Jackpotjoy plc — Update 10 February 2017

Jackpotjoy plc (JPJ) is the world’s biggest online bingo operator and also offers online casino and social gaming. Its Prospectus has just been published and its shares will begin trading in London on 25 January 2017 when it will become the holding company for The Intertain Group, which will de-list from the Toronto Stock Exchange (TSX) at the same time. Intertain listed on the TSX in February 2014 (TSX:IT) and grew rapidly, with four acquisitions in 2014 and 2015 including Jackpotjoy (April 2015), which was acquired for £436m (C$814m) plus earn-out from Gamesys, which remains its platform provider. After a strategic review in H116, new UK management was appointed (Neil Goulden and Andrew McIver) and the decision made to list in London as Jackpotjoy plc (JPJ), pursuing a largely organic growth strategy.

JPJ has grown very rapidly since 2014. Headline growth has been driven by acquisitions but it has also delivered good organic growth in each of the three divisions. Management has forecast 2016 adjusted EBITDA of C$175-195m; Edison’s C$180m estimate implies 7% organic growth despite adverse FX. We expect revenue to grow by 14% in 2017 (in £m) and 11% in 2018 with EBITDA rising by 6% pa despite cost headwinds, and margins remaining above the industry average. Historic reported results have been affected by high levels of transaction costs and non-cash items but we expect only modest charges going forward. Intertain geared up in 2015 with the acquisition of Jackpotjoy and adjusted net debt (including earn-outs) was C$790m, but we estimate this fell to C$638m (£385m) by end 2016. We forecast additional earn-out payments of £87m in June 2017, £31m in June 2018 and £10m thereafter, which can be funded from cash flow. JPJ is highly cash generative with an operating cash flow/adjusted EBITDA conversion rate of c 95%, implying c £100m a year going forward, underpinning our expectation of a rapid fall in net debt from H217.

JPJ is rated at a material (46%) discount to the sector on a P/E basis, although the EV/EBITDA discount (11%) is narrower due to its capital structure. Intertain’s 2016 TSX rating was depressed by adverse sentiment post a short seller report, the strategic review, adverse FX, and low volume ahead of the move to the LSE (originally planned for October but delayed by the debt raise and UKLA). However, legacy issues have been addressed (page 8), JPJ has a highly respected UK chairman and CEO (Neil Goulden and Andy McIver), and the amended agreements with Gamesys and debt raise put the group on a very sound footing going forward. As a 78% regulated business the rating should be much closer to the sector average. A 10x 2017e P/E would imply a share price of 908p and a 9.2x 2017e EV/EBITDA, still slightly below 888 Holdings. Our DCF comes in higher than this at 1,088p/share (range of 941p to 1,293p).

JPJ is 78% regulated, but licensed markets may still change tax rates or conditions (eg UK remote gaming duty will be applied to gross rather than net revenues from August 2017), and other markets may introduce licensing regimes with new taxes or product requirements. JPJ is dependent on Gamesys for the operation of its largest segment, the ‘Jackpotjoy’ division, but the relationship is good, the operating agreements have considerable protections in place and JPJ has much more control over strategy and budgets from this March (the end of the main earn-out period). Gamesys’s indirect fees will rise by 25% from April 2020 (currently supplied at cost) and we allow for this in our DCF. Other sensitivities include competition, including any pressure to spend more on marketing, the general economy, and the need to reduce debt/leverage before dividends can be paid.

JPJ has a market-leading UK position, high-growth businesses in Europe (mainly the Nordics and Spain) and opportunities for expansion into new territories such as Latin America. It mainly targets the female demographic (age 35-50), which differentiates it from most sportsbook and pure casino brands which are male (18-35) focused. The group was built by acquisition but has now moved into an organic growth phase, although ongoing consolidation in the online gaming sector means that we would not be surprised by M&A activity. It is relatively indebted (2016e adjusted net debt/ EBITDA of 3.5x) but strong underlying cash flows means that the June 2017 Gamesys earn-out (estimated at c £87m in cash) should easily be covered. Thereafter leverage should reduce rapidly.

JPJ provides online gaming to a global customer base, with its main focus being online ‘bingo-led’ real money gaming in the UK and Europe. It is the number one bingo-led operator globally and bingo-led gaming accounted for c 71% of revenue in the 12 months to September 2016, casino 22% and social gaming 7%. About 78% of revenue came from regulated markets (66% from the UK), which compares with Paddy Power Betfair (95%), 888 (59%), GVC (55%) and Playtech (41%).

JPJ is organised into three divisions, of which the ‘Jackpotjoy’ division is the largest, accounting for 69% of revenues and 80% of EBITDA in the 12 months to September 2016. JPJ operates its Vera&John casino brands on its own proprietary platform. The operation of its Jackpotjoy brands is fully outsourced to Gamesys, while Mandalay’s bingo-led brands are hosted by Dragonfish (888 Holdings).

