OPAP — Responsible gaming with high cash flow

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 83.5% 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 and halls (3,779 shops and 428 halls in Greece and 199 shops in Cyprus at FY19) 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 41.7% 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 and it has almost completed its 2020 Vision transformation programme.

Similar to many retail gaming operators, OPAP’s business has been severely disrupted by COVID-19, and the share price has fallen by c 25% year-to-date . Therefore, clarity regarding the duration of shop closures and the impact on retail confidence would be helpful for share price performance.

Beyond the macro drivers (duration of Covid-19 disruptions and Greek GDP), we believe key catalysts for the stock are evidence that the VLT roll-out is able to maintain momentum in terms of 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 25.4% in FY19. Using a WACC of 8.0% produces a value per share of €9.5; flexing the WACC to 9% gives a value of €7.86. Our core DCF valuation equates to 8.9x EV/EBITDA and 16.7x P/E for FY21e, with an 8.5% dividend yield.

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 €734m or c €2.2/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 retail and sports-led gaming sector has fallen sharply this year due to COVID-19 disruptions and OPAP has been no exception. OPAP trades around the average of the broader group on both an EV/EBITDA and P/E basis, although its dividend yield is far more attractive, eg 9.9% for FY21. Overall, however, 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).

It is clearly very difficult to forecast the duration of the COVID-19 outbreak, and the subsequent economic impact of the restrictions. We summarise the key dynamics here:

In 2016, the incoming CEO Damian Cope instigated a programme called 2020 Vision to create a world-class gaming entertainment company, a process that involved product enhancements, cost containment, investment into the network and technology, as well as focusing on corporate responsibility. The next stage – ‘Beyond 2020’ – is expected to focus on further growth.

In this section, we discuss the following key elements of OPAP’s strategy:

OPAP’s portfolio of games is split between fixed-odds betting games and mutual betting games (where the total amount is distributed to winners). In FY19, numerical lotteries comprised 48% of total GGR, with the contribution from other divisions (specifically VLTs) expected to steadily become more significant. Following the additional €163.4m investment into Stoiximan (online casino and sports betting), we have assumed this business will be fully consolidated from Q420 (see below for more details). We show the separate line item in our forecasts.

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.

Sports betting games include fixed odds games Pame Stoixima 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 an 83.5% 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 and post offices, etc.

The VLT product was officially launched in January 2017 and OPAP has successfully rolled out all 25,000 VLTs (certified retail slot machines), into ‘Play’ gaming halls and selected agencies. This investment in VLTs and 428 new concept shops was one of the largest and fastest gaming store roll-outs in Europe. The majority of the new Play stores contain c 30–40 machines, although OPAP has also opened 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 fixed odds betting terminal (FOBT) stake limits in the UK. Importantly, unlike the traditional over-the-counter (OTC) games, players are required to register and there were 440,000 registered players at December 2019, with 130,000 monthly active users. In terms of demographics, 63% of VLT players are younger than 45 and 30% are women. Average spend per visit is €29. 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 will provide a suitable incentive for players to shift allegiance. It is also possible that COVID-19 could be a catalyst for these illegal machines to shut down permanently.

For FY19, VLTs generated €298m GGR, averaging €39 GGR/machine/day for the year. As the estate matures, we are forecasting a rate of c €35–40 per day.

Unlike its other listed peers, OPAP’s online presence has been relatively small, but the group has now started to grow momentum in its online customer base. During Q419, OPAP achieved 77,000 average monthly actives, driven largely by the Joker acquisition campaign. In terms of sports, the migration to the multi-channel platform has been completed and the virtual games were launched in late March 2020. In addition, as of 27 April, OPAP has launched its online casino games through pamestoixima.gr platform.

Online regulation is now expected in mid-2020, which will allow for additional products, and OPAP is very well positioned to benefit from online growth given its ubiquitous brand name and strong presence across the country.

OPAP has also announced an additional €163.4m investment (after the initial €50m stake) 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. On a pro-forma basis, OPAP estimates that total online would have comprised c 11% of GGR, including Stoiximan.

In September 2018, OPAP announced the acquisition of a 36.75% stake in TCB Holdings for €50m. In April 2020, it announced a further €163.4m investment (due within the Q2/Q320 period) in Stoiximan (TCB’s Greek and Cypriot business). As a result, OPAP will have an 84.5% controlling stake in TCB’s Greek and Cypriot operations and a 36.75% stake in the other markets. 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.

