Key Financials
List: Aktietorget
Market
Cap: 1,716 MSEK
Industry: Betting/Entertainment
CEO: Fredrik Burvall
Chairman: Rolf Åkerlind
9.0 points 9.0 points 7.0 points 5.0 points 6.5 points
Share information
Share price (SEK) 120.0
Number of shares (m) 14.3
Market Cap (MSEK) 1,716
Net debt (MSEK) -14
Free float (%) 30 % Daily turnover (’000) 7 Analysts: Philip Skogby [email protected] Kristoffer Lindström [email protected]
The Transformation Begins
Cherry reported a strong Q4 report across all segments, the online casino delivered in line with expectations SEK 118.7 million (estimate 118.6 million kronor). Adjusted EBIT for revaluation of additional purchase price came in stronger than expected at SEK 14.9 (estimated 11.5) million led by operational efficiency and stronger than expected result from Yggdrasil.
Yggdrasil has gained significant momentum operationally and financially with the company growing approximately 100 percent QoQ showcasing its quality games performance across some of the most innovative operators in the business. Although, the company’s growth story has only begun, we expect more top-tier games to climb the ranks amongst operators continuously. Moreover, the company has a small games portfolio and still a small portion of the large and fast growing operator market. It reported revenues of SEK 8.2 (expectation 5.5 MSEK) before internal revenues.
Our confidence in Yggdrasil’s growth trajectory has increased due to enhanced durable competitive advantage, which the market still barely perceives at all. Consequently, our SOTP and DCF intrinsic value increases significantly to SEK 200 per share (Previously: SEK 140). Bear and Bull case scenarios are revised to SEK 90 and SEK 320 per share (previously SEK 60 and 200). Furthermore, as previously the scenarios continue to be built upon warranted margin of safety mechanisms for all segments – the online casino itself is able to defend the majority of the current market cap. Moreover, continued intense focus on shareholder-friendly measures will further enhance shareholder value.
0 50 100 150
23-Feb 24-May 22-Aug 20-Nov 18-Feb
OMXS 30 Cherry
Management Ownership Profit outlook Profitability Financial strength
Summary
Cherry
(Cherb.st)
Redeye Rating (0 – 10 points)
2014 2015 2016E 2017E 2018E
Revenue, MSEK 340 529 798 1,041 1,303 Growth 28% 56% 51% 30% 25% EBITDA -18 36 103 182 272 EBITDA margin -5% 7% 13% 17% 21% EBIT -33 13 71 135 195 EBIT margin -10% 3% 9% 13% 15% Pre-tax earnings -37 7 71 137 198 Net earnings -39 0 46 105 153 Net margin -12% 0% 6% 10% 12%
2014 2015 2016E 2017E 2018E
P/E adj. -13.4 - 37.1 16.3 11.2
EV/S 1.4 0.9 2.1 1.6 1.3
EV/EBITDA -26.4 13.6 16.5 9.0 6.1
2014 2015 2016E 2017E 2018E
Dividend/Share 0.00 0.00 1.00 1.00 5.34
Redeye Rating: Background and definitions
The aim of a Redeye Rating is to help investors identify high-quality companies with attractive valuation.
Company Qualities
The aim of Company Qualities is to provide a well-structured and clear profile of a company’s qualities (or operating risk) – its chances of surviving and its potential for achieving long-term stable profit growth.
We categorize a company’s qualities on a ten-point scale based on five valuation keys; 1 – Management, 2 – Ownership, 3 – Profit Outlook, 4 – Profitability and 5 – Financial Strength.
Each valuation key is assessed based a number of quantitative and qualitative key factors that are weighted differently according to how important they are deemed to be. Each key factor is allocated a number of points based on its rating. The assessment of each valuation key is based on the total number of points for these individual factors. The rating scale ranges from 0 to +10 points.
The overall rating for each valuation key is indicated by the size of the bar shown in the chart. The relative size of the bars therefore reflects the rating distribution between the different valuation keys.
