Disclaimer: We are shareholders of Enlabs AB.
NB: Enlabs is listed in Sweden while its financial reporting is in Euro and under IFRS 16. All operational figures are therefore stated in Euros (EUR) and share prices are stated in Swedish Krona (SEK). The same applies for Global Gaming 555, mentioned later. The EUR/SEK exchange rate used in this write-up is 10.31.
Summary
Enlabs is the biggest gambling operator in the Baltics with a market capitalization of SEK1.39bn. It derives 94% of its EUR40m revenues from online operations where it has a 25%+ regional market share. Online penetration in the region is still low, in the high-teens range (vs. 40%+ in some Western European countries) but growing +15% per year thanks to excellent broadband and 4G coverage. We believe the company can disproportionately benefit from this secular tailwind thanks to its unique proprietary technological platform and the local restrictions on gambling advertising favoring incumbents’ brands. This moat currently translates into 30% EBITDA margins, little need for capital reinvestment and therefore a 90% ROIC ex-goodwill.
A true asset light compounder, we think the company has a clear path to an 18% FCF CAGR, reaching EUR19m in 2024. Applying an 8% FCF to EV yield in 2024 leads to an intrinsic value of SEK48 per share, or a 21.5% IRR on capital invested from current levels (SEK22 per share). This does not include the optionality of entering neighboring markets (such as Finland, Belarus or Sweden), where we think the company is very well positioned. This could add north of SEK10 of intrinsic value per share. Lastly, insider ownership is high with the Chairman owning 21% of the company. He has significant knowledge and experience growing gambling operations in the Baltics and is involved in the day to day operations of the business.
1 - Company Description
Enlabs’ online business generates almost all of its revenues from the Optibet brand. It launched a secondary brand called Laimz in June 2020 targeting the female customer segment. Revenues are split 66% from Casino, 28% from Sports-Betting and 6% from Poker. Latvia, Estonia/Lithuania and Finland/Other account for 70%, 24% and 6% of revenues respectively.
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| Company Reports |
The company also operates land-based sports-betting bars in Latvia and Lithuania, representing 6% of revenues.
Primer on Gambling Economics (skip if you are already familiar with gambling operations)
Revenues are derived from a take-rate on the volume wagered by customers.
- In casino the take-rate is fixed on a per game basis (c.3/4% of wagers) and has a rather low variance quarter on quarter.
- The take-rate in poker is a percentage of the pot levied at the end of each hand, called the rake(c.5% of the pot).
- In sports betting the operator uses an overround system (the fact that odds add to more than100%) which translates into a built-in edge for the house (c.8/9% of wagers). Adverse game results can however result in a high variance of the take-rate quarter on quarter.
The unit economics of online gambling are excellent:
- On average, customer lifetime value is around 3x the customer acquisition cost.
- The business generates 80%+ of its revenues from a very sticky 15% of customers (called VIPs).
These metrics translate into businesses that generally have >60% contribution margins, >25% EBITDA margins and >30% Return on Capital employed.
2 - Moat and Financial Snapshot
Enlabs’ moat is built on three pillars:
Industry regulation, which keeps competition low and incumbents’ brands strong
- The Baltic market is regulated on a country by country basis and operators need to apply for a license from the regulator. There is a relatively high share capital requirement to be eligible for a license, varying from EUR1m (Estonia and Lithuania) to EUR1.5m (Latvia).
- More importantly, advertising of gambling products is heavily restricted in both Estonia and Lithuania, while it is banned in Latvia. This strongly benefits incumbents like Enlabs who already have a slice of the customer’s share of mind. Enlabs ‘cornered’ the sponsorship market in Latvia in the last few years (where it owns the naming rights for Football and Hockey national leagues and federations, two of the country’s most popular sports) and is replicating this strategy in Estonia and Lithuania to gain market share.
- Additionally, the Baltic market is very niche and not of interest to the biggest industry operators. For instance, if GVC Holdings (Europe’s leading gambling operator) was to reach a 50% online market share in Latvia, it would increase its online sales by a meager 1.4%.
In Latvia Enlabs sees almost no revenue churn from cohorts going as far back as 2007, a testament to the competitive positioning of the company in the country. It is therefore an extremely profitable market for Enlabs with more than 90% contribution margin.
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| DK Value estimates |
Enlabs leading technological platform
The company spent the last three years building a new proprietary technological platform.
- This is a significant competitive advantage as it means greater operating leverage and reduced third party variable costs on incremental sale.
- It also means an improved user experience thanks to a faster go-to-market route with new products/games and full flexibility when making adjustments to the app’s front end. This in turns leads to less churn, improves engagement and extends the customer lifetime value.