TCB Holdings comprises two online gaming brands: Stoiximan in Greece and Cyprus and the Betano brand in Romania, Germany and Portugal. TCB has been growing strongly across its major markets (Greece, Cyprus and Romania) with a successful cross-sell strategy (27% of total GGR is derived from casino). TCB’s online market share is 49% in Greece, 47% in Cyprus, 18% in Romania and 8% in Portugal.

During FY19, the profit contribution from TCB was €8.5m, with €3.8m during Q419. We are assuming the full consolidation of Stoiximan (Greece and Cyprus) at Q420 and an equity contribution until that point. We further assume that the 37% stake in the international division (Betano) will not be fully consolidated at any point.

Stoiximan (Greece and Cyprus) reported FY19 GGR of €196.7m and EBITDA of €44m. For the final quarter of FY20, we forecast a consolidated GGR of €60m and an EBITDA of €9m. Our FY21 forecasts are €210m GGR and €42m EBITDA. We have also assumed a €10m equity contribution during the first nine months of FY20. The international business is expected to break even during FY20 and we forecast an equity contribution of €4m for FY21.

OPAP has negotiated an earn-out provision based on EBITDA (8–10x EBITDA) and we estimate that the total additional acquisition costs will be c €60m (split evenly between FY21 and FY22).

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 net gaming revenues (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 the financials section 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 the UK, 18% in Sweden, 20% in Spain, 20% in Denmark and 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 VLTs in Greece expires in 2035. To date, OPAP has paid €1.43bn for these concessions. For a full discussion of the concessions, please refer to our initiation report.

OPAP is the largest social contributor in Greece operating under the World Lottery Associations (WLA) and responsible gaming standards, while it transforms its business excellence into a social contribution through an integrated corporate social responsibility (CSR) strategy. A summary of OPAP’s credentials are shown in the chart below.

OPAP’s board comprises 10 non-executive directors (including four 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. At the FY19 results in April 2020, Mr Cope announced his decision to step down in May and OPAP is currently looking for a replacement. CFO Pavel Mucha (previously the CFO of Czech company Sazka, the national lottery operation of Czech Republic, which is a member of Sazka Group) joined in 2019, following the resignation of Michal Houst. Details of other management team members can be found in our 2019 initiation report.

Many of the board members are associated with OPAP’s major shareholder Sazka Group (Europe’s largest lottery business). Sazka Group recently increased its stake to 41.7%, following a tender offer in 2019 as well as through the recent scrip dividend.

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 the total legal Greek gaming market amounted to €2.2bn GGR in 2019, of which OPAP games comprised €1.36bn GGR. Land-based casinos comprised an estimated €247m and total legal online gaming amounted to €437m. Online gaming is dominated by betting (73.4% of the total), with casino comprising 23.8% and poker comprising 2.6% of GGR.

OPAP estimates that GGR per adult in Greece is €230, 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 1.16% in Greece, compared to the European average of 0.67%.

The Greek online lottery business is still nascent, although, as discussed above, OPAP is transitioning some of its key games online, largely to attract a younger demographic (Joker in particular). Over time, this online revenue should supplement the established land-based business. It is possible that COVID-19 could be a catalyst for online revenues to grow more quickly.

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 has 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 has an impact on 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 grew 10.9% in 2019 to €437m GGR, although this is still far lower than other European countries. Greek GGR taxes are 35%, which is much 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 (which is in the process of being acquired by OPAP), bet365 and GVC.

The full regulation of the online market is expected in mid-2020. Under the current proposals, seven-year licences will cost €3m for sports betting and €2m for live casino and poker and there is no limit to the number of potential licences. 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. In addition to the specific COVID-19 disruptions discussed above, the main sensitivities to the business model are:

Similar to many retail gaming operators, OPAP’s business has been severely disrupted by COVID-19, and the share price has fallen by c 25% year-to-date. Therefore, clarity regarding the duration of shop closures and impact on retail confidence would be helpful for share price performance.

Beyond the macro drivers (Greek GDP, duration of COVID-19 disruptions), we believe key catalysts for the stock are evidence that the VLT roll-out is able to maintain momentum in terms of GGR/VLT/day, as well as a demonstrable increase in online revenues.

We have performed a DCF valuation, with a terminal growth rate of 1.5% and a terminal EBITDA margin of 22%, vs 25.4% in FY19. Using a WACC of 8.0% produces a value per share of €9.5; flexing the WACC to 9% produces a value of €7.86. Our core DCF valuation equates to 8.9x EV/EBITDA and 16.7x P/E for FY21e, with an 8.5% dividend yield.