Management
Our Management rating represents an assessment of the ability of the board of directors and management to manage the company in the best interests of the shareholders. A good board and management can make a mediocre business concept profitable, while a poor board and management can even lead a strong company into crisis. The factors used to assess a company’s management are: 1 – Execution, 2 – Capital allocation, 3 – Communication, 4 – Experience, 5 – Leadership and 6 – Integrity.
Ownership
Our Ownership rating represents an assessment of the ownership exercised for longer-term value creation. Owner commitment and expertise are key to a company’s stability and the board’s ability to take action. Companies with a dispersed ownership structure without a clear controlling shareholder have historically performed worse than the market index over time. The factors used to assess Ownership are: 1 – Ownership structure, 2 – Owner commitment, 3 – Institutional ownership, 4 – Abuse of power, 5 – Reputation, and 6 – Financial sustainability.
Profit Outlook
Our Profit Outlook rating represents an assessment of a company’s potential to achieve long-term stable profit growth. Over the long-term, the share price roughly mirrors the company’s earnings trend. A company that does not grow may be a good short-term investment, but is usually unwise in the long term. The factors used to assess Profit Outlook are: 1 – Business model, 2 – Sale potential, 3 – Market growth, 4 – Market position, and 5 – Competitiveness.
Profitability
Our Profitability rating represents an assessment of how effective a company has historically utilised its capital to generate profit. Companies cannot survive if they are not profitable. The assessment of how profitable a company has been is based on a number of key ratios and criteria over a period of up to the past five years: 1 – Return on total assets (ROA), 2 – Return on equity (ROE), 3 – Net profit margin, 4 – Free cash flow, and 5 – Operating profit margin or EBIT.
Financial Strength
Our Financial Strength rating represents an assessment of a company’s ability to pay in the short and long term. The core of a company’s financial strength is its balance sheet and cash flow. Even the greatest potential is of no benefit unless the balance sheet can cope with funding growth. The assessment of a company’s financial strength is based on a number of key ratios and criteria: 1 – Times-interest-coverage ratio, 2 – Debt-to-equity ratio, 3 – Quick ratio, 4 – Current ratio, 5 – Sales turnover, 6 – Capital needs, 7 – Cyclicality, and 8 – Forthcoming binary events.
The Growth Saga Vitalizes
Cherry’s Q4 report was strong, the online casino reported in line with our expectations; SEK 118.7 (expected 118.6) million kronor. The above should also be seen in light of continued increased deposits QoQ, likely a large part attributable to Almor, which holds significant potential to turn these deposits into more game win in relation to revenues as its mobile platform compatibility and user convenience are further nurtured in the future. High outgoing payments was likely in place but we see most of these as
necessary. The growth rate became, on an entity level, 71 percent (expected
68 percent before revaluation of APP). As the current quarter did not include a reference to any newly acquired
business, the indicated online casino numbers is the organic growth rate. Indeed, both the SunnyPlayer & Kingplayer platform have not yet been transferred to Cherry’s own platform. We think that the SunnyPlayer implementation is the most interesting one from a shareholder perspective and expect it will take place during the first half of 2016, adding another layer of profitability and revenue improvement going forward. It has not yet been decided if Kingplayer will be transferred to Cherry’s platform. After the period the company launched its new upgraded platform across its brands which can create some churn in the short-term but will likely in the longer term be value-accretive. Nevertheless, continuous agility within the innovation field is imperative, if Cherry is to secure the best solution and experience for the customer (new instated Malta CEO is one cornerstone of this pursuit).
Estimate vs actual
MSEK Q3'15 Q4'15E Actual* Dif.
