Evolution AB (EVO.ST) Equity Research Report
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Thank you all for the recent support. As part of our ongoing effort to highlight our portfolio, we’re releasing detailed write-ups for each stock we invest in. This approach gives you insight into the companies we believe in and the reasoning behind our investments. This weeks research report is on Evolution AB, a B2B provider of live casino and slots systems.
Evolution AB was founded in 2006 and is headquartered in Stockholm, Sweden. The company reports only two primary revenue lines —Live and RNG. The details of which are as follows:
Live Casino:
The company's primary product, Live Casino, which accounts for approximately 85% of its revenue, features a human dealer running a real-time casino table streamed directly to digital devices. This setup allows players to place bets on desktops, smartphones, and tablets, and engage with the dealer 24/7 through Evolution's software, ensuring a comprehensive and interactive online gaming experience. By providing these business-to-business solutions, Evolution AB licenses its services to casino operators.
Evolution’s portfolio of online live table games includes Live Roulette, Blackjack, Baccarat, Super Sic Bo, Dragon Tiger, Craps, Live Casino Hold'em, Three Card Poker, and Ultimate Texas Hold'em, operating around 1,600 tables at the end of the last financial year. With over 800 customers, including a majority of online casino operators as well as land-based casinos, Evolution serves a broad client base.
The company’s business model leverages high fixed costs, including personnel and technical infrastructure, across multiple operators. Personnel costs have been on the rise recently, driven by an increase in headcount to 21,141 employees, putting pressure on margins. However, CEO Martin Carlesund emphasised that the costs associated with expansion and recruitment are expected as they precede revenue generation, and the company is making strong progress in its studio development plan. Other significant costs include royalties, consultants, communication, and ongoing product innovation. Overall, this approach creates significant entry barriers for competitors while enabling lower unit costs and strong earnings growth.
The majority of Evolution's revenue is derived from commissions, which are calculated as a percentage of the operator's winnings generated through the company's offerings. This commission-based model ensures a recurring revenue stream that scales with the success of the operators. Under standard agreements, streaming is conducted from generic tables that are accessible to any operator. Additionally, Evolution also offers dedicated tables that are fully tailored to meet specific operator needs, including aspects such as studio environment, branding, graphics, and language. These tables are exclusively reserved for the operator, providing a unique and personalised gaming experience for their customers. The fees for dedicated tables are charged monthly and vary based on factors like the type of game, the number of tables, and operating hours. Additionally, Evolution generates revenue from setup fees for new customers during the launch of their casino offerings.
The Live Casino stands out as a preferred choice over electronic versions because it provides a higher level of trust by allowing players to see the dealer in action and offers a more social experience through the ability to chat with the dealer and interact with other players.
RNG:
In addition to Live Casino, Evolution offers RNG slots, which contribute the remaining 15% to revenue. These digital slot games use Random Number Generator technology to determine outcomes, providing a variety of gaming options to players. People can place bets privately behind their screens, enjoying their own space, but for those who want to "GO LIVE" or are new to Live Casino, EVO offers an innovative solution. With its First Person games, players can seamlessly transition to the Live Casino experience with just a single button, immersing themselves in real-time gaming action.
Geography Split
Evolution AB's revenue is geographically diversified across several key regions. Asia now represents the largest portion, accounting for approximately 39.5% of total revenue. Europe follows closely, contributing around 37.6%. North America, driven by the expansion of online gaming in the United States, contributes about 11.8% of the revenue. Latin America generates roughly 7.2%, while other regions make up the remaining 3.9%. This geographic spread highlights Evolution's global presence and its ability to capture market share across diverse regulatory environments.
Clients
As mentioned, Evolution claims to have over 800 customers, including some of the most prominent names in the gaming industry. These include major online operators like Paddy Power, Betfair, William Hill (now part of 888 Holdings), Unibet, 888 Casino, and Betway, as well as global brands such as MGM, Caesars, and Hard Rock. This extensive client base highlights Evolution’s leadership in providing top-tier live casino solutions to both online and land-based casinos across the world.
Moat Analysis
Evolution AB has built a formidable moat in the online gaming industry, primarily through its dominant market position, vast scale, and continuous innovation. With a global market share of 75-80% by revenue, Evolution is recognised as the leading B2B provider of live casino games, supplying content to top B2C operators, as mentioned above. The company’s ability to attract and retain top-tier clients is a testament to its high-quality service and comprehensive product offerings.