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 €734m or c €2.2/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 the peers do operate in the retail space (GVC, William Hill, Rank, Francaise des Jeux). Additionally, as OPAP begins to grow its online presence, the comparison could become more relevant.

The retail and sports gaming sector has fallen sharply due to COVID-19 related disruptions and OPAP has been no exception (down c 25% year-to-date). OPAP trades around the average of the broader European gaming sector on a P/E and EBITDA basis, but its dividend yield continues to be more attractive than average, as demonstrated in the exhibit below.

OPAP’s stores and gaming halls across Greece have been closed since 14 March and will not reopen until at least mid-May. OPAP stores are now expected to open on 11 May and will be required to follow specific conditions and precautionary measures (social distancing and no seated customers). An announcement regarding gaming halls is expected in due course. Similar measures have affected the Cypriot business (c 5% of total revenues) and the nationwide lockdown has restricted street vendors for the distribution of Scratch & Passive lotteries.

The online lottery business has seen an increase in activity and, although this remains only a small portion of the total, OPAP has stated that it is focusing on expanding its online games portfolio. In terms of online sports, this has also been significantly affected by the lack of sporting fixtures.

It is currently very difficult to forecast the duration of the COVID-19 outbreak, and the subsequent economic impact of the restrictions. Current restrictions are leading to a 99% reduction in gaming revenues. However, about 60% of GGR are linked to revenue-based payments and therefore OPAP has a relatively low fixed cost base, for example the commission structure for agents, and 35% gaming tax based on revenues and revenue sharing agreements with multiple vendors. The company has specifically not reduced headcount or salaries at present.

Management has stated that the monthly financial impact from COVID-19 related restrictions will be c €130–140m on GGR and c €50–53m on EBITDA, before cost mitigations of c €4–6m. The expected cash burn per month is c €20m, due to fixed costs. We assume a total disruption duration equivalent to three months (which allows for a slow return to normality), and we recently lowered our underlying (excluding Stoiximan) FY20 GGR forecasts by €400m and EBITDA by €145m.

Including a €400m COVID-19 related reduction in GGR, we forecast a total GGR decline of 15.6% in FY20 to €1,367.1m. For FY21, we have assumed continued softness in consumer confidence, with revenues of €1,748.1m (compared to €1,619.9m in FY19). Note that our forecasts include the full consolidation of Stoiximan from Q420.

OPAP’s 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. Despite the disruption caused by COVID-19, the balance sheet remains robust. Our forecasts assume a total of three months’ equivalent of negligible monthly revenues and, on this basis, we believe that OPAP continues to have a sufficient cash position and sufficient liquidity to meet future payment obligations.

At FY19, OPAP had debt of €1,052.5m, €64.8m lease obligations (IFRS 16) and cash of €633.8m, equating to net debt of €483.3m (post IFRS and excluding €10m of investments). Since year end, OPAP has redeemed €200m retail bonds, paid a €1.00/share extraordinary dividend (€172m cash component) and raised a further €325m debt. At 1 April 2020, OPAP’s cash balance was €623m, with total net debt of €609m (post IFRS, excluding €10m of investments).

During FY20, we forecast cash outflows of €163m for the Stoiximan acquisition and €15m for capex, as management is proactively managing capex by freezing uncommitted spend. Excluding debt movements and after dividend payments, we forecast a net cash outflow of €148.8m in FY20 returning to a positive net cash inflow of €154.1m in FY21. The €200m bridge facility is payable in FY21, which OPAP expects to refinance via capital markets. We are forecasting a €30m cash payment for both FY21 and FY22 for the remaining Stoiximan earn-out payment.

Net debt/EBITDA (calculated pre-IFRS 16) was 1.0x at FY19, which we forecast to rise to 1.9x in FY20 (due to the COVID-19 impact on EBITDA, as well as the Stoiximan acquisiton), before falling below 1.0x during FY21. OPAP’s long-term net debt/EBITDA target is 1.35x and therefore we believe that OPAP’s balance sheet remains robust.

OPAP paid a €1.00 extraordinary dividend in Q120, which was distributed as €172m cash with 48.2% of shareholders electing to receive a scrip dividend. Given the current uncertainty surrounding coronavirus, management will delay its recommendation concerning a final dividend for FY19.

As shown in the exhibit below, we have assumed no further dividend to be paid corresponding to FY19, but we assume the company will return to its normal dividend policy from FY20, which is to pay out the bulk of free cash flow. Our forecasts assume a final FY20 dividend to be paid in FY21.