OPAP — Exclusivity pays dividends

OPAP was founded in 1958 as the Greek national lottery and it is the exclusive licensed operator of all numerical lotteries (seven games), sports betting (four games), horse racing and VLTs. Through its 67% holding in Hellenic Lotteries, OPAP also has an exclusive licence to operate passive lotteries and instant (scratch) games. The company operates a network of franchised shops (c 4,000 in Greece, and c 200 in Cyprus) and is expanding its online offering in sports betting and lottery games.

OPAP listed on the Athens Exchange in 2001 and, after a series of further secondary offerings and international tenders, it was fully privatised in 2013. Sazka Group, the largest pan-European lottery operator, holds a 23.7% shareholding and is well represented at the board and executive level. Since 2013, OPAP has undergone a number of significant changes, to both modernise and streamline the business. A new CEO, Damian Cope, was appointed in 2016 and the company is halfway through its 2020 Vision transformation programme.

OPAP’s share price is currently c 20% higher compared to full privatisation levels in 2013, with the stock having returned c 50% to shareholders via dividends during this period. During 2018, the shares declined by c 27% in 2018, in line with the Greek market, but this was still better than the general European gaming sector, which fell sharply in 2018 (largely due to regulatory burdens and tax increases in other countries, especially the UK). Year to date, the shares have since recovered by c 17%.

Beyond the macro drivers (Greek GDP), we believe key catalysts for the stock are evidence that the VLT roll-out is picking up pace (ie an increase in GGR/VLT/day) as well as a demonstrable increase in online revenues.

We have performed a DCF with a terminal growth rate of 1.5% and a terminal EBITDA margin of 22%, vs 22.5% in FY18e. Using a WACC of 8.5% produces a value per share of €10.0; flexing the WACC between 8.0% and 9.0% gives a range of €9.20–10.90. Our core DCF valuation equates to 9.0x EV/EBITDA and 15.9x P/E for FY19e.

For our valuation, we have assumed that OPAP will not receive a cash payment for its €1.8bn tax asset in 2030. Instead, we believe there will be further negotiations with the Greek government, such that the exclusive concessions could be renewed free of charge (or at least, inexpensively) in exchange for the repayment. However, should the contract be honoured at face value, we estimate that the present value of the €1.8bn payment in 2030 is equivalent to c €650m or c €2/share. Clearly, any clarity regarding this tax asset is unlikely to materialise in the near term, but at the very least, we believe it demonstrates OPAP’s strong positioning, which can only be a positive.

The gaming sector fell sharply in 2018, largely as a result of regulatory concerns and higher taxes (particularly in the UK). None of these issues affected OPAP, which now trades in line with the broader group (on EV/EBITDA basis) but with a very attractive FY19 dividend yield of 8.3%. Overall, we believe the peer group valuation is of limited value, given that the business models of the other listed European gaming companies differ quite considerably from OPAP (eg they are not monopolies, mostly do not participate in lotteries and mostly are far more reliant on online revenues).

OPAP’s business model is highly cash generative, with steady revenues from the core lottery business and upside from new products. Cost cutting and realigned commission structures also contribute to a forecast 2018–20 EPS CAGR of 17.9%.

OPAP’s business model is predicated on continuing cash flow from the monopoly businesses, supplemented by product enhancements and moving online. The key sensitivities are the risk that concessions will not be renewed or that taxes will be increased (both highly unlikely in our view). Revenues from the VLT roll-out have been slightly disappointing to date and there remains a certain amount of execution risk regarding both the VLTs and the introduction of online products, both of which could cannibalise the existing core business.

Importantly, OPAP’s top line is intrinsically linked to Greek GDP so there will continue to be a high degree of economic and country risk. Also, Sazka Group’s significant executive representation could impact future board decisions, although the positive is that OPAP should be able to derive synergies from being part of the wider group.

OPAP’s strategy is to grow the existing business through product enhancement, as well as streamline operations with continuing cost controls. The key elements of the strategy are:

CEO Damian Cope joined OPAP in 2016 and has embarked on an ambitious 2020 Vison plan to modernise the company. OPAP is halfway through this plan and it has now largely completed its transformation and investment phase (2016–2018). As detailed in Exhibit 3 below, many of the major initiatives over the past two years were necessary to either reduce third-party costs or to provide much-needed investment. OPAP is concentrating on growing top-line through new products (eg online and VLTs) as well as becoming increasingly efficient (eg improving performance and databases).

The company has outlined eight strategic priorities (below) to be used as a general framework for establishing OPAP as a world-class entertainment group.

OPAP’s portfolio of games is split between fixed-odds betting games and mutual betting games (where the total amount is distributed to winners). Numerical lotteries comprise c 50% of total revenues, with the contribution from other divisions (specifically VLTs) expected to steadily become more significant. Following the €145m investment into Stoiximan (online casino and sports betting), we have assumed this business will be fully consolidated from H219 (see below for more details). We show the separate line item in our forecasts, although this is likely to be included in sports betting in the future.