- It makes market entry quicker and easier as the platform can easily be adapted to local market requirements. For instance, in Belarus, Enlabs was one of the first operators to submit a compliant platform to the regulator.
The scale of Enlabs’ operations, which benefits the company in three ways:
- First, and in relation to the above-mentioned naming rights, Enlabs can significantly overspend its competitors during the bidding process because it can spread the cost over more users.
- Second, as a multi country operator, it can leverage its dominant position in Latvia (#1 operator with >50% market share and >90% contribution margins) to finance its market share grab in Estonia and Latvia where it is only in the top 5.
- Third, Enlabs can afford bigger and bolder IT investments than competitors. We mentioned the proprietary platform in the last section. Enlabs will in this regard be the only gambling operator in the region not relying on third-party technology.
The truth however lies in the numbers: this moat, coupled with the asset light nature of the business translates into 30% EBITDA margins and a ROIC ex-goodwill of 90% in the last 5 years and a ROIC including goodwill of c.30% (the goodwill is linked to a 2008 acquisition and has been grossed-up for any impairment).
3 - Market
Latvia:
- According to the regulator, total market size is EUR310m, of which EUR55m is online. This represents a 17.8% online penetration rate in 2019, up from 5.7% in 2015.
- Enlabs has a 50% market share of the online market and is the #1 operator. Enlabs also has a 60% market share of the EUR3.2m land-based betting shop market.
- We forecast a flat offline market and annual increase of online sales in the EUR11m range per year (EUR13m in 2019 and 2018), meaning a 2.3% increase in yearly online penetration. This would lead to a 28.4% penetration rate in 2024.
Estonia:
- The Estonian regulator doesn’t publish market data, but it has been estimated by H2GC at around EUR170m, of which EUR31m is online. This represents an online penetration rate of 18.3%, quite similar to Latvia.
- Enlabs has a 20% online market share in Estonia, making it the #2 biggest operator in the country. The company is targeting the top 1 position by replicating its Latvian strategy (especially regarding sponsorship).
- We forecast a 2.5% increase in penetration, close to Latvia’s numbers which has similar online penetration levels. This would lead to a 30.8% penetration rate by 2024.
Lithuania
- The Lithuanian regulator’s 2019 data shows a market size of EUR112.6m but effective total market is closer to EUR400m (adjusted for offline illegal activities). Online revenues of EUR40m represents a 10% penetration in the country.
- Enlabs entered the market in Q4 2018 and therefore only has the #4 spot in the market with 3% online market share. The company is however gaining market share due to its superior Casino offering.
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| Regulators’ data & DK Value estimates |
In summary, Enlabs is generating c.EUR40m of revenues in a c.EUR150m Baltics online market which we expect to grow at 13% p.a. until 2024, reaching EUR270m.
4 - Market expansion
In addition to the company’s core markets, there are three significant opportunities where Enlabs could leverage its strengths in the medium term:
Belarus: This is a EUR500m market, of which EUR50m is currently online, representing a 10% penetration rate (on par with the size of the Latvian online market). The country liberalized its online gambling market in 2019 and therefore the licensing process is ongoing (with only one license awarded so far). Enlabs applied early and should be among the first 3 operators to enter the market.
Finland/Sweden: The company has started to target users in Finland in 2018 where it is seeing very interesting unit economics and allocating more marketing (albeit from a low base). This is a EUR800m online market (15x the Latvian online market). Enlabs also has a Swedish license (EUR1bn online market) but so far, the company has not entered the country.
Ukraine: Ukraine is set to legalize online gambling in 2020 following an order by the President to reform the industry in 2019. Ukraine has a large market despite it being illegal. According to unofficial statistics, online gaming market should alone be worth EUR300m.
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| H2GC & DK Value estimates |
Obviously, the company doesn’t have the manpower to execute on all fronts, but it is testament to the many opportunities that Enlabs is currently considering.
5 - Global Gaming 555 Acquisition
The company announced in June 2020 that it acquired 29.9% of a Swedish online gaming operator, at SEK8 per share. (Implied EV of EUR20m – 1x Sales’20E). This represents a EUR10m outlay and was financed half in cash and half in Enlabs’ shares (a 3.5% dilution at current prices). A full takeover has not been announced but we believe it will be Enlabs endgame with the company.
Global Gaming will generate around EUR20m of revenues in 2020 in Finland and Estonia from its ninjacasino.com brand. It used to operate the brand in Sweden (where it generated c.EUR60m in revenue two years ago), but the Swedish regulator took its license away in 2019 due to poor KYC compliance systems.
