With Gaming Getting Re-Rated, Time To Look At SciPlay

SciPlay Corporation (NASDAQ: SCPL) is one gaming play that is delivering but investors by and large continue to ignore the name. Yes, the story is not as sexy as some of pure-play digital sports betting plays like DraftKings Inc. (NASDAQ: DKNG), but now that there is a growing consensus among investors that the broader gaming sector is ready for a re-rating, SciPlay deserves another look.

The company is a subsidiary of Scientific Games Corporation (NASDAQ: SGMS), a stock included in our most recent list of top ideas for the week. Like many investors, we too are usually skeptical of subsidiaries, but SciPlay is one of the gems and a major value driver for Scientific Games stock, and sooner or later, the business will have its share of freedom, quite possibly at the insistence of debt on the balance sheet of Scientific Games.

Gaming is getting re-rated

Post lockdown, the online gaming sector started to attract investor attention believing that people will be spending more time online, benefiting these businesses, rightfully so, but over the past few months, there is a renewed understanding among the market participants that the story is more than just a temporary jump in traffic and maybe there is a major shift underway in how people spend their time and capital online, leading to a better understanding of the earnings potential of online gaming and betting businesses.  

With online gaming getting recognized as a major revenue and earnings growth story of the year, the sector is getting re-rated. Recent results from numerous companies in the space are easing investor doubts over the sustenance of these favorable user and monetization trends, even though the economy is opening up.

Every investor would attest that too many have been burnt trying to pick reversal in industry trends. So rather than fighting against trends highlighting consumer shift favoring more screen time for online gaming and gambling, investors might be better of acknowledging the shift.

Time to overlook some of the concerns

The market is valuing SciPlay as just another casino app, ignoring the strategic advantage that the business enjoys in a crowded field with low barriers to entry, scale, momentum, or the shift towards turning into a full-fledged mobile gaming company.

Besides misunderstanding the business, the Street is also worried about the growth rate leveling off now that casinos are starting to open up. Yes, the growth rate of key performance indicators like DAUs (daily active user), MAUs (monthly active users), and ARPU (average revenue per user) are bound to level off a bit from the heady days of peak lockdown, but important to remember that the stock is still trading at barely 20% higher than levels seen before Covid-19. Indeed, some of the games and titles will complement the casino business.

Another factor that may hold back investor excitement that the yearly growth in audience, i.e. number of players and payers, haven’t shown the kind of growth seen in traffic or revenue, suggesting the improvement may be largely due to the same set of players spending more time and money thus temporary factors of growth. Here again, the company’s move into social gaming and growth in the number of players on a quarterly basis may ease some of those concerns.

Strong performance, hard to ignore anymore

Whichever way one slices the numbers, the business is performing on all cylinders, validating the steps taken by the management at the beginning of the lockdown to manage costs tightly, launch feature enhancements and improve quality.

Revenue increased by 40% during the second quarter, but the improvement was much deeper than the topline, with adjusted EBITDA increasing by 80% and key performance indicators at record levels, be the 40% increase in average revenue/ daily average user, average monthly revenue per payer increasing by 24%, payer conversion rate at 6.8%, or the mobile penetration at 87%, up 4%.

From the portfolio of games standpoint, Gold Fish, Jackpot Party, Quick Hit, and MONOPOLY were exceptionally strong, diversified enough to remove any concerns like one-hit-wonder story and giving credence to the company’s goal of growing faster than the market.

More than just a good hand; growth catalysts for the next leg

What gives us the confidence that the story is more than just a lockdown driven jump in traffic are the numerous growth catalysts shaping up fast, namely

  • Entering the casual gaming market with Come2Play acquisition
  • New products and features catering to existing markets
  • Monetization and margin improvement opportunities
  • International expansion

Acquisition

Last quarter, the company acquired Come2Play, a casual game developer, thereby significantly increasing the addressable market as well as entering into the board game and solitaire game markets. Besides helping SciPlay move beyond the casino apps, the new combination can leverage a large DAU base to build on.

If history is any guide, the acquisition should be good for both top and bottom lines over the next few years given SciPlay’s last acquisition, SpiceRack in 2017, has increased revenue by 300% after the acquisition.

New products and features

Historically, the addition of new features, like a tournament of champions in Jackpot Party game, has proved to be quite a success in terms of growing players’ interaction with the platform, both times played and frequency of coming back to play.

Recent efforts to organize dedicated teams around live ops, which is one of the hottest topics in games development today, feature implementation and quality improvement should start delivering results over the coming quarters.  

Monetization and margin story, not fully appreciated yet

Yes, more interaction leads to better monetization opportunities over time for the businesses and the recent increase in DAUs and MAUs do inspire confidence that ARPDAU growth in the most recent quarter is sustainable, even though not at the same rate of 40%. Both focus on live ops and increased player interaction will help improve monetization.

SciPlay Corporation    
     
As % of revenue2017201820191H 2020
Gross profit61.6%61.5%66.0%68.1%
Sales and marketing24.0%25.4%27.8%22.3%
General and admin12.3%8.3%8.7%8.9%
Research and development7.3%6.2%5.1%5.5%
Depreciation and amortization4.7%3.6%1.5%1.5%
Operating margin13.3%18.0%22.8%29.9%

Part of the reason gaming companies, especially with fast-growing revenue and KPIs, command rich trading multiples is the inherent margin leverage in the business model and SciPlay is no different.  Looking at the margin trajectory of the last few years, the company’s 3-5 year goal of achieving 35% AEBITDA doesn’t look too egregious.

International

Right now, international business is small, even though the business is growing fast in percentage terms, and acquisitions like Come2Play, which can introduce the platform to a large user base, as a social gaming platform should help the company monetize the opportunity. App installs, a good leading indicator for the business, are already growing fast in the international markets. 

Valuation

With the stock trading at 15-16 times price to forward earnings, the case for valuation is easiest to make and requires limited coverage, especially in a market where high profile names like DraftKings are trading at more than 15-16 times sales.

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