What did we see in evolution when we invested in the stock at a price below 200 SEK

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At the time of writing the price development of the Evolution Gaming Group stock looks like this. The stock price just recently surpassed 1100 SEK, but this was however not the picture we were seeing when we started investing.

We started investing in the companies Evolution and NetEnt in 2018 and 2019. NetEnt got acquired by Evolution in the last quarter of 2020.

The price development of Evolution looked more close to this when we bought our first shares:

The stock had nearly done 6x in four years (from 25 to 150). Wouldn't that seem expensive to you? Little did we know that this would turn out to be more than a 50-bagger a few years later (from 20 to 1100).

What made us invest in the company in the first place? Why didn't we sell our shares earlier? What did we see in the company that would make it into one of our biggest holdings?

The answer to this and more will be found in the article, so continue reading!

How did we discover the company?

The story behind the first purchase of shares in Evolution does not come from any interest in online gambling in particular. One of us is educated as an engineer and wanted to test out how long it is possible to earn money by playing Roulette by following the Martingate Betting System. This was back in 2018. The idea was to set up a Monte Carlo Simulation and see how a large set of scenarios would pan out. Would it be possible to win in the long run?

The Martingale idea is that you make money on Roulette or similar games where there’s a ca 50% chance of winning, by doubling your stake every time you lose. When you finally win you reduce the stake to the minimal amount again.

When we had set up an online account for trying out the casino games we figured out there was many ways to play Roulette online. First we discovered the games of NetEnt. They had a version where you could bet at games really quickly after another in a short amount of time. When we tested the Martingale Betting System we figured out that you could earn about €30 per hour by playing with a minimum stake of €0.1. That is, as long as we got lucky. It turned out, as the model of the Monte Carlo Simulation had shown beforehand, that the house would win in the end. So it was nothing but a fun way to test out an idea for our sake. But it did lead us to discover which companies that make the games.

As an alternative to the NetEnt games we saw that there was a category called live casino. And the games in that category were mainly made by a company called Evolution. Instead of playing Roulette like in a computer game you could stream a real dealer live. Imagine a real person doing the Roulette game for you. For us at the time, this seemed too slow for us to try out the Martingale Betting System while getting a higher hourly gain, but it occurred to us that this might be a nice place to have another type of gaming experience, where you can take more time.

With that we got familiar with the two large players from Sweden, namely Evolution Gaming and NetEnt.

Let it be said that we found it disappointing that the Martingale Betting System would not work and that the house would always win, but that got us into other ideas. It might be more fun to try to earn money being on the other side of the game, namely to deliver the games instead of playing them.

Therefore we started studying different companies in the business. We saw in 2018 that there were a lot of casino operators that had gotten cheap in 2018. So we bought a few shares of Betsson for example, in the summer of 2018 at around 50 SEK per share. The company seemed pretty profitable, but we soon after discovered that the game developers were even more profitable. NetEnt for example had about the same P/E ratio as Betsson, but the game developer earned much higher sums on capital employed than the casino operator.

Since we already knew about some of the games of NetEnt after the story about the Monte Carle Simulation, we decided to spend even more time researching the company. What looked interesting to us in the summer of 2018 and later in 2019 was that the company seemed pretty cheap in relation to the free cash flow it was generating to its shareholders. The cash flow was high, but the growth had stopped, and perhaps that was the reason for the stock market to price is so much cheaper than before. It was about to lose activity in Sweden, but that seemed quite a small market compared to their whole business.

We started researching Evolution in detail

Unfortunately a lot of time passed before we finally got into researching the annual reports of Evolution Gaming. If we had been earlier, we might have been lucky to take part in a 50-bagger ourselves! It was only at the beginning of the spring in 2019, when the annual report of 2018 got released, that we started taking a deep dive into the business of the company and its numbers.

The annual report of Evolution was very well written and it explained to us what the business was made of and what they did in a very clear way. It started dawning on us that this business was positioned for much growth ahead, and that it was operating with huge tailwinds.

You can read the report that we read which gave us the first proper impression of Evolution here.

Qualitatively speaking we saw the following beneficial factors for Evolution:

• Streaming of live casino makes it possible to have more players per dealer than in regular casino environments
• Their revenue model was based on a game win split with the operators. That means the more players they get all the upside.
• More players and activity on their platform and games will not mean relatively higher costs. Possibility of margin expansion.
• Evolution is market leading in its segment. They are best at doing what they are doing in their niche. There must be a good reason for that, which we believe they will maintain.
• They have won several prices and have been awared for making the best live online casino games, and for being the most innovative game developer in the field.
• They seem to think a lot about how to make their games better and better, and that the customers will enjoy them a lot. They think about how the customer will feel when playing their games, and they care a lot about every detail. Their Chief Product Officer, Todd Haushalter, looks like he’s doing a good job of making a culture that makes the company try to develop their games into better and better versions, and where their employees are not afraid of contributing with new ideas.

What did we see by looking at the numbers?

Here’s a figure from Börsdata.se which shows the profitability metrics and development over the last ten years. We had about the same impression in 2019.

As you see in the figures above, the numbers have gotten better year by year.

In particular what we liked about their numbers was the following:

• High gross margins
• High operating margins
• High free cash flow margins
• Very high return on capital
• Numbers that improve year by year, while return on capital was maintained

The operating margin was formidable high already in 2018. They earned well over 40% of their revenue before tax. That meant to us that it doesn’t seem to cost much in terms of personnel, sales and general to run the business. They are in a good business it seems.