Revenues 154.1 168.2 171.1 2% Restaurant Casino 42.5 44.1 44.3 0% Growth 13% 5% Online casino 107.6 118.6 118.7 0% Growth 131% 109% Yggdrasil* 4.1 5.5 8.2 49% Growth 339% 696% EBIT** 10.4 11.5 14.9 30%
Revenue growth rate 70% 71% -1%
EBIT-margin 6.7% 6.8% 8.7% -27%
*Exclusio n o f Internal Revenues **Revaluatio n M &A Online Casino So urce: Redeye Research, Cherry
Strong growth ahead for Almor
Marketing expenses came in at 26.6 percent (expected 30 percent) compared to 25.5 percent for the previous quarter, and still managed to grow immensely during the quarter. Revenues grew faster than marketing expenses relative to last quarter, indicating further scale and optimization of its marketing activities. Indeed, this shows that the company is now in control of its marketing rather than letting it control the online casino. Overall, the company was affected by Almor’s optimal cost structure which brought the margins up considerably and continued with strong growth in its existing business where the personnel expenses stayed largely flat. In essence, the company has now turned its business around with several value-accretive acquisitions on the affiliate and online casino side, along with a profitability momentum for its brands. Interesting to note is that the mobile segment (including Almor) represented 27 percent of total revenues, which is expected to converge over time and subsequently follow or increase beyond its competitors. With Almor releasing its mobile support, the path is set to converge to the current 34 percent rate (excluding Almor) and beyond in the future. This is a significant growth catalyst going forward as it will mean more bets and less volatile earnings – this goes along with other fundamental growth factors such as an immature market, platform excellence and unique games.
Unfortunately, we cannot go into detail about the revenue composition of the company between affiliates and direct channeling sales. Albeit, we think the online casino has a large amount of affiliate sales. The revenue from partner sites is also likely significant (as Game Lounge is meeting high expectations) – but it’s important that the company remains highly active within this medium, if it is to absorb the growth from this large customer segment within gambling.
The restaurant casino announced a turnover roughly in line with
expectations; 44.3 million kronor (expected: 44.1), a strong performance. Review our later section for more detailed analysis of this segment going forward.
Yggdrasil – Rapidly Ascends The Value Ladder
Yggdrasil showed considerable results with a reported turnover of 10.4 million kronor (post internal revenues) and 8.2 million SEK excluding internal revenues (expected 5.5). This figure is estimated to be largely free of setup-fees which indicates that the majority of revenues originate from actual operational performance amongst the operators. EBIT was also strong, showcasing the strong profitability at this early stage – but we urge that stakeholders of Cherry let the company pursue rapid expansion to be able to absorb market share in this large window-of-opportunity rather than optimizing short-term performance.
The games have continued to receive good reception at Mr. Green, Betsson, Vera&John, LeoVegas as well as Unibet –where amongst others, free-Mobile support for Almor
is imminent
Yggdrasil crushed expectations
spinsmarketing has been executed with the operators during the quarter. The game “Nirvana” paves a new way of dynamic graphics, interaction and game mechanics. The Nirvana slot was very well received by its operator base, reaching many top popularity listing. Another slot that was recently released, Incinerator, highlighted the company’s focus on gamification, which we believe is what the operators increasingly wish to use to differentiate themselves to the competition. We believe there is a lot of things to do in this field and we believe that Yggdrasil will be an important part in achieving the next-generation slot games. The rest of its portfolio is continuing to perform well, with Vikings Go Wild and the Sherlock Holmes having high-ratings.
Indeed, this represents well what the company wants to perform, doing things differently to the competition, constantly looking to improve the user experience. Organizationally, the company has the rare prerequisites to become a fresh twist in this industry with an underlying genuine passion for developing games. The company continues to make the betting numbers (total wagers) public, meaning that you could approximate the amount of winnings based on an approximation of the average RTP (Return to player) and the amount of retention within each specific game. If the RTP is 95 percent, then payout from player is 5 percent on average (across the games portfolio) times the wagered amount of approximately SEK 2.3 BN during Q4, which would be
equivalent to a GGR of SEK 115 million - attributable to the operators. The attributable royalty amount to the games supplier is then
approximately 10 percent judging by the SEK 10.4 million reported by the example above, considering that the RTP varies both in games and in theoretical averages.
