consumer (B2C). The gaming operator must provide services such as user authentication and player account management.

The majority of Evolution’s revenues consist of commission fees and fixed fees for dedicated tables, which are paid monthly by operators. Commission is calculated as a percentage of the operators’ winnings generated via the company’s Live Casino offering. Since the growth of land based casinos is naturally limited, some of these casinos seek to expend their market by offering online gaming. Evolution tries to be the partner of choice for these casinos. With the implementation of one stop shop (OSS) Evolution offers the customers full access to the whole portfolio of games with a single integration into their back end.

Evolution has a strong presence in regulated markets and aims to be the first live casino in those markets. Evolution is active in markets such as US, Canada, Italy, Spain, Belgium and many more.

Evolution offers its products through four brands: NetEnt, Red Tiger, Big Time Gaming and Nolimit City.

Evolution offers RNG games(Random number generator, a short term for an algorithm which produces random numbers) and live games, which are streamed from a studio similar to a TV studio. Customers have the option to book dedicated tables for their games, which can be fully branded and customized based on the operators wishes. The end customer can access the games through all platforms. Mobile revenue made up the lion share of Evolution’s revenue with 68%.

Europe and UK make up 43%, Asia 33% and North America 13% of the revenue. The core of the offering are well-known games, such as Roulette, Baccarat and Blackjack.

In 2022 Evolution introduced a new smart lobby for players, which follows the idea of Netflix: Players are presented with a wide choice of games to play and based on their past playing history, the lobby shows similar games. This personalized lobby makes it easier to lure players into new games. The goal for 2023 is to launch 100 new games to offer players and even broader choice.

Writing a deep dive takes me 40+ hours to get a proper understanding of the company and the attributes of the industry it is working in. You will support me a great deal if you a) subscribe to this substack and b) recommend this blog to your friends and family. To all existing subscribers: Thank you for your support! :)

Live Gaming

Live gaming is the main revenue contributor and also a lot faster growing than RNG. With 81% of the revenue and a growth of 42% compared to the previous year it shows strong momentum.

The game presenters of Evolution need go finish a 100 hour training course, before they embark on a three month long trainee period to ensure the proper skill set to present the games. Evolution has their own workshop in Riga, Latvia to produce the equipment necessary for the studios. To give you an idea what the live studios look like:

Here are some more examples of live games. I can believe, that it is a lot more interesting for potential players to interact with a real human, compared to a random AI bot. These game presenters create a real-world casino like feeling, even though you might be sitting at home or riding the bus while playing a round.

Here are some examples of the non-traditional live games, which Evolution is constantly developing to keep the users engaged.

Fun side note: My favorite game which I found on the website of Evolution is called: “EXTRA CHILLI EPIC SPINS”. The setup and the guy and the costume just look amazing.

The Management

CEO Martin Carlesund, CPO Todd Haushalter joined Evolution in 2015, the CFO Jacob Kaplan joined in 2016. All of the managers own shares in the company, while the CEO owns 585k shares at a market value of €55m.

One point of criticism is the huge amount of stocks warrants offert to the management. These dilute the share basis over time and the €200m spend on share repurchases in the last two years were necessary to keep the number of outstanding shares stable.

Risks

The largest risk is an increased regulation for online gaming. Another risk could be that their customers, the gaming operators, see the crazy high margins from Evolution and will therefore build an in-house solution.

The Fundamentals

Revenue, net income and FCF have been rising steeply in the last years. FCF has been steadily climbing with the earnings. A relatively low CapEx was necessary to fuel the growth with CapEx between 5 and 10% of the OCF in the last years.

Revenue went from €49m in 2014 to €1457m in 2022, net income from 12m to 843m and FCF from 13m to 817m. All this happened, while the amount of shares outstanding rose by just 25%. Free cash flow margins are increasing and show numbers, some software companies can only dream of: 56% for 2022.

The numbers for HY1/23 have been impressing with revenue growth of 28% and net income growth of 29% YoY.

Revenue growth has been especially strong in Asia, with a growth of 48% YoY. Antoher important takeaway is, that Evolution is growing in all markets.

The development of the FCF over the last quarters has been mind boggling and almost seems to be too good to be true.

As with many other companies who own a strong balance sheet, Evolution saw a steep increase in its interest income from €230k in 2021 to €5.3m in 2022. The objective is to distribute at least 50% of the net profits as dividends to the shareholders over time, which happens in the first half of the year. The dividend yield is currently 2.2% and will continue to go up with rising earnings.

Valuation

Evolution is trading currently at an EV/Earnings of 20.2 and an EV/FCF of 20.3.

Sales are expected to grow 20% for the next year. If Evolution keeps their margins stable and keeps a growth rate of 20%, we are looking at a valuation of an EV/FCF of 14 in two years.

Summary

Evolution is valued attractively for a normal growing company. Considering that the growth forecast is 20% for next year, the current valuation is very attractive. Attached you will find the chart for its home listing in Sweden.

Since Evolution’s business is centered around a tightly regulated environment, there are higher risks associated than with companies such as Adobe, Visa etc. The Q3 results will be announced on the 26th of October and we will know, if the growth continues.