Online bingo is a community game where scale matters, and JPJ’s UK market leadership (22% market share, Exhibit 7) is a key advantage. Its ‘liquidity’ enables it to offer more frequent games with lower waiting times, bigger prizes and more jackpot winners, and with vibrant social chat rooms. At the same time, side games (normally slots) are very popular with bingo players and hence the term ‘bingo-led’, since 75-80% of the revenue from an online bingo site typically comes from slots.

JPJ’s main brands are illustrated below. Its main bingo brands are Jackpotjoy and Costa Bingo in the UK and Botemania in Spain. Its main casino brands are Starspins in the UK and Vera&John in the Nordics. InterCasino is a very long-established casino brand with scope for revitalisation under the Vera&John management. JPJ also has a number of secondary brands (especially within Mandalay) that can be used to target specific demographics or cross-sell to lapsing players.

JPJ’s flagship brand is Jackpotjoy, which has a c 23% share of the UK online bingo-led market (page 6). The division includes the Starspins and Botemania real money gaming (RMG) brands. Jackpotjoy and Starspins also offer social games. The UK is the biggest market, accounting for 80% of revenue, with Sweden at 5%, Spain 4%, other 4% and the US 7% (social gaming only).

Jackpotjoy UK was launched in 2002 by Gamesys and grew rapidly to become the UK’s leading online bingo-led brand, with over 1.6m registered players on its database. It has won many awards and enjoys very strong brand recognition, helped by high-profile television campaigns fronted by personalities such as Barbara Windsor. It has a loyal customer base and in the first nine months of 2016, 77% of revenues came from players who joined in 2014 or earlier, much higher than the industry average. The Jackpotjoy brand was launched in Sweden in 2012, where slots are the most popular product offering. Starspins was launched in the UK in 2013 to complement Jackpotjoy with a pure slots offering. Botemania was launched in Spain in 2007 and regulatory changes allowed it to reintroduce slots in June 2015. Although still small, Botemania is the leading bingo-led site in Spain, with a market share of c 25% (source: JPJ prospectus) and is growing rapidly.

Compared with other gaming operators, Jackpotjoy was slightly behind the curve on mobile, but it is now catching up fast, with new platform launches and upgrades. Mobile usage is up by more than 83% since Q115 and mobile accounted for 52% of Jackpotjoy UK revenues in Q316 (Q216: 47%). In Botemania, mobile was 35% of revenue in Q316 versus only 12% in Q216, helped by its launch of a new range of slot games in Q216.

Mandalay mainly operates UK online bingo-led sites on the Dragonfish (888) platform and has c 43,000 monthly active customers. Its flagship brand is Costa Bingo, which was launched in 2009 and accounted for 59% of Q216 revenues. Sing Bingo was launched in 2010 and since April 2014 the group has pursued a multi-brand strategy, with 13 new ‘skins’ launched since January 2015. In this respect the Mandalay brands complement Jackpotjoy, since although they appeal to broadly the same demographic they typically have lower ticket prices and a more value driven proposition. From April 2017 JPJ will be able to cross-sell Mandalay brands to lapsing Jackpotjoy and Starspins players for the first time, once their earn-out period has finished.

Mandalay also has two slots-only brands, Costa Games and Slot Crazy which it launched in 2015.

Vera&John was launched in 2011 and is a global online casino operator. It offers over 800 games (slots, table games, live casino, etc) both proprietary and from third-party suppliers such as NetEnt and Microgaming. It aims to offer a differentiated casino experience and many of its RMG games also have social variants that are played on a freemium basis. Its main RMG brands are Vera&John and Vera&Juan and it had an average of 29,000 monthly active players in the nine months to September 2016. It operates in over 10 countries and while the bulk of its revenues come from northern Europe, notably Sweden, we estimate that c 30% comes from Asia (mainly Japan).

Vera&John has a proprietary platform, which it is leveraging through a B2B white-label offering with c 5,000 monthly actives for white-label customers.

JPJ’s longest established brand is InterCasino, which was launched in 1996 and acquired by Intertain (from Amaya Inc) in February 2014. InterCasino was a leading online casino before 2006 but its fortunes waned when the US market closed and revenues were only £6m (C$11m) in 2015 (mainly in the UK). There were only 1,500 active players in H116 (with, we assume, a more VIP skew than Vera&John), but during H116 a platform agreement with Amaya ended and the brand was migrated onto the Vera&John platform. JPJ’s September 2016 investor presentation reported encouraging post-migration KPIs with 28% more users, 41% more first-time depositors and a 77% increase in first-time deposits. We believe that InterCasino has considerable growth potential.

JPJ operates in growing markets, with positive structural drivers. Internationally online gambling still only accounts for 13% of the total market, with scope to rise as broadband penetration and trust grows. In the UK 33% of the market is now online (Gambling Commission) but new ways to gamble have proved to be incremental rather than cannibalistic. Over the past three years mobile has taken over from desktop as the key driver of growth. Mobile now accounts for over 50% of Jackpotjoy’s revenues and its average monthly yield is 2.5x higher for multi-channel players than for those playing on desktop or mobile alone. Similarly, Mandalay’s multi-channel players deposit 2.8x more than desktop players and 1.7x more than those playing on mobile alone.

