ARISTOCRAT LEISURE--FH24--good result, some changes mooted

 Understandable business

ALL started as a leader in poker machine (EGM) manufacture and sale. The development of software allowed the expansion into more creative products and services. The base of the core business is the design, manufacture, distribution and monitoring of games for worldwide casinos. The core business can be split into outright sales of machines and the more lucrative profit share and leasing of machines. ALL’s higher-yielding machines allowed ALL to participate in this development.

The industry is highly regulated and the existing relationship with the casinos allowed ALL to venture into connected games and then onto online gaming.

ALL entered Social casino through acquisition which has a similar skill base but the company also pursued broader gaming categories of role play, strategy and casual gaming.

The latest acquisition has ALL entering the platform market where the company can deliver online games to many participants, both ALL and third-party games. The ilottery market has also been entered.

The company relies heavily on the productivity of design and development spending. The ability to recruit and retain talent to drive product development is critical.

Interestingly, ALL has announced the strategic review of the casual gaming and role play/strategy, parts of Pixel, the online gaming division. These parts comprise 43% of the divisional revenues, with social casinos being 57%. The review may indicate ALL assessing whether it has a reasonable competitive advantage in these areas compared to social casinos. There are likely to be competitive advantages in retaining the social casino compared to the other businesses.  The last couple of acquisitions allow the company to focus on the new division having a better competitive outlook.

The main EGM competitors are LNW, Konami, IGT and AGI. Historically ALL has been the best run with the best results and returns. The recent resurgence of LNW with ex-ALL executives will have to be monitored.

The broader gaming market is fragmented and competitive. ALL best opportunities lie where the business is closer to its core competitive advantages being gaming content in regulated markets.

Last result FH24

The strong result was driven by the land-based gaming division, which may have relieved some. Market share was gained, although there was a change in disclosure with the ROW lumped together. Asia looks to have been strong but can be lumpy. The fee per day was better and the installed base grew well. Some new growth areas were mentioned and management is confident of continued growth. Overall ALL remains well placed.

Pixel was mixed. The User acquisition costs were reduced, being digital marketing spend. ALL explained this as redirecting marketing spending in social casinos and more mature games without the reduced spending having a top-line impact, while new games need UA spending. The decline in UA spending equalled the total profit growth for the division.

The new division, Interactive, comprises an igaming platform and an ilottery business was heralded as another growth avenue. The business is live with 10 major RMG operators across 6 countries and three US states, a promising start.

For the full year, the result implied revenue growth in line with my forecasts, NPATA much better (+5%). No numeric guidance was given.

 

Operating History

ALL EPS growth has been very good with (5Y rolls) around 13-18%pa excluding the C19 year, even then it was 9%, still good. EPS growth consistency has also been good at 77% r2 or 93% without C19.

ROE has averaged 26% over the last 9 years but only 17% over the last four. The C19 impacted year was 11%.  GM has been in the 52-56% range, C19 year being 47%, TA growth (5-year rolls), between 13% and 46% pa. The reinvestment rate is 97% (last 9 years) and forecast ROE of 25% gives a McNiven PE of 24.5X. NPM has averaged 16.3%, C19 being 8.6% and a high of 20.2%. FCF reconciliation is strong, 5 years at 110% and 3 years at 106%. The company has invested 19% of CFO into internal capex over the last 9 years.

 These numbers indicate a strong business, especially if we eliminate the C19 impact. There is a potential issue though in that the company is focussed on growth, much through acquisition, into areas where it has a lower level of dominance and where its competitive advantage is less, IMO. The TAMs are large but the issue is are some of the markets too competitive? The strategic review, likely driven by the perceived opportunities in the new acquisitions, is important, in that, we may see ALL allocate its capital closer to its core where it has a competitive advantage. ( a good thing)

Management

It is difficult to be too critical of management except to point out the obvious being that they have lost a reasonable level of experience to a competitor. The management track record is quite good given the competitive market. There have been no large disastrous acquisitions and the company has reinvested reasonably well.

Balance Sheet

ALL has been prepared to use debt to grow but the lowest IC has been 5X. In the last 9 years IC has averaged 13X and is currently well below that. The aborted Playtech acquisition after a raise to fund it, led to a series of buybacks but while the recent acquisitions regear the balance sheet, gearing is still below ALL’s 1-2X Target.

Other

Amortisation has been a factor in results being about 6% of NPAT. ALL discloses NPATA as well as NPAT.

ALL has traded on a median PE of 32X over the last five years a low of 20X and a high of 42X.