Assuming a takeover for the remaining shares at SEK8 a share, it will cost Enlabs a total of EUR30m. However, Global Gaming has a net cash position of EUR10m so the EV price paid is EUR20m. While generating breakeven EBIT for the moment, we estimate the synergies at around EUR5.5m at the EBITDA level or 20% of projected sales. These would come from a migration onto Enlabs technological platform (c.5% of sales estimated impact by cutting third party suppliers), contract renegotiations with casino games provider (c.2-3% of sales) as well as downsizing the cost base in the countries where Enlabs already has a footprint (c.10-12% of sales). On a post-tax basis, this transaction would therefore represent a c.20% return on capital spent.
In a best-case scenario, we believe Enlabs could be relaunching the ninjacasino.com brand in Sweden with its own Swedish license and its own KYC compliance systems. If this is the case and if Enlabs manages to reactivate 30% of ninjacasino.com old Swedish customer base, it could generate an estimated additional EUR4m of EBIT. The return on capital would then hover around 40%.
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| DK Value estimates |
We believe Enlabs will finance the remaining of the transaction in the same way it financed the first tranche, i.e. 50% in shares and 50% in cash. At current prices (SEK22 per share) and assuming an SEK10 takeover price for the remaining shares, the entire deal will increase the share count from 62.8m in 2019 to 68.9m, or 9.7%. We are fervent supporters of the transaction, which we believe will allow Enlabs to boost its scale in Estonia and more importantly accelerate its growth strategy in Finland with a strong brand. We are further encouraged by the optionality of the Swedish relaunch, which could generate significant shareholder value: At 10x EV/EBIT, this additional EUR4m in EBIT corresponds to c. 30% of the current Enlabs’ market capitalization (at SEK22 per share).
6 - Balance Sheet and Financial Health
The company is EUR20m net cash with no debt (15% of the current market capitalization). We believe Enlabs’ cash position has materially increased in ‘value’ during the Covid-19 with weaker peers struggling throughout the crisis. This will most likely mean two things: distressed sellers of assets and cash strapped competitors shrinking both marketing and technological/product investments. Either way it will significantly benefit Enlabs operations.
7 - Ownership
The chairman, Niklas Braathen, owns 21% of the company, representing EUR28m at SEK22 per share. He is involved in the company’s strategy and talks daily to the CEO. He sold the Optibet brand to the company back in 2008 and has extensive knowledge in building and growing a gambling brand in the Nordic/Baltics market.
Christian Haupt, another board member owns 9% of the company, representing EUR12m at SEK22 per share.
8 - Valuation
Taking 2019 revenues (EUR39.6m) and adding 5 years of increased online penetration in the Baltics takes us to EUR72.2m revenues in 2024 (12.8% CAGR). We expect gross margin to decrease from 70.6% to 69.6% because of higher content costs. Marketing expenses are expected to increase to 18% vs 17% in 2019 because of new sponsorship deals. Meanwhile, we expect fixed costs to grow at a 5.7% CAGR from 2019 to 2024, reflecting 1/3 of costs (rent, utility & central costs) growing at 5% and the rest growing at half of the sales rate. This would bring Enlabs organic 2024 EBITDA to a 31.5% margin, or EUR22.7m in absolute amount.
As previously mentioned, we believe Enlabs will take over Global Gaming in the coming months. This would add a EUR5.6m EBITDA in 2024 post-synergies. Adding Enlabs’ organic EBITDA to Global Gaming’s leads to a combined EUR28.3m EBITDA in 2024.
As Enlabs owns its technological platform and doesn’t capitalize much R&D opex, we expect capital expenditures to stay at around EUR3m per year. At the company’s 20% tax rate, this leads to a free cash flow pre and post interest (as there is no debt) of EUR19.6m (a 18.5% CAGR over 5 years).
Applying a conservative 8% Free Cash Flow to Enterprise Value gives us a target Enterprise Value of EUR245m in 2024. Due to its high cash conversion, we expect Enlabs net cash position to reach EUR76m by 2024, leading to a target Market Capitalization of EUR322m or SEK3.32bn, i.e. SEK48 per share. An investment at current prices of SEK22 per share would therefore generate a 21.5% IRR over 4 years.
This IRR is solely based on Enlabs’ s expansion in its current geographical footprint. It does not include any upside from the adjacent market opportunities mentioned above. Of these opportunities, we consider two of them as very likely to materialize by 2024: an entry in Belarus and a relaunch of the ninjacasino.com brand in Sweden. As an example, if Enlabs were to capture 10% of the Belarus’ online market as well as get 30% of its old customer back in Sweden, this would increase Enlabs revenues by EUR22m in 2024 and FCF will increase to EUR24.6m (a 24% CAGR over 5 years). Using the same valuation methodology, we derive a target price of SEK58 per share, or a 27.4% IRR over 4 years at current prices.