The global online bingo and casino market is estimated to have been worth $14.8bn in 2015 (source: H2 Gambling Capital) and to account for 28% of the global online gambling market. It is forecast to grow at a CAGR of 10.6% to 2018, only slightly slower than the 11.4% CAGR between 2008 and 2015.

The UK Gambling Commission reports that online bingo generated £152.7m of gross gaming revenue in the year to March 2016, out of a total UK online gambling market of £4.47bn (US$5.5bn). This is the pure bingo figure. Gambling Compliance (2015 Report) expected the total bingo-led segment to total c £600m in 2016, which tallies in that it implies that casino games account for 75% of the bingo-led market. Gambling Compliance estimates that the UK bingo-led market has grown at a CAGR of c 7.5% between 2011 and 2016 and we believe that rate is being sustained despite the maturity of the sector, due to the shift to mobile. H2 Gambling Capital forecasts a growth rate of 9.1% between 2015 and 2018. We believe that slots are growing faster than pure bingo, because they work better on small smartphone screens.

The UK bingo-led market is highly competitive and estimated market shares have shifted slightly in the two years since remote gaming duty (RGD or POCT) was introduced. Jackpotjoy is market leader with a share of 23%; its H116 RMG growth was 10% and we believe it has recently benefited from Sun Bingo’s loss of share due to a platform migration. Of the other gaming specialists, Gala Bingo appears to have maintained share (nine-month revenues to June 2016 up 8%) but Rank (Mecca) has also been affected by a platform migration (revenues down 2%, six months to June 2016). The larger multi-product operators such as GVC (Foxy Bingo), Ladbrokes and William Hill appear to have been prioritising their marketing spend towards sports and pure casino. Stride Gaming has been the main winner recently: its share doubled to 10% at the end of August 2016, when it acquired two smaller operators, but it has also grown strongly organically with FY16 bingo RMG revenues up 31% due to aggressive marketing.

M&A has been a feature of the sector in the past two years, driven by economies of scale in the business model and cost pressures including RGD in the UK and new taxes and compliance costs in regulating markets. JPJ is currently focused on organic growth (Strategy, page 10) but could become an acquirer again, or indeed a target. Exhibit 8 shows some of the larger deals that were completed during 2016. In addition, William Hill was involved in two proposed transactions that did not proceed: a consortium bid by Rank and 888 (which valued it at c £3.1bn but was rejected by the board) and a proposed merger with Amaya (AYA:TX, which was vetoed by shareholders).

Vera&John has its own proprietary casino platform, which successfully transitioned across the InterCasino brand in 2016, and also has a small B2B business, which has scope for significant expansion. JPJ outsources the operation of its bingo-led brands to Gamesys, in the case of the Jackpotjoy division, and Dragonfish (888) for Mandalay. As at December 2016 JPJ had 243 employees, of which 196 were employed in Dumarca, the operating arm of Vera&John (not counting consultants and contractors), 24 in Mandalay and most of the rest in corporate operations in the Bahamas and Toronto. It also had c 269 employees dedicated to it within Gamesys.

Outsourcing is very common in the gambling industry, particularly for bingo, given the need for liquidity. Mandalay’s relationship with 888 is typical for a bingo ‘skin’: Dragonfish provides the platform, gaming licence, customer support etc, while Mandalay is responsible for marketing. It also has bespoke elements (eg a loyalty programme) to differentiate itself from other 888 ‘skins’. Dragonfish is one of the leading bingo networks and has over 140 partner brands, including Foxy Bingo (GVC), Wink Bingo (888) and numerous Stride Gaming brands.

Gamesys is a long-established private operator, having been formed in 2001. It is headquartered in Piccadilly, London and has c 1,000 employees worldwide, including c 269 dedicated to Jackpotjoy. Other B2B customers include Virgin Games, Virgin Casino (New Jersey, US) and Caesars Casino and Bingo. Intertain acquired Jackpotjoy from Gamesys in April 2015 for £436m plus an earn-out, which runs to 31 March 2017 for Jackpotjoy and Starspins and to 31 March 2020 for Botemania. (we estimate a total of £278m, of which £150m has already been paid).

JPJ owns the brands, exclusive content, intellectual property, customer data and liquidity. Gamesys provides the content and hosts the platform, but it is more than just a platform provider as it is also responsible for marketing and customer support. In the past Gamesys had substantial control over Jackpotjoy’s strategic plan and budget, but this will change at the end of March 2017 (the end of the Jackpotjoy/Starspins earn-out period) and we believe JPJ has already had considerable input into Jackpotjoy’s 2017 marketing plan and budget.