The business figures seemed to be very good. Their business model also seemed to be very lucrative. After they have built a studio at a physical location and staffed it with dealers and other personnel that operates it 24/7, the revenues can scale a lot. They can get huge amounts of revenue in only one studio. A studio and a dealer might as easily service 50 customers as a thousand. It doesn’t cost much more in direct personnel costs to service more customers that crowd towards a popular game. The company can therefore scale a lot on the best games, and the studios can be very profitable once the amoutn of players get high enough.

What other factors did we think were in favor of the company?

As with NetEnt there was many more factors that made us believe that Evolution would have tailwinds ahead.

• Online casino is a growing business as a whole
• More people start to play online instead of visiting physical locations
• More people get better internet connection
• The more players with capacity of streaming live, the more potential players for Evolution
• Gaming on mobile is growing
• Both NetEnt and Evolution already do a good job of making their games highly accessible on mobile devices
• Gaming in general is growing
• Evolution is also making game shows
• They are not just competing on the gaming space, they are trying to take market share from streaming companies in general, like Netflix, and others who make the customer spend time on screen

How can you find a similar winning stock yourself? What could it be wise to look for?

It’s funny, but as far as we can see on social media and Twitter in particular, the higher the price of the stock, the more popular the stock becomes. More and more people have started investing in it, but that might be after most of the growth has already been made. Why didn’t they buy a truck load when the stock was selling for closer to 200 SEK instead of at 1000? Naturally, people like to speak more publicly about a stock that has gone up a lot, rather than one that has fallen much, and where they have lost money.

A substantial part of our profits from participating in the Evolution journey has been from investing in NetEnt early on. NetEnt was as mentioned above a good game developer of casino games, slots in particular. We bought shares in the company because it seemed to us that the company was running a good business model, it had high profitability on its capital, and it had a strong free cash flow.

Evolution and NetEnt showed up on our radar when we used screeners of stocks that had high return on capital and good operating margins. You can for example use the screener of Börsdata.se to filter out companies that earn a certain percentage on capital or higher for example. And you can filter out companies that have a high operating margin, and even if they are priced low enough for your standards.

The reason that we liked the NetEnt company in particular was that it looked quite cheap in comparison to its value of the cash flow value we expected the company to deliver in the future. And we felt we had a margin of safety even if the growth was not all that much.

It was an advantage that the company was already a market leader within slots. It made us think that it would help them maintain a competitive advantage. They were also buying other companies and competitors such as Red Tiger, and they did so at fairly low prices.

NetEnt had been priced at around 70 SEK before we started buying shares. Our average price as close to 25 SEK. In March you could get shares as low as 15 SEK. Such an entry price into the stock would translate into a corresponding price of only 114 SEK in Evolution Gaming, because they got acquired in return of shares in the company. The ratio was 0.1306. So for every 10.000 shares you had in NetEnt you would get 1.306 shares in Evolution if their offer was accepted, and it was. If you had bought NetEnt in March of 2020, you could have had 10x on your investment already, in under a year. That just goes to show there are possibilities out there!

Since we bought shares in a company at low multiples of free cash flow, we thourght that we were getting a lot of value for the money. NetEnt was aquired by Evolution in December 2020 in exchange for shares in Evolution, and you could trade your NetEnt shares for around 90 SEK when the offer was publicly announced in the summer of 2020.

It seemed obvious that Evolution was earning a lot of money and they looked like they could grow a lot in the future. We didn’t know that they could keep growing as fast as they did, but the price of the stock in 2018 and 2019 was quite cheap compared to the quality of the company, and compared to a relatively high expected growth in the years to come.

Now, as we see the stock price soaring, we are on the lookout of other stocks to put our money in, that have a similar huge upside.

What we look for is some of the following, or in short words “an excellent company priced cheaply”:

• The company must have a very profitable business model
• The stock should be relatively undiscovered or misunderstood, so that the price of the future expected cash flow is low still
• It runs its business in a niche where it has a durable competitive advantage. A market leading position is a good sign.
• The company should have a promising future of growth ahead, and it should be able to do so without needing to deploy a lot of capital.
• It must be possible for us to understand the company, so that we know what we own and keep ourselves updated on the progress

Why did we not sell earlier and take a profit?

Shares in Evolution seem quite highly priced at the moment, at least in relation to a short time ago. We would definitely take out a lot of profit if we had sold now. We have not sold the stock, because we think that it is a very good company for us to keep holding. We think that the company will earn more than 10% on the price we have paid on our shares in the future. And we even think we can earn at least 15% on the investment every year in years to come. Let’s say that out entry point is 200 SEK on average. With a future earnings per share of 30 SEK and growing we would have achieved that goal. We don’t think that is far fetched either. We would on the other hand be sceptical of buying shares at the current prices.

We believe the company (not the stock price) has a good journey ahead when it comes to growth. If the stock market price should fall we would welcome it. That would allow us to buy more shares at a lower price. We haven’t planned on selling the shares even if the market price would fall suddenly, and because the market believes the growth will be lower. Before we would read such news we have already made our own judgement, and only if we are presented with data that makes the facts change, we won’t change our opinion of holding the stock.

Disclaimer

This article shall not be viewed as investment advice or a buying recommendation. It is only mean as educational purposes, and it represents our own beliefs and opinions. We have personally been buying shares around a price of 170 SEK to 600 SEK, and we feel it is risky to buy the shares at higher prices.

Further reading

Did you like the article? Read more about Evolution and it’s latest figures in our previous article here!