We believe the average RTP across its games should be in the range of 95-97 percent which indicate a higher royalty rate (10-14 percent) than the rate mentioned above. Indeed, for large operators it’s likely that the game supplier must accept a lower initial rate – at this stage however, we deem that Yggdrasil does not approach operators to the same extent, there is now a more mutual interest to apply its games where Yggdrasil set more of the terms. Another factor to consider in this argument is the theoretical RTP vs actual which can vary greatly in smaller samples – which is what Yggdrasil is somewhat more exposed to – however, due to increasingly larger sample size and increasing mobility usage, it’s more probable that the theoretical RTP is reached. This holds true especially when considering its large degree of mobile game win which means that the theoretical and actual should converge given the increased number of bets (retention).
In September it amounted to 37 percent of its game win and by the end of the year it had increased to 41 percent.
Guiding how to approximate the royalty rate
It’s hard to know what is better operationally or financially, besides the top-reception of its games, the company is now beginning to expand to the huge UK operators - Bet365 being the first evidence of interest by these
operators. The company is set to conquer more UK focused operators in 2016 and beyond. Indeed, the company will likely to be able to use its well-renowned games to gain negotiation leverage in deciding the appropriate royalty rates. Over time, these operators will grow in importance as they utilize inferior games if compared to the more mature Nordic markets which presents an interesting kind of “first-mover” advantage (albeit, that
does also apply for the Nordics but not to the same extent). Full portfolio release takes time for new operators and step by step, the
company is taking over the most popular games on tier-1 operators along with gaining more and more promotional time showcasing the game quality. We also expect more Jackpot slots and its current flagship Joker millions, which has so far been a success with Leovegas and MrGreen is now utilizing its slot. We think that, in relation to its planned games portfolio, there will be 1-2 Jackpot slots released in 2016 and we expect a big slot improvement relative to Joker millions. The number of people working is now currently around 45 people and increasing on a step-by-step basis. The advantage of the low number of competitors in the slot games development industry is reflected in the barriers to entry in the form of experience, game design and regulatory challenges. It should be mentioned that the company is still experiencing a considerable challenge in its efforts to increase the quantity and at the same time being the most imperative factor: to constantly improve the quality of games. This will be a constant struggle for Yggdrasil and we expect that Yggdrasil will act as a challenger to the norm of games developing industry in the future.
Cherry currently owns approximately 86 percent of Yggdrasil, however, if Yggdrasil’s management members choose to utilize their options, the ownership level will decrease to 84 percent (previous threshold 86). Now, we think that management will not only offer shares beyond 80 percent but options in Cherry as well, in order to retain top talent.
On all accounts, the report in general and developments of late has yet again surprised positively with the underlying fundamentals improved and Yggdrasil continued being de-risked in the quarter and we think the market has yet to grasp the extent of the current operational development on the long-term intrinsic value.
UK players extension will provide a strong pillar of future revenue growth
NASDAQ OMX Listing, M&A & Insider Transactions
Cherry was also active during the quarter in terms of shareholder-friendly actions. The company promptly, after warranted share-price appreciation, decided to open up for a listing during 2016 – we expect that this can either take place on mid-cap or small-cap. This will help the company gain institutional ownership and will help in closing the price-value gap. We expect certain key players in the ownership and management sphere to keep their ownership stakes or increase their positions based on the long-term
fundamentals. In regards to M&A, the acquisition of Moorgate contributes strongly to the bottom-line as these will eliminate the affiliate contract costs associated with web resort brands. We expect to see further M&A activity during the year as the company has a decent foundation, strategy and size to
successfully engage in M&A activity.
Acquiring more companies at a low valuation or lower than Cherry itself is a tangible opportunity for the company to grow faster than the market and further evolve its brand and product offering. We believe a major
acquisition can indeed happen during 2016 – enhancing shareholder value significantly.