Gamesys supplies its dedicated staff at cost until April 2020, when its fees will rise by 25%. There are two detailed Operating Agreements (one for RMG and one for social gaming), which were amended in September 2016 in JPJ’s favour. The operating agreements were extended by five years, to 2030 for the platform and 2040 for content, and a non-compete agreement (covering bingo-led sites in Jackpotjoy territories) was extended by two years, to April 2019. The total earn-out was capped at £375m (previously uncapped). The amendments were agreed on condition that £150m of the earn-out was paid early (by 27 February 2017) and it was paid in December 2016. JPJ is also paying £660k pcm from April 2017 for the non-compete extension (a total of £24m over 36 months). The amended agreement and the fact that we are now very close to the end of the main earn-out period (31 March 2017, with only Botemania remaining after that, as shown in Exhibit 19) removes a considerable degree of uncertainty.

Under the amended agreements JPJ has an option to internalise some of the dedicated Gamesys staff after 31 March 2017 and to segregate its player liquidity from April 2018. It can internalise all the staff from April 2019, when it could also switch platform provider (subject to a six-month notice period). We expect it to start to internalise a small number of staff fairly soon, and in particular we consider it might make sense for it to take over marketing after April 2019 (perhaps bringing 25-30% of the staff in house). We would not expect this to make a material difference to our profit forecasts but it would give JPJ control over a key aspect of the business. However, Gamesys is an excellent B2B operator and we do not expect JPJ to move to a new platform provider given the disruption that typically occurs on platform migrations.

JPJ started life as Aumento Capital II in Canada in 2011, a special purpose acquisition vehicle. It Acquired InterCasino in February 2014, changed its name to The Intertain Group and listed on the TSX (TSX:IT). It grew very rapidly on the back of three further acquisitions (Exhibit 9), which took 2015 revenue to C$385m (2014: C$41m).

Intertain’s shares rose strongly from around C$4.0 in February 2014 to a peak of $19.94 in June 2015. The shares then ran into a period of profit taking despite the fact that Q315 results (October 2015) showed adjusted EBITDA of C$43.7m, well ahead of the consensus of C$35.6m. After such rapid growth, management began to review the next steps for the group’s development but on 17 December 2015 Intertain was targeted by a 120-page short-seller report, which was the catalyst for a formal strategic review.

The Spruce Point Capital Management short seller report made a range of allegations, which were investigated by an independent committee and Deloitte. On 22 February 2016 it reported that “the allegations and innuendo of the short seller related to the quality and financial performance of the Group’s underlying business were wrong in every material respect”. Intertain did make changes after the committee’s review, although some of those may have happened anyway. Internal controls and reporting were strengthened and John Kennedy FitzGerald (then CEO) departed, saying that the focus of the group had moved from acquisitions to operations.

We consider that the bear points have all been addressed by management actions, the passage of time and the amended agreements with Gamesys. The report should be consigned to history, but for completeness we summarise the main points:

On 6 March 2016 Intertain announced that it had received expressions of interest in acquiring all or parts of its business. A Special Committee considered a range of options and announced (26 July) that shareholder value would be maximised by the group remaining independent, re-domiciling to the UK and moving its share listing to the London Stock Exchange (LSE). The UK is JPJ’s biggest market, accounting for 66% of revenues, and has a long-established fully regulated gaming sector; Europe overall is 87%, while virtually no revenues arise in Canada. It recruited two new highly experienced UK directors to be chairman and CEO: Neil Goulden and Andrew McIver.

JPJ’s listing is on the Standard segment of the LSE, but the board’s intention is for it to move up to the Premium segment in due course and its corporate governance is fully compliant from the outset. JPJ becomes the ultimate holding company via a plan of arrangement. Intertain shareholders could elect to receive JPJ shares or exchangeable shares; the latter are listed on the TSX and enable the holders to retain a Canadian listed instrument and defer potential CGT. They are redeemable after five years or on upgrade to a Premium listing, ie, the exchangeable shares are something of a transitional arrangement. The LSE listing was originally planned for mid-October but there were delays both with the debt raise (to fund the Gamesys earn-out prepayment and secure the amended agreement terms) and with obtaining UKLA approval. The Prospectus has just been published and the shares will begin trading on the LSE on 25 January.

JPJ’s board is highly experienced, with both British and Canadian representation and with remuneration and a new long-term incentive plan (LTIP) in line with UK market practice. Six of the nine board members have been appointed to Intertain/JPJ since February 2016 (including three new non-execs on admission to the LSE).

JPJ’s Chairman Neil Goulden and CEO Andrew McIver are both extremely well known and respected in the UK. Neil was group MD, CEO and chairman of one of the UK’s leading gambling groups, Gala Coral from 2001-2014 (FY15 adjusted EBITDA of £205m; businesses include galabingo.com; recently merged with Ladbrokes). Andrew was CFO and then CEO of Sportingbet between 2006 and 2013, one of the leading UK-listed online sports books (acquired by GVC in 2013). CFO Keith Laslop joined Intertain in February 2014 and provides considerable executive and financial continuity. The non-executive directors provide a broad range of industry and financial experience. Full biographies are provided in JPJ’s Prospectus.

In addition, Noel Hayden is a special adviser to JPJ. Noel founded Gamesys and remains as its chairman and major shareholder. He was a director of Intertain until September 2016 and is a 3% shareholder in JPJ; his new role should maintain the strong relationship between the two groups.