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| DK Value model |
9 - Risks
We focus a lot on what could go wrong and how could it lead to permanent loss of capital, which is why we spent a lot of time considering and quantifying the key risks related to this investment:
Money laundering in gambling and in the Baltics:
- Put simply, money laundering is the process of depositing cash proceeds from illegal activities into legitimate financial institutions. One can only do so if it appears to come from legitimate sources.
- It is a very simple process offline: People can walk into casinos with large amounts of cash which they trade for chips without facing the questions they would face if they were trying to deposit the same amount of cash with a bank. Gambling winnings are considered a legal form of income, therefore any money that is taken out as winnings is "clean" money that can be deposited in any bank. There are two reasons why we are not overly concerned with this risk with Enlabs retail operations. First, they operate only sports betting shops which are less appropriate for money laundering as the operator margin is higher (c.8%) than casinos (c.3%) and the matches outcomes can result in high variance of win/losses. Second, sports betting shops are a very limited market (In Latvia and Lithuania it represents less than 1% and 5% of the total market). This makes it less attractive to money launderers as they can find bigger markets where their wagers will be lost in the overall volumes.
- After careful research we came to the conclusion that investors do a system 1 association of money laundering in offline to the online segment. However, in the Baltics, the regulator only allows deposits throughs banks or a few PSPs providers. None of them allow cash to be converted directly digitally and therefore the money used to deposit on the gambling website is already in the system. There is no need to launder it as it is already ‘clean’. Furthermore, online operators must ascertain the identity of every user through national ID checks. In Latvia use of e-wallets/PSPs are altogether banned and customers are allowed to deposit money online only through their personal bank account. Additionally, they can only cash-out their winnings through the account used to initially deposit the money. This therefore makes it not fit for money laundering purposes.
- We went deeper and compared the Revenue to Deposit ratio of Enlabs and some peers that disclose these metrics and found no discrepancy in the numbers: While Enlabs stands at 30% (for every euro deposited over a quarter, Enlabs generates 30cts in revenues), Leovegas (a Swedish online casino operator) is at 31% and Mister Green’s (a German and Nordic online casino operator) at 32%. A very low revenue to deposit number would have indicated money laundering risks (since criminals laundering money generally deposit a lot of cash, only play with a little portion and then cash-out)
As an aside, money laundering in online operations is very much possible and present. It however predominantly concerns black market operators which do not abide by the regulators rules and allow PSPs that transfer physical cash directly into digital money or tokens used on the black operator website.
Gaming tax increase:
- Gaming taxes on revenues are currently set at 10% in both Latvia and Lithuania and 5% in Estonia. In most European markets the gaming taxes are around 20% of revenues with the UK at 21%, 20% in Spain and 24% in Italy for instance. It is important to note that taxes are levied on revenues which means that regulated operators are at a disadvantage compared to black (unregulated) operators because they need a higher handle on wagers to reach the same profitability.
- While we do not dismiss such an increase, the UK, Spain and Italy all have a very high customer channelization rate, so the black-market size is low. In the Baltics, black markets represent around 40% of the legal market which is unheard of in Europe. The governments are trying hard to fight this, but they have overall poor domain ban enforcement. Increasing taxes would therefore only push more people onto the black markets because regulated operators would need to increase prices (i.e the handle) in order to keep their profitability levels.
Higher marketing intensity for offline sponsorships:
- Enlabs has almost all of its sponsorships coming for renewal in 2021 and we believe these are a must have for every operator. We would therefore expect some price increase as the markets have gotten bigger since the last auctions (two to three years ago).
- In Latvia, we expect rationale behavior from peers as they are not overly well capitalized and can seldom afford marketing commitments as big as Enlabs which has a 50% market share. Latvia’s marketing budget is 30% of Enlabs total marketing spend and we expect an increase of 30% for the offline sponsorship’s costs, which are 70% of the overall marketing budget.
- In Estonia and Lithuania, we expect Enlabs’ s push into the sponsorship market to result in 30% higher prices. These countries represent 70% of the total marketing budget and sponsorships costs are 50% of the overall marketing spend.
- Put together we expect marketing costs to increase from 17% to 19.5% of sales. However, these costs will allow for higher sales levels and the impact will therefore be closer 18.5%, which is the number we use in our forecasting.
To quantify those risks, we modelled a scenario where gaming taxes would increase in the Baltics to 20% as well as a loss of market share in each country in the 20% range (for instance in Latvia the company markets share would go from 50% to 40%). Enlabs ‘s free-cash flow would only increase to EUR13.6m (10% CAGR over 5 years). Using the same valuation methodology, we derive a target price of SEK30 per share, or an 8.0% IRR over 4 years at current prices. We therefore think that permanent loss of capital is extremely low even in a worst-case scenario.
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| DK Value model |
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