Evolution’s significant scale allows it to invest heavily in research and development (R&D), leading to continuous innovation in its product line-up. The company releases over 100 new games annually, far outpacing its nearest competitor, Playtech, which releases around 20-25 games per year. This relentless focus on innovation and product development creates a flywheel effect, where new game releases drive increased player activity and revenue. The extensive resources at Evolution’s disposal enable the company to test and perfect its games more thoroughly than any competitor, resulting in the highest-quality and most entertaining games in the market.
The industry’s unit economics support a winner-take-most structure, which further reduces the risk of competitive encroachment. Evolution typically charges operator customers a take rate of 10-15% on gross gaming revenue (GGR). While competitors might attempt to gain market share by offering a lower take rate, they would need to generate at least 85% of the revenue per game that Evolution can achieve to be competitive. However, due to the superior performance of Evolution’s games, competitors often struggle to reach this threshold. For instance, a competitor's game might produce considerably less GGR than Evolution, resulting in much lower net revenue for the operator, even if the competitor offers a reduced take rate.
This dynamic makes it challenging for competitors to undercut Evolution on price without sacrificing significant revenue, reinforcing Evolution’s competitive advantage. The company's ability to consistently outperform its rivals in revenue generation per game, combined with the high fixed costs and extensive R&D investment, creates a moat that is difficult for others to breach. This self-reinforcing cycle of innovation, scale, and superior product quality ensures that Evolution remains the leader in the live casino gaming industry, with a competitive position that is both robust and sustainable. Additionally, the company's strategy of acquiring recognised brands strengthens its portfolio, creating network effects and reinforcing its brand.
Management and Capital Allocation
According to Yahoo! Finance, insiders hold 21.29% of Evolution AB's shares, which is a strong positive sign. Companies led by founders or insiders tend to be more committed, especially in industries facing regulatory challenges, as having significant ownership often ensures responsible and aligned management.
Founders Jens von Bahr and Fredrik Österberg together hold a 10.57% stake in the company and serve on the board. The management team is experienced, with substantial personal investments in the company, aligning their interests with shareholders. Key figures include:
Martin Carlesund (CEO, age 52): Holds 684,710 shares with additional rights to 175,000 warrants.
Todd Haushalter (Chief Product Officer, age 41): Owns 96,300 shares with rights to 60,000 warrants. He joined in 2015, bringing extensive experience from the land-based casino sector.
Sebastian Johannisson (Chief Strategy Officer, age 41): Holds 700,000 shares with rights to 60,000 warrants. He has been with the company since 2008.
This leadership team, with its vested interests and long-term focus, continues to drive Evolution's strategic growth, ensuring the company's sustained success in a competitive and regulated industry.
Investor relations at Evolution AB are of exceptional quality, characterised by transparent communication and straightforward reporting. The management team has established a solid reputation for integrity, supported by their background and track record, leaving no doubts about their credibility or commitment to shareholders.
Capital Allocation
The management team demonstrates strong competence in capital allocation. The Board of Directors has clearly communicated its capital allocation strategy, which includes distributing 100% of excess net cash flow after investments, including M&A, to support operations. They will maintain a 50% annual dividend pay-out of net profits and use the remaining funds for share repurchases unless an extraordinary dividend is more beneficial. Believing in the value enhancement of share buybacks, the Board has also recently initiated a program of up to EUR 400 million.
Additionally, the acquisition of US-based Galaxy Gaming is a strategic move that enhances Evolution's presence in the US market, where Galaxy holds licenses in 28 states. This acquisition not only strengthens Evolution's game portfolio but also fast-tracks future licensing opportunities by establishing relationships with regulators across multiple states.
Financials and Rough Valuation:
Evolution has excellent net profit margins at around 56%, and FCF margins around 62%. Evolution also boasts a 37.5% return on equity and 40% return on invested capital (ttm).