After a period of acquisition-led growth, management is now focused on organic growth and no further acquisitions are being actively pursued. That said, there is a high level of M&A activity within the sector and we tend to assume that all operators talk informally from time to time, at least in terms of individual business segments (both as buyers and sellers). Management’s strategy is set out in the Prospectus (page 92): it aims to capitalise on its leading market position and diverse customer base (both geographically and demographically) by:

JPJ’s UK bingo-led business is mature (although fairly predictable and cash generative) but we see specific growth opportunities from further mobile-led growth (multi-platform customers spend 2.5 times as much on average), internationally in Sweden and the Nordics (leveraging Jackpotjoy and Vera&John strengths), Spain and potentially Latin America; and also in B2B (leveraging the Vera&John platform).

Regulation: JPJ holds licences in Malta, the UK and Denmark, while services provided by Gamesys and 888 are covered by their Gibraltar, UK and (in the case of Gamesys) Spanish licences. Licence conditions and tax rates can and do change in regulated markets. For example, the 15% UK remote gaming duty (RGD or POCT) will be extended to ‘free play’ from August 2017 and we allow for a three-point margin impact. The current UK gambling triennial review could tighten rules around daytime TV gambling advertising, which would be unhelpful (bingo is currently allowed to advertise before the 9pm watershed), but this may be more likely to affect advertising around sports. In common with most other online gambling operators, JPJ derives revenue from markets that are not yet regulated (c 22% of NGR). It may face additional taxes and costs when regulation is introduced (eg Sweden, 9% of NGR, is expected to introduce licensing in Q418) or sanctions where online gaming is more explicitly prohibited (eg Japan, c 7% of revenue, although Japan has recently decided to legalise land-based casinos).

Relationship with Gamesys: JPJ is dependent on Gamesys for the operation of its largest segment, Jackpotjoy. Gamesys is responsible for all aspects of the operation, including marketing, and has substantial control over the strategic plan and budget until 31 March 2017. Its indirect fees will increase by 25% in April 2020 (for staff that have not been internalised by JPJ before then). The earn-out period is almost over for Jackpotjoy and Starspins (31 March 2017) but runs to 31 March 2020 for Botemania. Gamesys could have run the business to maximise short-term profits during the earn-out period, eg by minimising marketing at the expense of longer-term brand development prospects. When the earn-out is over it could focus more of its resources on its other B2B brands. However, the relationship between the two companies is good and the operating agreements have considerable protections in place, including:

Technology and platform risks: aside from Gamesys, JPJ is also dependent on 888 (Dragonfish) and other third-party suppliers such as payment processors. It is also exposed to the usual internet-related risks and the need to adapt to technological change.

Competition: JPJ operates in highly competitive markets. Some of its competitors are bigger, with greater financial resources, but JPJ is the biggest bingo-led operator, with the highest liquidity. The UK gaming tax, and its extension to free play in August 2017, is a barrier to entry for smaller operators. Gamesys could become a bingo competitor once the non-compete restrictions expire but its CEO Lee Fenton provided reassurance that would not happen at an Investor Presentation in September 2016 and we believe that other verticals and geographies would offer more profitable expansion opportunities for Gamesys. JPJ’s marketing spend is below the industry average due to the strength of the Jackpotjoy brand (at c 17% of revenue versus an average of 20-30%) and our forecasts are sensitive to assumptions about future spend ratios. Our forecasts assume it remains broadly unchanged; by way of illustration an increase in the marketing ratio to say 20% would cut our 2017 EBITDA forecast by £9m or 8.6%. Online gambling also competes for consumer spending with other forms of leisure activity. However, JPJ’s management has a depth of market experience.

Economy: gambling has historically proved resistant to economic slowdowns, but not immune, although the structural growth in online gambling outweighed economic pressures in the last major slowdown of 2007-08. Brexit could have an effect on the group’s customers or markets.

Indebtedness and earn-out liabilities: JPJ reported net debt of C$270m (£158m) at 30 September 2016 (61% of shareholder equity) and we expect this to have increased to C$500m (£302m) at 31 December 2016 due to the addition of £160m to fund the £150m pre-payment of the Gamesys earn-out (made in the same month). We estimate that it has around £128m of remaining earn-out liabilities, of which £87m falls due in June 2017. However, we calculate that JPJ will generate ample cash to fund the payments and that its adjusted net debt/EBITDA ratio (including the earn-out) will fall from 3.5x in December 2016 to 2.8x by end 2018 (and project that management’s 2.0x target will be attained in 2019). Underlying cash flows are strong, but the board’s ability to introduce dividends could be restricted by ‘cash sweep’ requirements, ie, a proportion of free cash flow must be applied to debt repayments.