We do not expect a slowdown in the short-term future or long-term of these activities. Nevertheless, we’d rather see that the company takes significant care in making a few but effective long-term decisions rather than the other way around.
In terms of insiders, Betsson’s founder, Anders Holmgren, increased his position by approximately 13 percent of his total holdings during Q4, whom is also strongly connected to Yggdrasil as a board member.
The 2015 Dividend Revoked – Amplifies Strategy
As previously and clearly outlined, we were strongly against a dividend – the company can now rightfully further focus on increasing market share across its existing business comfortably and create far larger rate of returns
than the effect of distributing the dividend to shareholders. We want to be very clear in the following: we are still against a dividend in
the future and would want to see management initiate a share buyback instead if it returns for 2016, to showcase the growth trajectory, or
alternatively invest the cash flow in its business to achieve a high degree of
returns and further enhance shareholder value. This is important in another highly important context as well - Yggdrasil
should receive the freedom it rightfully deserves and never be driven on ill-focused short-term objectives in the pursuit of profitability.
Solid Balance Sheet
Cash and equivalents was approximately 20 million kronor by the end of Expecting further intense
focus on shareholder value creation measures
Share buyback a better alternative to dividends
supports the growth trajectory along with support from its almost unused overdraft facility of SEK 25 million. There is a conditional additional purchase price of maximum 18.6 million for Game Lounge which can be paid at the earliest of by the end of February. We expect that it will be paid in full (considering the decent feedback it has received in the latest reports – along with the minority interest accelerating which we deem is a combination between Almor and Game Lounge) and that it would most likely be paid by shares in Cherry to further align with the stakeholders at Game Lounge. It should be noted that the company utilizes funds in order to maintain compliance for its Malta Gaming license and Jackpot reservation (which restricts its cash position somewhat).
Cash Flow Effects During The Quarter
We have nothing particular to add to the cash flow reported during the quarter – it correlated well with the reported figures and boosted the cash position as these figures would naturally inhibit.
However, we would welcome more detail in regards to the general effect on cash flow between quarters in the future as possible capitalizations, working capital differences and investments as we can only assume the composition above. Most companies do not do this anyway (except capitalizations), but that does not mean Cherry can’t be better. It would help in deciphering and thus increasing the accuracy of the underlying earnings power estimation
when there there can be many acquisitions and possible one-offs.
Misappreciated Value Machine Emerging
Cherry has a long track-record of successful acquisitions and Game Lounge and Almor is no exception according to us. Now with Moorgate, its
Webresorts brands are more cost-efficient with the affiliate costs being cut significantly. Game Lounge will enable Cherry to continue to channel customers to its brands and generate revenue through other brands as well. We expect further M&A activity in this field in the future, directly with
Game Lounge or stand-alone. The recognition of these efforts now and in the future along with its current
brands rapidly reaching critical mass volume (evidenced by the profitability expansion), will make the market appreciate more and more of the
underlying earnings power of the company. Along, with future expected share buyback or dividend, which will be highly-attractive relative to peers, will shrink the price-value gap in time. Thus, the company is still forming a new depiction of Cherry as a profitable and high-growth company – in our view; still yet to be appreciated by the market. Furthermore, Yggdrasil is still being largely ignored which relates more to the natural lack of understanding of the potential whereas the online casino is now clearer for the market and incorporated in the valuation. Nonetheless, the market is fiercely competitive (but the industry continues to evolve rapidly) and regulatory hurdles are likely to increase in the future,
but with Cherry’s innovative DNA it is likely that the company can avoid being significantly burdened, by being one or a few steps ahead of its competitors. Please review the section starting from P.11 carefully of how and why we asses that Cherry is undervalued.