Numerical lottery games comprise the largest portion of GGR and consist of six games. The fixed odds games are Kino, Super 3 and Extra 5 and the mutual games are Joker, Lotto and Proto. The two key games are Kino and Joker, which OPAP is planning to bring online during FY19.

Sports betting games include fixed odds games Pame Stoixima and Monitor Games and the mutual betting games Propo, Propogoal, Horse Racing Stoixima and Pame Stoixima Virtual Sports. The main game in this category is Pame Stoixima.

OPAP holds a 67% stake in Hellenic Lotteries which has operated Passive and Instant lotteries since 2014. The three Passive brands are Laiko (weekly jackpot), Ethniko (using unique numbers) and State Lottery (the traditional draw game on New Year’s Eve). Instant lotteries include Scratch. Passive and Instant Lotteries are available at OPAP agencies and street vendors and Scratch games can be found at kiosks, post offices etc.

As part of its growth strategy, OPAP is rolling out 25,000 VLTs (certified retail slot machines), into ‘Play’ gaming halls and selected agencies. This ongoing investment in VLTs and 300+ new concept shops is one of the largest and fastest gaming store roll-outs in Europe, over one and a half years. The majority of the new Play stores will contain 30–50 machines, although OPAP is also opening some larger flagship stores alongside smaller ones (with lower capex requirements), which are more suitable for less dense locations.

VLTs have a €2 limit, which is in line with the recently reduced FOBT stake limits in the UK. Importantly, unlike the traditional OTC games, players are required to register and there were 270,000 registered players at September 2018 (which helps populate OPAP’s database). In terms of demographics, 40% of VLT players are younger than 35 and 30% are women. Importantly for incremental revenues, 20% of all VLT players are new to OPAP. Apart from the general reliance on the macro environment, a key driver for the VLT business will be to shift revenues away from the illegal machines towards OPAP venues. OPAP is hopeful that its VLT jackpots in H119 will provide a suitable incentive for players to shift allegiance. See below for more details on illegal gaming.

The VLT product was officially launched in January 2017. Over the year, OPAP rolled out 10,000 machines with an anticipated 19,000 finalised by YE18 and 25,000 by YE19. At Q318, 16,043 VLTs were operational in 320 Play gaming halls and 1,762 agencies. At this stage, there are indications that VLTs in the Play gaming halls are performing better than within the agencies, although we believe it is too early to discern a long-term trend.

At Q318, VLTs generated €51m GGR, up from €16m in the prior year and from €46m in Q218. We note that GGR per VLT per day has declined from a high of €51 in Q417 to €40, suggesting the second batch of machines has experienced a more limited ramp up. However, we believe this metric should rise to c €45–50 in FY19 onwards.

Unlike its other listed peers, OPAP’s online presence has been negligible to date and the company does not yet break-out online GGR. One of the reasons for the delay into online has been agents’ concerns about cannibalisation of retail revenues (and hence lower commission). However, following the migration of all games to the new IT platforms, OPAP is now focusing on providing an online option across many of its products, starting with online sports betting from late 2018 and also importantly an online offering for Joker and Kino in 2019.

Ahead of the upcoming regulation of the online market, OPAP has relaunched its online sports book (Pamestoixima.gr) in November 2018, which has more betting opportunities and competitive odds. OPAP has also announced a €145m investment for a controlling stake in the largest online sports player in Greece (as detailed below), which will be run independently from pamestoixima.gr and will clearly extend OPAP’s online presence.

In September 2018, OPAP announced the acquisition of a 36.75% stake in TCB Holdings for €50m, followed by a further €94.9m investment in January 2019. As a result, OPAP will have a 69% controlling stake in TCB’s Greek and Cypriot operations and a 36.75% stake in the other markets.

TCB Holdings comprises two online gaming brands: Stoiximan in Greece and Cyprus and the Betano brand in Romania and Germany (and possibly Portugal). TCB’s online market share is 49% in Greece, 44% in Cyprus and 10% in Romania.

In FY17, Stoiximan reported GGR of €136m and EBITDA of €16m. The implied valuation for the deal is therefore 8.5x EV/EBITDA, which is in line with the international peer group.

The deal will enable OPAP to leverage the latest in digital technology, ahead of the anticipated regulatory changes in FY19, when operator licences for online sports betting, live casino and poker could be granted. We note that the deal is still subject to regulatory approval.

The deal will enhance OPAP’s presence in the Greek and Cypriot online sports betting markets but will be run independently from the existing business.

Given the 69% controlling stake in the key Greek and Cypriot markets, we have fully consolidated Stoiximan into our figures from H219, contributing €11m and €25m to EBITDA in FY19 and FY20. We note that the transaction has not yet concluded and thus there is no auditor’s approval on the consolidation method.