Online gambling companies are generally valued on a P/E and EV/EBITDA basis although we have also performed a DCF. Exhibit 11 shows the main UK-listed peers, of which we consider the closest to be 888 Holdings and GVC, both of whom have sizeable online bingo and gaming operations, and the smaller Stride Gaming. Paddy Power Betfair is also a comparator, and highly rated; 32Red and Gaming Realms are also online gaming operators but Ladbrokes, William Hill and Rank have large, low-growth, land-based estates as well as online operations; Playtech is mainly software/B2B. Internationally, B2C operators Betsson and Kindred (formerly Unibet) are the closest peers but we also show a number of other B2C and B2B operators.

JPJ’s 2017e P/E of 6.6x is little more than half the UK sector average of 12.1x and the EV/EBITDA of 7.1x stands at an 11% discount. Legacy issues have been addressed and the UK listing should be the catalyst for a re-rating as the group demonstrates a lengthening track record as a 78% regulated, cash generative gaming operator in a growing and consolidating marketplace. A 10x 2017e P/E would imply a share price of 900p and a 9.2x 2017e EV/EBITDA, still slightly below 888 to allow for the above-average leverage and dependency on Gamesys.

The delay in the planned move from the TSX to LSE (from October 2016 to January 2017) meant that Intertain experienced a period of low trading volumes and some share price volatility in Q416. We expect low volumes to persist for a while on the LSE until more shareholdings move across from Canada and UK broker coverage increases.

DCF: For our DCF we have run forecasts through to 2022 with revenue growth moderating to 4.0% by 2022 and a terminal growth rate of 2.0%. Our forecast EBITDA margin for 2018 is 33% (2016e: 37%) and we assume this falls to 28% by 2022 (Gamesys fee increase and a slight rise in the marketing ratio), with a terminal 26%. With a WACC of 10% our DCF value is 1,088p/share. Flexing the terminal margin between 25% and 27% produces a range of 1,047-1,128p while a 9-11% WACC range (and 26% terminal margin) gives 941-1,293p.

We expect JPJ to deliver EBITDA growth of about 6% pa between 2016 and 2018, with 2017e normalised PBT and EPS affected by higher interest charges but growth resuming in 2018. We allow for a three- to four-point reduction in EBITDA margins over the forecast period as the 15% UK gaming duty (RGD) will apply to gross rather than net RMG revenue from August 2017. We assume that the marketing ratio (a key variable) remains broadly unchanged. JPJ is relatively highly geared compared with other online gaming operators due to its acquisition history, but it now has finance in place to cover the anticipated earn-out payments and strong forecast operating cash flow of almost £100m in 2017e. Management’s dividend policy is to target a 50% pay-out ratio once the group reaches a UK sector average leverage ratio.

Intertain filed quarterly reports in Canadian dollars (C$). We expect JPJ to report 2016 results in both C$ and £ sterling and to move to sterling reporting thereafter, since its functional currencies are sterling and the euro. Under IFRS it is required to convert historic results at the prevailing spot rate but to provide a more realistic comparison we also expect it to show 2016 results based on average rates, as we have done. It will continue to file quarterly accounts until the proportion of shares held in Canada falls below 10%. Exhibit 12 illustrates the sterling depreciation since mid-2016, which has adversely affected the translation of sterling results into C$.

JPJ provides pro forma quarterly results for each of the three divisions in their functional currencies, which facilitates the analysis of underlying trends, since reported results only include the businesses from their dates of acquisition and have been affected by C$ FX.

Jackpotjoy increased revenues by 11% CAGR between 2013 and 2015 and we expect similar growth in 2016, helped by rapid progress in Botmania and Starspins, which together delivered “triple digit” growth in 9M16, helped by a better mobile offering and Botemania’s slots launch in Q216. We expect Botemania in particular to continue to grow strongly over the next two years, while we forecast 4-6% growth for the Jackpotjoy brand (RMG plus social) within a mature market.

Jackpotjoy’s EBITDA margins are unusually high for a B2C operator at 39% in 2015 and 46% in 9M16, versus a sector average of 20-30%. This reflects two main factors: Gamesys provides its direct services (ie its dedicated staff) at cost under the terms of the operating agreement; and Jackpotjoy’s high level of brand loyalty means marketing costs are low (they are not split out at the brand level but total group marketing costs were only 16.5% of revenue in 9M16 versus more typical industry averages of 25-30%).

Our forecasts allow for some margin pressure (c three percentage points) from August 2017 due to the extension of RGD to ‘free play’, which means the 15% tax will be levied on gross rather than net real money gaming revenue. The competitive response and extent to which the impact can be mitigated is still uncertain. From April 2020 Gamesys’s direct fees will increase by 25%: this applies to platform costs (10% of revenue) and direct admin costs (perhaps 8-9% of revenue). This is outside our forecast period but by way of illustration, the proforma impact on our 2016 EBITDA of £83m would be a c £8m reduction or a margin reduction of five percentage points. This is probably worst case (3-4% might be more realistic) and it may be mitigated to the extent that Jackpotjoy brings certain functions in house. However, we have allowed for a small reduction in divisional EBITDA between 2019 and 2020 in our DCF.