We believe that the company has acted wisely in betting on a balance of the two elements - profitability and growth. High growth will help them prepare for re-regulation of the fast growing online casino market via the mobile and organic segments, as well as with the transition away from the physical casino. When the new regulation comes into effect in the Nordic countries, the company will need to be in a position either as a consolidator, or as a potential acquisition object, which will require a sustained greater growth
rate in Scandinavia and Europe. From the sole perspective of profitability, it will become essential to obtain
a high growth rate to keep a strong profitable position in the market which is experiencing a climate of re-regulation (which is partially compensated by the increased turnover), increased taxation as well as competition. Brand Awareness Reflected by Fundamental Improvement In the table below, it can be observed that the company is allocating significant resources on marketing as it has historically provided an acceptable yield. Now, the trend is clear the company is achieving better returns on investment – as the scale and efficiency of its market budget gradually improves.
The MAE-Ratio broke another record, being approximately 4 times the money invested, showcasing the brand recognition, smart marketing and increasing volume advantage. Now, as we have depicted later in this text, in relation to revenues relative to deposits, it is more of a challenge to convert deposits further which would indicate higher and successful retention of its players.
Source: Redeye research
The company is showing strong signs of an improving MAE-Ratio trend (Marketing Efficiency Ratio – Onlinecasino revenues divided by marketing expenses) which reflects the former deduction. However, it is worth noting that at the same time personnel costs and cost of sales must also improve over time in order for the figures to be equivalent to tangible profitability improvement – which is the case.
The company has continued to invest in marketing endeavors for CherryCasino and Spilleautomater during the quarter. It should also be mentioned that the company invested in par with operators such as Betsson & Unibet, with a total of 26.5 percent in marketing expenses and still manages to outgrow them significantly. We think that the company should establish itself by investing some resources on the ranking of
Casinomeister.com, and by utilizing their experience, platform and
trustworthiness. This is not only a good marketing strategy but also a way to get closer to its customers.
We also believe that the company will reduce COS in relation to revenue to the same levels of the competition – to about 25-30 percent as the online casino division progressively expands beyond that of the restaurant casino in sheer size (which is the primary driver of COS). The regulatory effect is included in the above COS number. As of now, the royalty rates are likely higher on some of its brands due to its relatively low volumes with tier-1 gambling developers.
Continued substantial marketing expenses –
improvement in the MAE-ratio
Continued Strong Player Retention
The company continued to increase the number of active customers
substantially, from 60300 to 70746 players during the quarter led primarily by Almor and Eurolotto. It is also highly likely that the turnover increased is also driven by Cherry’s continued efforts and use of CRM/VIP to manage its customers. Approximately 90000 new customers were registered during the period, which represents a large chunk of the marketing expenses, where turning these into and maintaining these as active players is important. In turn, this depends on factors such as the gaming experience
itself, responsiveness and support – these are highly intertwined. It is essential for the company to make people return and play more
frequently, if it is to sustain low customer acquisition costs, enabled by the previously mentioned. Overall, we believe that the company has potential to improve and lower the frequency of bonus utilizing players.
Source: Redeye research
As also observed in the previous quarter, the reason that the quarter’s high deposit amount (albeit slightly improved) was not fully converted to net gaming gains to the same degree, is probably due to the high outgoing bonus payments and potential to further improve retention. The ratio is expected to improve over time as the platform gains better mobile support, user convenience and Almor’s brands become fully mobile-compatible. Moreover, adjusting bonus amounts in general can be dangerous if not planned well as it can detract the ones who actually enjoy playing. CRM and VIP
management continues to implemented
Development of deposited amounts is positive, but a greater amount must be converted
Deposited amount (MSEK)
Source: Redeye research
As Cherry has affiliate owned businesses, the company is making money on other sites as well. However, as previously mentioned, the distribution between direct and affiliate revenues is unknown. We think affiliate revenues are in the range of approximately 30 percent of revenues, with an
increasing amount in the future as the company accelerates this venture. The affiliate costs being the RSA (Revenue Share Agreement) are reported
in marketing costs for its partnership affiliates - the payout for its affiliates depends on a variety of factors, such as what the operator wants to charge on the affiliate and in turn on its customers, usually performed by setting a progressive payout dependent on Net Revenue per client. It’s better to have broad low netting affiliates rather than to have a few very high net revenue affiliates as that would increase the margins and possibly its viability for Cherry.