The issues that the market appears concerned about are any headway that LNW makes into the core business, the ability of the new acquisitions to gain traction, and the ability to maintain or grow the areas where the company doesn’t have a competitive advantage, that is, some parts of Pixel. The company is growth-focused so where it is likely to spend capital is an ongoing issue.

CONCLUSION - VALUATION

My assumptions on ALL are 5-year eps compound growth of 11%, an exit PE of 20X and 2% yield. At the current price, these numbers give an 8%pa return. A share price of around $41 is a buy-level offering above a 10% return. The lowish PE (20X) reflects business mix changes and more uncertain growth paths compared to the historical comps.

Held

 

 

 

Please note the disclaimer.

 

ARISTOCRAT LEISURE

Opinions and observations

Notes on FY 23

Result $1.3b +21% and epsa similarly up 21%, above my estimates.

Broadly, there was a return for casino-based businesses to pre C19 levels and a softening in the online based businesses (Pixal) that thrived during C19. Casino gaming 52% of revenues, Online 42% for the group.

The interesting strategic direction for ALL and the industry as a whole is the move from land based gaming to online gaming driven by the opening up of US regulations and technical developments. ALL approaches this change by focusing on online real-money gaming and finding new verticals to deploy their existing and new content.

Longer term the success then depends to a reasonable extent on the payback on the design and development (D&D) of games.

Looking specifically at the result, although above my numbers, were driven by a lower quality mix, imo. That can be seen by removing favourable FX and IR moves delivering an underlying 6% growth in NPATA. (I don’t specifically model FX).

ALL make money through selling machines to casinos that can be outright sales or a profit share for the more lucrative and popular games, profit share is better for ALL. FY23 saw a large increase in outright sales, which is great, but lower quality. Overall strong growth in North America and International (mainly Asia) delivered, Australia flat. ALL gained share and globally remains dominant in this sector.

The Pixal business was softer as the mobile gaming market was described as mixed. Whenever this happens thoughts shift to whether is it the market or ALL, as this is a more competitive space. Over the last 3 years ALL has spent about $5b on capex (ALL market cap $26b), D&D and User acquisition. The growth has been in D&D, which shows the need to develop games and obviously, the return on this spend over time is critical. UA spend was lower in fy23 which helped reported profits and management described it as dynamic, depending on the game launch sequence, so new games require more spend. There was a lull in the cadence of releases, with 10-15 pending. There is a sneaking suspicion that ALL games are not as potent as they were a while ago. Of course, there is some lumpiness involved here and the success of RAID will be difficult to replicate (fy23 24% of bookings for Pixal). The top 5 games comprise 74% of bookings so some concentration exists. No doubt ALL can outspend most of the competition but getting effective returns is the key. There are rumours of creative personal departures that may impact the quality of games, have to watch this carefully. Pixal has historically surpassed my expectations but remains a moving feast with higher levels of competition. Management has been changed here as well.

ALL launched anaxi which looks to provide content to casinos and others, I suspect, for casinos to take gaming to their clients using a mobile device. That is, ALL games on a mobile device with casino logos, is my read. No doubt this is a large part of the story moving forward and again it is competitive. Early days on this one. ALL has a competitive advantage given relationships and proven in casino games.

ALL gave some info on TAMs for the Pixal subgroups. Social Casino $6.6b of which ALL share is 14%, Casual gaming $19b, ALL share 1%, Role-playing games $13.5b, Strategy games $13.5b and Action games $3.7b of which ALL combined share is 2%. From this we can see that ALL has a reasonable share in its wheelhouse, SC, but a minuscule share in the highly competitive other categories. There lies the opportunity and challenge.

The cash conversion remains strong. The balance sheet is good with the cash raised for the aborted Playtech acquisition being redirected to buybacks and more acquisitions, Roxor and Neo Games, these are part of the anaxi push. Expected to be initially neutral to eps. The b/s moves to net debt but remains below ALL target range of 1-2X ND/Ebitda.

My conclusion on ALL is that it remains a highly profitable and well led growth stock. The valuation is full to fair around these levels. The feature that strikes me is that its markets are changing and more challenging than other growth stocks which probably deserves a lower rating. That is the ability to generate successful games is not as clear-cut as other growth paths.

Disclosure Held – I have reduced over $40 and although ALL remains in my top 10 holdings I don’t think the risk-reward is as good as some of my other quality growth stock exposures, therefore holding at a lower weight than other similar quality growth stocks. Any errors please tell me.