Vera&John has grown very strongly over the past three years with gaming revenues more than doubling between 2013 and 2016, from €33.5m to an estimated €70.1m. In April 2016 InterCasino was migrated on to the Vera&John platform, which caused a short-term reduction in revenues but we believe the brand has considerable potential for medium-term rejuvenation and our revenue forecasts could prove cautious. InterCasino’s vendor Amaya provided a two-year revenue guarantee but this ended in February 2016.

Vera&John’s EBITDA margins exceeded 30% in both 2014 and 2015 but this included income from the revenue guarantee (100% margin). We expect margins to settle at 25-26% in 2017 and 2018, on gaming revenues growing at 8% and 6% respectively.

Mandalay’s revenue grew by almost 20% CAGR between 2013 and 2015 and EBITDA by 18%. Progress slowed in 2016, despite increased marketing, due to increased competition at the lower end of the UK bingo-led market. We expect JPJ to focus more on its other brands in 2017/18 but note that the ending of the Jackpotjoy earn-out period on 31 March 2017 will allow it to cross-sell Mandalay’s brands to lapsing Jackpotjoy and Starspins players for the first time. EBITDA margins were below trend in Q316 (at 26.7%) due to TV advertising campaigns, which are not expected to repeat at the same level in 2017. However, we expect 2017/18e margins to be nearer 30% than the 39.5% achieved in 2015 due to increased RGD (Mandalay offers a high level of free play).

JPJ/Intertain has grown very rapidly since its formation in 2014. Much of the headline growth has been driven by the acquisitions but JPJ has also delivered organic growth in each of the three divisions as demonstrated in Exhibits 13-15. Group revenue has multiplied from C$41m in 2014 to an estimated C$476m in 2016e with adjusted EPS more than doubling from C$0.80 to an estimated C$1.96 over the same period (before material exceptional costs and other items).

Our 2016e headline estimates are in line with management guidance: revenues of C$460-500m, adjusted EBITDA of C$175-195m and diluted adjusted EPS of C$1.87-2.13. The guidance was originally announced in March 2016 and is repeated in the prospectus. At the time of the Q316 results management said that it expected results to trend towards the lower end of the range due to FX (sterling’s depreciation against the Canadian dollar). Our 2016e EBITDA estimate of C$180m represents 7% growth over 2015 pro forma (as if Jackpotjoy had been owned for the full year) despite the shift in the average C$/£ rate from 1.95 in 2015 to 1.80 in 2016.

Adjusted figures are before material exceptional and other items. In 2015 these included C$57m of transaction costs, C$121m fair value adjustments for contingent consideration, C$37m goodwill impairment and a C$10m gain on a cross-currency swap. For 2016 we expect C48m of transaction costs (including a C$10.5m severance payment and London listing costs), C$85m fair value adjustments and a C$40m gain on the swap. But for 2017 we only expect £1.5m of exceptional costs (mainly London costs not already provided) and do not forecast material fair value adjustments (aside perhaps for any adjustments relating to the expected Botemania earn-out).

With Jackpotjoy having been acquired in April 2015, Q316 was the first like-for-like quarter. On the face of it, the results appeared lacklustre with revenue of C$113.7m down from C$122.2m in Q315 and adjusted EBITDA almost unchanged at C$43.8m. However, the decline was entirely a function of currency. On a constant currency basis, revenue increased by 10% and adjusted EBITDA by 17%, with an average C$/£ rate of 1.71 (Q315: 2.03). Q316 adjusted net income of C$36.3m was 25% up on Q315 on a constant currency basis. Reported net income was a loss of C$31.8m (Q315: loss of C$17.5m) after transaction costs (C$17.8m), amortisation of acquired intangibles (C$24.8m), fair value adjustments on contingent consideration (C$24.9m) and other items.

Based on our divisional forecasts, we expect group revenue to grow by 14% in 2017 and 11% in 2018. Our group EBITDA margin falls by from 37% to 33% over the period, mainly due to the extension of the UK gaming duty to free play but also reflecting some change in the mix, eg strong growth in Botemania (which is just scaling up and pays 25% gaming tax on gross revenues). Our margin assumption is sensitive to marketing spend, which we assume does not increase materially from the 2016 level of c 17% of revenues, although this is low relative to peers (see ‘Sensitivities’). Overall we expect c 6% growth in adjusted EBITDA in both years.

Our 2017e adjusted PBT forecast is affected by a material increase in our estimated interest charge, from £17.5m in 2016e to £33.0m in 2017e. This reflects the assumption of £160m of new debt in December 2017 to fund the Gamesys earn-out pre-payment, £90m of which carries a coupon of LIBOR plus 9% (see below). As a result, we expect adjusted EPS to decline in 2017 (by c 15%, to 90.8p) but growth should resume in 2018. Thereafter we expect steady single-digit growth (in the absence of acquisitions), with perhaps a temporary flattening in 2020, which will include eight months of the increased Gamesys charges in Jackpotjoy.

