The purpose of these considerations is to point out the market inefficiency in understanding the results of the affiliation industry in the gambling sector. The inspiration to write this notice was the market reaction (significant decrease in price) for numerous earnings releases in November 2023. A reaction that we are struggling to agree with.
The story starts on the 25th of September when Entain decides to update the market and warn about poor sports margin in September. The metric is essential for the operator’s profitability and underlying EBITDA. The market reacted in an unprecented 13% slump in one day. It proved to be only a prelude to an even worse October.
On November 2nd, Entain published a full Q3 trading update. In the notice, we can find out an interesting graph regarding the sports margin, which shows the scale of disaster for operators in recent weeks.
Source: https://www.entaingroup.com/investor-relations/
Since the beginning of 2019, there have never been two loss-making weeks in a row for Entain Group. Very rare situation, that has a significant impact in the short term for operators and their partners, but is not really important in the long term. In order to understand this situation better, we have to get to know the player cycle in that business. Most of the players that won a significant amount of money in September and October won’t stop playing. They are either long-time players that play for the sake of playing or new players who will be encouraged with early success. Nevertheless, this creates a situation when players have more available money to spare and bet. Usually, this kind of situation leads to greater betting volume in the following weeks. Since sports margins tend to reverse to the long-term mean (as we can see on the graph), single negative weeks don’t influence the overal year profitability of operators. However, it is useful guidance to understand the underlying results and how to interpret them.
But you can ask, quite fairly, how it is connected with affiliation. And the answer is quite straightforward. Many companies in that sector, including the biggest – Better Collective, Gambling.com, Gaming Innovation Group, Raketech, XL Media, etc. have a strong presence in European markets with a significant part of their business based on revenue share contracts with operators such as above mentioned Entain. It means that their sales are directly matched with the operator’s income on all the players that the affiliate sends to the website. That’s why affiliates rely indirectly on sports results and their partner’s performance. Many of these rev share contracts are based on legacy clients (acquired many quarters or years ago) on which the affiliate doesn’t reflect any new costs, just benefits with revenue with a really high margin. After Entain’s trading update, it was already more than certain that many, if not all affiliates will underperform in Q3. It was predictable, in some way even calculable, but for some reason, market decided to ignore that and decided to sustain its high expectations. Most of the analyst’s reports that we have seen remained unchanged before Q3, even though the numbers were impossible to reach. This resulted in a surprise on the day of the results publication and unprecedented declines on a stock exchange. Let’s give just a couple examples:
November 8th, before the session starts, GIG announces its financial results, which adjusted for one-offs, are lower than the market expected both in revenue and EBITDA. The company informs that due to unfavorable sports results, it lost nearly 1 million in revenues only in September. Operationally, the affiliate manages to deliver 32% growth of FTDs (first time depositors) and accounces a significant acquisition a low EV/EBITDA multiple of KaFe Rocks. Stock exchange reaction is not pleased, the ticker opens at 30 and decreases 6,5% in a single day.
November 15th, before session starts, Raketech shows the report for first nine months of the year. Overall results are better than expected, but affiliation marketing segment has the worst quarter LTM with management pointing out weak performance in Nordics and US. Market reacts immediately opening with nearly 10% slump, which finishes in 5% discount at the end of the day.
November 15th, after the closure of the stock exchange in Sweden, Better Collective, the biggest affiliate in the world, presents results for Q3 2023. Revenue is 1,5% lower than consensus and EBITDA is almost 15% lower than expected. Furthermore, the trading update for October proves to be significantly below consensus (24,3 vs 27 million). The company communicated that with normalized sports margin, it should be over 8 million higher. On the other hand, FTD’s number increased by 27% y/y and 73% y/y in the North American market. Additionally, the company made the second biggest acquisiton in its history, cementing its dominant position in the rapidly increasing South American market. How did the market react? The stock crumbled nearly 19% in one single day.
November 15th, after the session in the USA, Gambling.com publishes its earnings for the third quarter. Interestingly enough revenue is even higher than market expected, but EBITDA missed by 2,5%. Performance in the USA was rather good, but the UK and other European markets declined first time in many quarters due to different reasons (google updates above mentioned sports results). EBITDA margin decreased due to two big media partnerships (which is lower margin business for affiliates due to the nature of the contract). Overall not a significant fundamental change in a business, where Q3 is the slow season in the USA. Result? The stock crashed over 20% in one day on Nasdaq.
All these examples show that the market was unpleasantly surprised by the results posted by the affiliation industry. Many companies performed worse than expected in Q3 (at least at first glance), which resulted in a significant decrease in valuation and multiples in the sector. We, in Betplay Capital, strongly disagree with the market overreaction of the market looking at it from a fundamental point of view. We struggle to see the logic of such behavior. Among the arguments, we should mention a couple crucial points.
First of all, the unfavorable conditions on the market (sports margin) is something beyond the affiliate’s control. The company is not able to influence sports results in any way and months with worse margins will happen in the future from time to time. It is the normal cycle of probability.
Second of all, most of these companies delivered quite a strong customer intake of new players, which is the key indicator of their performance and impacts their future revenue growth and profitability. Overall performance in that area was rather normal or even better than we expected. Investors seem to concentrate too much on short-term underperformance over long-term value creation. Situations like that are rather an element of speculative trading and do not influence the future prospects of the business.
Third of all, the market had all the necessary information to predict a softer Q3, when Entain shared its trading update but decided for a major sell-off only after earnings release. All necessary information was there, but nobody could properly analyze them, which seems to be not a rare case in investing as a whole. Forecasting this type of sudden market reaction is possible in advance and can be useful to find the moment of entry into position.
Finally, the market is a peculiar place, where the swing between overoptimism and extreme fear happens to be really sudden. Companies with higher multiple, viewed by the market as the leaders of the industry, with the most sustainable and high growth got hit most significantly by this unpredictable event, even though fundamentally nothing essential in their businesses has changed. Heading into Q4 many affiliates touched the lowest historical multiples in many quarters, just before the most profitable time of the year.
To sum up, we don’t aim to give investors any guidance on what to expect or what to do with their positions. We wanted to highlight the inefficiencies of the affiliation market that led to (in our view) an unjustified major sell-off in the industry. This situation teaches us that we should pay more attention to detail and information available publicly, as well as the fact that Mr Market tends to be moody from time to time without any specific reason. But in the end, Mr Market is here to serve us, not the other way around.
Disclaimer Betplay Capital Sp. z o.o. (“Betplay Capital”) is a private family investment firm. This information is provided for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in any stock or other security. Betplay Capital holds long positions in many stocks in the gambling industry, including some of the above mentioned tickers.