SNA IM - Snai SpA

[ContrarianNick]

Hey Guys,

I though I'd post a small description of Snai an italian gaming company which I mentioned in the Intralot chat in late November and that it looks like an interesting stock to look at for international small cap investors. Enjoy and let me know if you have any comments.

 

Snai is a gaming operator based in Italy. The company focuses on two main kind of gaming operations, fixed-odds and sports betting, where it holds a top market position in Italy, its only area of operation. Snai recently completed the acquisition of Cogetech in December which allowed it to become the number 2 player in VLT and AWPs in the country while acquiring a new and experienced management team. We believe that Snai represents an attractive investment opportunity on the equity for an investor with a medium term time horizon. The buy thesis is based on the following points:

 

1. The recent acquisition completely changes the cash generation profile of the company and increases the stability of the results. Following the Cogetch integration, Snai will derive around  65/70% of sales from VLTs and AWPs operations which, unlike sports betting, it is not subject to a volatile payout but, instead, it will provide a much more stable and predictable stream of cash flows. We believe that the market has yet to realize that the underlying unpredictability of Snai results, deriving from a very volatile sports betting payout, is a thing of the past and that any worries regarding the sustainability of physical sports betting payouts will have a much lower weight on valuation going forward. As it can be witnessed from Q1 results (see appendix), Snai is now a much more stable gaming company with a diversified revenue generating base and a much more predictable earning power.

 

 

2. The new taxation regime introduced with “Legge di Stabilità 2016” radically improves transparency on AWP and VLT taxation while setting up the elimination of AWPs from the Italian market starting from January 2019. With the new draft law, in fact, the much debated Eur 500mln taxation introduced by the 2015 Budget will be eliminated and replaced with an increase in PREU on both VLTs and AWPs thus eliminating the uncertainty which plagued the previous budget law. While we believe that the taxation burden is in no way over (PREU on VLTs went from 4% in 2012 to 5,5% in 2016 and from 11,8% in 2012 to 15% in 2016), we are optimistic that further increases in taxation will have a lesser impact going forward. The Government seems to have learned that new tax increases will need to have greater clarity on the liability burden and that, in the future, every machine will have to be connected to a central control system.  Thus the gradual removal of AWPs and the introduction of mini-VLTs will lower tax avoidance and increase the earning power of concessionaries such as Snai. As a matter of fact, the new machines will require a significant technological know-how to operate requiring shops, therefore, to leave a greater percentage of revenues to Snai and its peers and decrease the margin differential versus VLT operations.

 

3. Snai has two separate bonds currently outstanding (the 7,625% and the 12%) which were issued in 2013 and thus do not properly reflect today’s interest rate environment. Management has acknowledged that it is time to start looking at the capital structure and we believe that the company will aim to call the bonds by year end (call date is on the 15th of December) thus creating significant shareholder value (similar deals by Gamenet and Sisal were well received by the market and currently offer 5/6% with comparable levels of debt). According to our estimates Snai is likely to end 2016 with around Eur 400 mln in Net Debt (excluding the costs associated with the renewal of sports betting license estimated to be around Eur 65mln which will be incurred in 2017) and an EBITDA around Eur 140/150 thus putting the Net Debt/EBITDA in the 2,8x range. Considering that, on an organic basis, the company should be able to generate at least Eur 110 mln in FCF before interests, we believe that the refinancing cost should not be above 5/6% thus reducing interest expenses by 30/40%.

 

4. At current market prices the stock yields over 38% on FCF without any benefit arising from debt refinancing which, by the way, could bring FCF yield to over 50%.

 

Sources:

On VLT and AWP: http://www.sisal.com/eng/offering/gaming-machines

On the different Earning Power of VLTs and AWPs earning power for concessionaries: https://www.gamenetspa.it/sites/default/files/investor-relations/2015%20and%202014%20Consolidated%20Annual%20financial%20statements.pdf

On Sports Betting Volatile Payout (Slide 7): http://www.grupposnai.it/sites/grupposnai.it/files/investor_presentation_-_1q_2016_0.pdf

2016 Legge di Stabilità (Italian):

http://www.ilvelino.it/it/article/2015/12/21/giochi-e-stabilita-2016-il-dettaglio-di-tutte-le-misure-introdotte-nel/fd26bff3-eea4-4876-875d-87b4cf5fb219/

Q1 2016 Results:

http://www.grupposnai.it/sites/grupposnai.it/files/investor_presentation_-_1q_2016_0.pdf

 

[winjitsu]

Hey there been a pretty nice run-up in price since July. What was the price/market cap you used when calculating FCF yield?

[ContrarianNick]

Hey, here is the calculation to arrive at the level I wrote above:

• EBITDA 140mln (once synergies with Cogemat are fully integrated, FY 2017, we should expect Eur150mln).

 

• CAPEX 20/25 mln (there are approximately 10mln in maintenance CAPEX and then you have approximately 60mln for the sports betting licence renewal which last for 5 years).

 

• WC is not going to have a material impact on cash generation.

 

• Taxes 0. The company has big DTAs and it is not expected to pay any cash tax for the next 2/3 years.

 

• Interest Expense Eur 55mln. This figure does not account for bond refinancing, very likely to happen within year end, which could significantly boost cash generation for shareholders. Assuming the company ends the year between 2,5/3,0x Net Debt/EBITDA, the cost of debt should not be higher than 5/6% from the current level (which is above 10%).

 

• At today’s price, Eur 0,93, the market cap is equal to 175mln, net debt is Eur 421mln and EV is 596mln. So free cashflow before interest payments to EV is 19% while free cashflow to equity is 34% before debt refinancing.

 

Happy to discuss it further.

 

[rtvinvest]

Thanks for the write-up. I took a brief look so please excuse potentially easy questions.

 

1) Why is D&A so much higher than your maintenance capex? Have they done large expansion capex which will not be required for a while?

 

2) What is the competitive dynamic? Are the various gaming operators competing aggressively for market share?

 

3) What is management's capital allocation track record? Do you believe they will be able to efficiently allocate/redistribute capital once FCF starts increasing or is this a risk?

 

4) Are there any regulatory risks that might explain the current market price?

 

 

[ContrarianNick]

No worries. So following your order:

 

1) The business is based on the idea that you pay for a gaming license in a one-off payment and then you amortize it over the life of the license. The company paid for the VLT/ AWP license until 2021 and D&A reflects that.

 

2) VLTs and AWP are completely regulated (in terms of number of machines, which is fixed) and license holders are not really competing on betting payouts, so the market is pretty disciplined. On the sports betting side the competition is pretty high especially as online sports betting tends to offers higher payouts than betting shops. However, since the cost structure of online betting is much lower than physical stores, the net effect on the bottom line is actually slightly accretive for operators such as Snai. Note that Snai is the first brand in Italy in the sports betting market and it holds a significant resonance with customers (at least on the physical side of the market).

 

3) New management, no track record so I cannot really comment on that. I would assume that in 2/3 years the company starts deleveraging quite fast and that dividend payments become the focus of management but as of today it is too early to tell.

 

4) There is a talk about reforming the AWP market and reducing the number of machines in the market however this is anticipated by all license holders and it should be a positive development for the industry as machine productivity will increase. My opinion on the stock price being so low (at least until the recent run up) is the fact that the company is underfollowed by the sell side, the stock is not very liquid and very few investors actually understood how much the Cogetech operation would change the company and lower its exposure to sports betting volatile payout.

Hope this helps.

 

[magno111]

Do you know the reason of yesterday's move?

 

Thank you

[ContrarianNick]

No news...

[winjitsu]

Some smart fund manager is reading this forum :)