The company has close to zero debt with a debt / equity ratio of 0.02. The current ratio is also positive at 2.19 showing good financial flexibility if needed. Evolution also has a very healthy cash pile as of the last report. Retained earnings are piling up nicely and management have recently committed to a EUR 400 million share buyback, as mentioned earlier. Overall Evolution AB is an exceptionally healthy company that is very well managed. (all data from finchat.io)
Below are our back-of-the-napkin intrinsic value estimates based on a 10% discount rate and a 5-year timeframe. Note: We've adopted relatively conservative EPS growth assumptions to account for the potential risks we'll discuss later, providing an additional margin of safety. ($EVVTY)
Bull: 18% EPS Growth Rate, 20 PE - $161.5 Per Share
Base: 12% EPS Growth Rate, 18 PE - $112 Per Share
Bear: 8% EPS Growth Rate, 16 PE - $83 Per Share
The Thesis:
Evolution AB is an exceptionally high-quality company with a strong balance sheet and outstanding profit margins. The company has one the strongest competitive moats in the industry, driven by its economies of scale, global reach, and advanced technology platform. The management team is highly competent and aligned with shareholders' interests, thanks to significant insider ownership and well-structured incentives.
We see robust growth opportunities across all geographies, with potential to compound returns in the mid-teens and higher over the next several years. The current attractive valuation, reflected in a forward P/E of 16, suggests that the market may be undervaluing Evolution’s prospects, likely due to perceived risks.
Addressing the Risks
Regulatory Concerns: A significant portion of Evolution's revenue—60%—comes from unregulated markets, which some investors perceive as risky due to the uncertain legal status of these markets. However, "unregulated" simply means that there are no laws explicitly governing online gaming in these regions, neither legalising nor banning it. Importantly, Evolution does not operate in "black markets," where online gaming is explicitly illegal or in countries sanctioned by the U.N. Additionally, Evolution's broad geographic diversification is a key mitigating factor; with no single country (other than the regulated U.S. market) contributing more than 5% of total revenue, the company is well-protected against potential regulatory shifts. This distribution ensures that even if some countries impose unfavourable regulations, Evolution’s overall revenue should remain fairly resilient, especially when combined with high organic growth rates from other regions. The company’s strategy of engaging with regulators and carefully selecting markets provides a buffer against sudden regulatory changes, ensuring long-term sustainability.
Competition: While competitors like Playtech and Pragmatic Play are respected in the industry, they have struggled to keep pace with Evolution’s level of innovation and market dominance. Despite being credible players, these companies have not been able to significantly dent Evolution’s market share. New entrants have also failed to make a substantial impact, largely due to the considerable challenges in achieving the same quality and scale that Evolution consistently delivers. Additionally, B2C operators attempting to develop their own live casino products are unlikely to pose a serious threat, as they lack the resources and expertise needed to compete effectively with Evolution’s offerings.
Recent Quarterly Results: The market's negative reaction to Evolution’s recent quarterly results, which showed slower growth and marginally lower profitability due to necessary investments in personnel, appears to be an overreaction. These investments are crucial for the company’s long-term growth, and punishing the company for positioning itself for future success seems unwarranted.
In our opinion, the current market misunderstanding of Evolution AB’s regulatory exposure and competitive position, along with an overreaction to recent earnings, presents a compelling buying opportunity. Evolution’s strong moat and financial position combined with effective capital allocation make it a robust investment capable of delivering significant long-term returns, even while navigating the industry's challenges.
Risks:
Regulatory Risks: A complex regulatory landscape, with 40% of revenue from regulated markets and 60% from unregulated markets, could pose challenges if regulations shift unfavourably.
Increasing Competition: Competitors like Playtech and Pragmatic Play could erode market share, though Evolution's innovation and scale help maintain dominance.
Technological Advances: The rise of virtual reality and new technologies could disrupt live casinos, but Evolution's continuous innovation keeps it competitive.
Operational Risks: Online card counters pose a threat, but Evolution's Game Integrity and Risk Department, along with Mission Control Rooms, ensures game integrity and compliance.
Disclaimer: The content provided in this newsletter is for informational purposes only and does not constitute financial, investment, or other professional advice. While we believe the information to be reliable, we cannot guarantee its accuracy. The opinions expressed are those of the author and do not necessarily reflect the views of Schwar Capital. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The author may or may not hold positions in the stocks or other financial instruments mentioned. Always do your own research or consult with a qualified financial advisor before making any investment decisions.
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