Online gaming companies are typically highly cash generative, with modest capex requirements. In Q316, for example, Intertain generated C$31.8m of operating cash flow or 72.6% of adjusted EBITDA (of C$43.8m) despite a C$10.5m severance payment (paid to the former CEO). For 2017/18 we expect operating cash conversion of c 95% implying operating cash flow of about £100m a year. JPJ/Intertain geared up in 2015 with the acquisition of Jackpotjoy and we estimate that adjusted debt (including earn-outs)/EBITDA was 3.5x at end December 2016, above management’s 2x goal. However, once the main Gamesys earn-outs have been paid we expect leverage to fall rapidly as JPJ begins to repay debt (especially the more recent second lien facility, which bears interest at LIBOR plus 9%).

.

Jackpotjoy was acquired in April 2015 for initial consideration of C$814m (£436m), settled as to C$688m in cash plus 7.36m shares worth C$126m. The price represented a 2014 EV/EBITDA of 6.2x. Acquisition-related costs totalled a further C$53m. In addition there was an earn-out (originally uncapped but now capped at £375m, although this is not expected to be reached). Exhibit 19 shows the formulae:

As at 30 September the discounted present value of the earn-out liability on JPJ’s balance sheet totalled C$426m (£250m). A £150m pre-payment was made in December 2016 to secure the amended operating agreements. Based on our Jackpotjoy division forecasts, we expect remaining earn-out payments of £86.6m in 2017 and £31.4m in 2018 (Exhibit 20) with additional payments of £5m in both 2019 and 2020 to give a total of £278m.

The Jackpotjoy acquisition and associated transaction costs meant that net debt increased from C$53.5m at end 2014 to C$372.8m at end 2015, or C$790.9m adjusted to include the then present value of earn-outs and swaps. This represented an adjusted net debt/EBITDA leverage ratio of 5.7x. By the end of Q316 reported net debt had fallen to C$270.3m despite transaction costs relating to the strategic review (including a C$10.5m severance payment made to the former CEO) and a C$12m (final) earn-out payment to Vera&John. In Q416 JPJ paid the £150m Gamesys pre-payment and we estimate that this will have left 2016 year-end net debt at around C$500m (£302m) and adjusted net debt at C$638m (£385m).

Online gambling is typically highly cash generative, with modest capex requirements, and operating cash flow/adjusted EBITDA conversion rates of over 80% are typical. Excluding the severance payment JPJ generated C$42.3m of operating cash flow in Q316 or 96.6% of EBITDA (of C$43.8m). H117 will bear the Jackpotjoy June earn-out payment and final cash costs relating to the London listing, but the group should turn strongly cash positive thereafter as exceptional items fade away and despite the increased interest costs. Overall we expect an increase in net debt in 2017 to £333m, but a reduction in adjusted net debt, to £374.4m. Net debt should continue to reduce in 2018, the final year of any material earn-out payments, and we tentatively project it to fall to c £230m by end 2019 when leverage should fall to management’s 2x target.

As at Q316 the bulk of JPJ’s debt comprised credit facilities put in place with Macquarie Capital at the time of the Jackpotjoy acquisition in April 2015: a seven-year US$335m term loan and a five-year senior secured US$17.5m revolving credit facility. They bear interest at LIBOR plus 6.5% or prime plus 5.5% (at Intertain’s election).

The revised agreements with Gamesys were contingent on Intertain paying a £150m earn-out pre-payment by 27 February 2017. It did not have sufficient internal resources for the payment and initially intended to raise the money by mid-October 2016 (just ahead of the targeted London listing date) by way of a sterling bond. However, market feedback was that to ensure adequate liquidity the bond needed to be bigger, but with less flexibility for early repayment given the lack of tangible assets in the business. Thus Intertain announced on 16 December 2016 that it had raised £160m of additional debt finance, arranged through Macquarie and with the consent of its existing lenders. The debt is in two parts: £70m is an extension of Intertain/JPJ’s existing first lien term loan (coupon of LIBOR plus 6.5%) while the other £90m is a second lien facility which bears interest at LIBOR plus 9.0%. There is no scheduled amortisation until April 2022 (first lien) and December 2022 (the second lien maturity date). Both facilities allow for early repayment (for a fee) and provide flexibility for JPJ to make dividend and other distributions subject to various conditions (mainly the discharge of remaining earn-out obligations and the leverage ratio not exceeding 2.75:1).

Exhibit 21 shows the quarterly movements in gross, net and adjusted net debt for 2015/16 and our sterling forecasts for end 2016 (based on the C$/£ year-end rate of 1.66) and 2017. Net debt at Q316 was C$270.3m and our year-end forecast of C$500m reflects the new debt raise and Gamesys pre-payment, partly offset by a positive underlying cash flow. In sterling, we expect 2016 year end gross debt of £370.9m and cash of £69.2m to give net debt of £301.7m. Our 2016 adjusted net debt estimate of £385.0m includes our estimated balance sheet NPV of the outstanding earn-outs (£115.3m) as well as c £32m of ‘in the money’ cross-currency swaps. We expect these to be crystallised before the March 2017 expiry date and replaced with new swaps to hedge the US$ element of the debt. We believe that the remaining earn-out payments can be funded from cash resources, without the need for further debt finance.