Within OPAP’s cost structure, the two major variable components are the GGR tax and agents’ commission. As discussed in more detail below, the GGR tax was raised from 30% to 35% in 2016. In terms of agents’ commission, OPAP has realigned the commission to reflect NGR rather than wagers. The company has also succeeded in maintaining stable operating costs, in the context of rising revenues, which has helped contribute to a steady increase in underlying EBITDA margins.

As a direct result of OPAP’s ongoing cost controls, other operating costs have remained relatively stable since 2013 despite the commencement of several material projects (Hellenic Lotteries, Horse Racing, VLTs and Virtual Games). This has been the key reason for underlying EBITDA margin growth (ie excluding the additional 5% GGR tax) and we forecast relatively stable operating costs going forward (see pages 18-19 for further details).

Coinciding with the full privatisation of the company in 2013, a 30% GGR tax was introduced by the Greek regulator. In essence, this tax replaced the dividend payments to the government. Three years later, the GGR tax was further increased to 35% (January 2016) and this is now at the very top end of gaming taxes across Europe. As a reference, other European gaming markets are levelling out at c 20% tax (eg 21% in UK from April 2019, 18% in Sweden, 20% in Spain, 20% in Denmark, 25% in Italy).

OPAP operates via a franchise network of shops throughout Greece and Cyprus, paying commissions to agents and committing only limited resources to the kit-out of the shops. The company has recently renegotiated its agents’ commission structure and the dynamics of the estate have also altered.

Key to OPAP’s strategy is that it holds exclusive concessions in all land-based gaming in Greece, apart from casinos. The core games exclusive licence has been extended until 2030, the Scratch tickets and Passives licence expires in 2026 and the Horse Racing licence expires in 2036. Additionally, the exclusive licence to operate 25,000 video lottery terminals (VLTs) in Greece expires in 2035. To date, OPAP has paid €1.43bn for these concessions.

Τhe lottery and betting products concession was originally granted for the 2000–20 period. When extended in 2011 (for an additional 10 years up until 2030), a consideration of €375m was agreed. 80% of the €375m consideration paid (namely €300m or a future value of €1.8bn) corresponded to the prepayment of GGR contribution over 2021–30 based on projections for GGR performance for this period. OPAP will be also liable for the payment of a 5% duty post 2020. In 2030, at the end of the 10-year period, there will be a settlement between OPAP and the Greek State, depending on the nominal tax that will actually apply over 2021–30 (35% based on the current regime). In 2030, OPAP will either pay an additional consideration, which will be calculated and adjusted annually in the years 2020–30, or in the event that the settlement amount is negative, this will be paid by the Greek State back to OPAP.

This estimated €1.8bn is therefore the sum that the government is contractually bound to return to OPAP in 2030 (assuming that the GGR projections are correct). As we discuss in the valuation section, we estimate that the present value equates to c €650m or €2/share (if taken at face value). In our view, however, it is highly likely that the Greek government will seek to renegotiate, given the implications for the country’s coffers. We believe a more realistic outcome would be that OPAP is granted a further extension of the monopoly in lieu of reduced tax payments. This is clearly also a big positive, but falls outside our discounted cash flow calculation.

OPAP’s board comprises of 10 non-executive directors (including three independent directors) and three executive directors (chairman, CEO and CFO). Damian Cope was appointed CEO in July 2016, having formerly been group strategy director at Ladbrokes and has been responsible for launching the 2020 Vision for the company.

Many of the board members are associated with some of OPAP’s major shareholders: Sazka Group (Europe’s largest lottery business), KKCG and EMMA Capital. KKCG and EMMA Capital are both key shareholders of Sazka Group with 75% and 25% stakes respectively.

The Greek gaming market is regulated by the Hellenic Gaming Commission (HGC) and a Three-Member Supervisory Committee is responsible for the supervision and exercise of preventive control over OPAP to protect the public interest. In 2014, the Greek State Council ruled that OPAP’s monopoly in Greek gaming was irrevocable and no appeal can be raised before a national or EU Court.

The HGC estimates that total legal Greek gaming market amounted to €1.9bn in 2017, of which OPAP comprised €1.37bn GGR (including Horse Racing and Hellenic Lotteries). Land-based casinos comprised an estimated €254m from Casinos, with online amounting to c €280m.

According to H2 Gambling Capital, GGR per adult in Greece was €210 in 2017, broadly in line with the European average. Given the longstanding cultural tendency to gamble in Greece, we note that GGR as a percentage of GDP was 1.12% in Greece, compared to the European average of 0.68%. During 2018, Greek GDP expanded by 2% and the IMF projects 2.4% growth in 2019.

