A hidden gambling star

FTSE 250 gambling operator and software business Playtech (PTEC) is faced with exactly this scenario. Investor sentiment has been damaged by an ongoing row with its Mexican joint venture partner, Caliente, which has pulled the shares down by around a fifth over the past year. 

This presents an attractive long-term buying opportunity. A look behind the headlines at Playtech's core operations suggests that it is well-placed to flourish despite the current legal headwinds. A good argument can be made, therefore, that the market has been too negative. Playtech has a strong track record, attractive growth potential and plenty of M&A opportunities, while investors have the chance to take the plunge at a nice discount.

The legal headache

Playtech and Caliente – Mexico’s dominant gambling business – enjoyed a rewarding financial relationship until the recent trouble. Playtech counts Caliente as its largest client, and has a 49 per cent economic interest in Caliplay, Caliente’s digital division. Mexico contributed about 10 per cent of Playtech's total revenue in the latest half year, with Caliplay paying plenty of software and service fees. Recent developments could change the relationship, however, with Playtech likely to receive less revenue from the partnership in the future.

There are two parts to the dispute. First, there is a disagreement in the English courts about whether a call option that Caliplay had to acquire Playtech's 49 per cent stake in the joint venture has expired or not (Playtech says it has). Second, as a result of action Caliplay has taken in the Mexican courts, fees due to Playtech have been paid into a court-mandated trust account since last August. 

On the face of it, this looks like a potentially damaging situation. If Caliente reduces its dependency on Playtech, for example, the latter’s fee income will suffer. What's more, investors hate uncertainty. But if we take a step back and consider the wider picture, it becomes clear that Playtech has enough markets, brands and new opportunities (more on this below) to bounce back from an unfavourable legal outcome.

Crucially, Caliente may be Playtech's largest individual client but it is far from being its most important revenue stream, as the graph shows.

Investec analyst Roberta Ciaccia argues that concerns are “overdone and the dispute likely to be resolved favourably". She also stresses that “no value is associated with the Caliente contract” and pointed out that if the Mexican company wins its case and exercises its option then Playtech would receive a “significant” cash injection. The stake is currently valued in Playtech’s books at $530mn (£415mn).

How the company is going to account for the fees locked up in Mexico isn’t yet certain, as its latest results covered the interim period to June last year. More will be revealed when the 2023 full-year results are published in March. 

Opportunities elsewhere 

Playtech started life as a pure business-to-business (B2B) software company, which focused on selling technology to gambling operators. This remains a key part of the group, and its client base includes gambling giants such as Flutter Entertainment (FLTR) and Entain (ENT), alongside Caliente. Software as a service (SaaS) contracts provide diversification and a regular income stream, with the board aiming for medium-term SaaS revenue of €60mn to €80mn. Key B2B growth drivers also include casinos and the Americas market 

New and developing relationships in North America with the likes of Hard Rock Digital, in which Playtech bought a minority equity ownership stake, and Canada's NorthStar open up attractive locales and revenue streams, which could feasibly replace lost Caliplay income in the medium term. Growing its presence in the liberalising US market is "a key strategic priority" for management. Elsewhere, the strategic agreement with Galera.bet is something to watch given that Brazil now regulates sports betting after recent legislative developments. 

However, most revenue now comes from the business-to-consumer (B2C) division. Playtech was transformed when it bought a 71 per cent stake in Italian betting and gambling operator Snaitech in 2018, and this brand contributes the vast majority of B2C revenue from its leading position in Europe's key gambling market.

This side of the business provides a range of services, from in-store and online retail sports betting to gaming machines. Snaitech, which generated 65 per cent of Playtech's total adjusted Ebitda in the first half of 2023 on the back of a 12 per cent profit uplift, even owns horseracing tracks. 

Solid underlying trading and notable growth opportunities across the company make the outlook far rosier than the Caliplay dispute would suggest. Playtech reported record cash profits in its 2023 interims and medium-term targets have been maintained, with the board aiming for adjusted Ebitda of €200mn-€250mn and €300-€350mn at the B2B and B2C divisions, respectively. 

M&A potential

There is also potential for M&A to catalyse a share price movement. Playtech has been approached several times in recent years, and there is evidence that it is in an acquisitive frame of mind itself. In other words, it seems to offer the best of both worlds.

Back in early 2022, investors rejected the board’s recommendation that they accept an offer from Australian gambling machine business Aristocrat Leisure (AU:ALL). There was also interest from Hong-Kong based TTB and a consortium called JKO Play which ultimately came to nothing. TTB subsidiary Gopher bought Playtech’s financial trading division, Finalto, for $250mn in 2022.

While Playtech has not commented on the matter, reports emerged last year that it had made a £700mn approach for William Hill owner 888 (888) last summer and was rejected. It did, however, report interest in a bid for sports betting and gaming operator SKS365 but was happy to step aside given the price offered by rival Lottomatica (IT:LTMC).

Once the Caliplay situation resolves itself, it would not be a surprise to hear further noises about acquisitions or potential acquirers. Playtech’s strong balance sheet gives it the necessary firepower to pursue targets, with net debt to adjusted Ebitda sitting at just 0.6 times at the latest reporting date. Something else to keep an eye on is a potential spin-off of Snaitech. The board has previously indicated that it is open to the idea, and if this plan were to be resurrected it could unlock significant value for investors.

Undeservedly cheap 

Given the inherent strengths of the business, alongside its track record and growth potential, Playtech looks undervalued across a range of metrics. The shares trade at a notable discount to key peers on both an EV/Ebitda and price/earnings basis, while a forward free cash flow yield of over 8 per cent is nothing to be sniffed at. 

In the short term, sizeable share price movements are likely to be linked to the Caliplay situation. Despite the legal uncertainty, however, we think this gambling tech star has a fruitful future ahead of it.