Although OPAP has been granted a monopoly on its gaming activities, there is still a significant illegal market, both in the machine market (VLTs) and with illegal online sites. Over 500 illegal slot machine venues have been identified (suggesting an illegal slots market larger than OPAP’s legal VLT business). In addition, over 2,700 online websites were blacklisted at September 2018.

The Greek online lottery business is non-existent although, as discussed above, OPAP is transitioning some of its key games online, largely to attract a younger demographic (Kino and Joker in particular). Over time, this online revenue should supplement the established land-based business.

As detailed in Exhibit 12 below, there is precedence in many other European markets that suggests significant upside potential from online lottery growth. Across Europe, online lottery comprises 10.5% of total lottery revenues and importantly, retail lottery has remained either stable or continued to grow at low single-digit rates.

While recognising that growth in Greece may not be comparable to other countries (given lower GDP growth etc), we believe the dynamics between online and retail should be reasonably similar and therefore approximately 10% of the lottery business should be derived from online in the medium term. In essence, even if softness in retail spending impacts the core business, this should be offset by the introduction of online (which also should appeal to a younger demographic).

We also note that in this area, OPAP should be able to benefit from expertise from its main shareholder, Sazka Group.

HGC estimates that the Greek online gaming market amounted to €280m in 2017 vs €215m in 2016 and €116m in 2015. This compares to other more mature markets such as the UK at c €6bn, Sweden at c €1bn, Italy at c €1.5bn and Spain at c €750m (Edison estimates). Greek GGR taxes are 35%, which is far higher than many other European countries and is one reason for the relatively high level of illegal online gambling. Within the legal sports betting market, the main competitors are Stoiximan, bet365 and GVC.

The full regulation of the online market could begin as early as Q419, following the publication of draft e-gaming legislation in 2018. Under the draft proposals, five-year licences will cost €4m for sports betting and €1m for live casino and poker and there is no limit to the number of potential licences. We note that online slots have been eliminated from the proposal. This is an important issue, as online slots are a very significant generator of revenues in other markets. We believe that the omission of online slots, combined with the extremely high tax rate, could prevent many operators from applying for a licence.

The blacklisting of unlicensed operators will continue and licensees will be required to have a registered office in Greece or another EU country. In all cases, there will have to be a physical server in Greece.

OPAP’s business model is predicated on continuing cash flow from the monopoly businesses, supplemented by product enhancements and revenue growth from online. The main sensitivities to the business model are:

OPAP’s shares fell c 27% in 2018, broadly in line with the Greek market, but still better than the broader gaming sector, which fell sharply in 2018 (largely due to regulatory burdens and tax increases). The stock has since bounced c 17% ytd. Beyond the macro drivers (Greek GDP), we believe key catalysts for the stock are:

We have performed a DCF with a terminal growth rate of 1.5% and a terminal EBITDA margin of 22%, vs 22.5% in FY18e. Using a WACC of 8.5% produces a value per share of €10.0; flexing the WACC between 8.0% and 9.0% gives a range of €9.20–10.90. Our core DCF valuation equates to 9.0x EV/EBITDA and 15.9x P/E for FY19e.

For our valuation, we have assumed that OPAP will not receive a cash payment for its €1.8bn tax asset in 2030. Instead, we believe there will be further negotiations with the Greek government, such that the exclusive concessions could be renewed free of charge (or at least, inexpensively) in exchange for the repayment. However, should the contract be honoured at face value, we estimate that the present value of the €1.8bn payment in 2030 is equivalent to c €650m or c €2/share. Clearly any clarity regarding this tax asset is unlikely to materialise in the near term, but at the very least, we believe it demonstrates OPAP’s strong positioning, which can only be a positive.

Although OPAP is a listed gaming business, we note that its business model is very different from the other listed European gaming companies (eg they are not monopolies, mostly do not participate in lotteries and mostly are far more reliant on online revenues).

We generally consider that the peer group valuation is of limited value (given the differences in models and geographies), but we nonetheless provide a peer group valuation table below, as some of them do operate in the retail space (GVC, William Hill, Rank). Additionally, as OPAP begins to grow its online presence, the comparison could become more relevant.

The broader gaming sector fell sharply in 2018, largely as a result of regulatory concerns and higher taxes (particularly in the UK). None of these issues affected OPAP, which now trades in line on an EV/EBITDA basis. However, the FY19 dividend yield of 8.3% is much higher than the average of 5.0% and we note that our forecasts do not include special dividends.

We believe GGR will continue to demonstrate ongoing weakness in traditional games (betting, scratch), which should be more than offset by the growth in new products (VLTs, Virtuals). In total, FY17 GGR grew 4.1% and we forecast FY18 GGR growth of 7.0%. We have consolidated Stoiximan from H219 and, including an additional €102m revenue, our FY19 GGR shows growth of 12.3%.

The business model is very cash generative, given the franchise model, the limited working capital risk and the fact that all licence payments have been made.