The Restaurant Casino Continues to Deliver
The restaurant casino experienced another strong quarter due to the seasonally high activity in Q4, better retention and the continued success of the new and faster cash register terminals. Operationally, Aron Egfors will now head this division, whom is a relatively large shareholder, and is likely to enable this segment to further take market share. With Cherry’s new cash registers which provide the customers with more payment options, we believe that it is likely that the company can continue to capitalize on quicker payments from the customers. There were a total of 12 new gaming location agreements entered into and 5 agreements were amended during the quarter. The company currently enjoys a significant market share of 65 percent, unchanged relative to the quarter before. A negative development is the payroll taxes (increasing from 16 to 25.5 percent effective as of July 1st)which we have seen the full effect of in Q4 which seems to be have been partially mitigated by the restaurant owners themselves. It can be quite a hassle for a restaurant to change operator to avoid sharing these costs efficiently, given that fewer organizations are involved in the industry. The division can likely grow by 2-3 percent per year with the help of acquisitions in the market. According to the company, the contraction in the restaurant casino industry is lower than previously and has stabilized at about 2 percent per year.
High turnover due to seasonal effects
At the same time, it is possible that a positive outcome of the incoming regulations of the gaming industry will contribute to a doubling of the turnover as well as profits. The cause is that the maximum bet would be increased from 70 to 200 kronor in 2019 (or later).
Another opportunity is that customers at physical locations can register their accounts on Cherry’s online platforms, which if executed well can act as an additional revenue pillar.
The Emerging Fundamental Components of The
Investment Case For Cherry:
Before this analysis goes any further we would like to evaluate some critical factors in going forward during the upcoming years. Thus, in the following paragraphs we list some of the most important value-driving characteristics that the market has already or will likely progressively appreciate for Cherry in the future.
Maturity Phase and Critical Volumes – Margin Expansion
Cherry will be able to cut costs as royalty decreases caused by incrementally i lifted volumes. Furthermore, as brand awareness increase the marketing budget, marketing efforts will become more efficient and thereby expand margins. Scale in terms of marketing costs will also help the company to expand its margins. Indeed, entry in to new markets will likely have some negative short-term impact on the margins depending on whether its
organic or acquisition based. The personnel expenses base is set to handle higher volumes, therefore,
personnel expenses relative to revenues will become incrementally more distant. Cutting out the middlemen such as affiliates, are another way to improve revenues in the future (Moorgate is a great example but a special case of gaining profitability through cutting existing affiliate contracts directly). Cherry is poised to carefully nurture all of these factors including that of letting the player enjoy the playing time to its maximum, thus increasing the retention rate.
The online casino industry is growing but there is also rapid expansion of newcomers that are quickly taking market share. Standing out of the crowd will become gradually more important, whether it’s the best and/or
exclusive games, customer service or any convenient or fun feature that makes customers more inclined to play on a certain platform, will become more and more imperative in sustaining a competitive edge. Along with this question, the company must be in a large enough position to handle the financial regulatory impacts without harming the valuation. With the earnings perception of the company changing due to maturity being reached by its brands because of the previous factors, a subsequent value appreciation will become ever the more likely in the future.
Essentially, the bottom-line is that we can expect EBIT margins of around 20 percent with a market growth of around 15 percent in a maturity phase. The Name of The Game is Evolution
The company has recently begun to expand to the sportsbook arena which can create a significant revenue and profitability boost in the future.
Furthermore, its strategy of waiting for the right acquisition works well, this could be a further catalyst in the future. But more importantly, the
company’s internal willingness to search and try out new things is in its DNA. It is no surprise that Cherry has been part of the production of both Betsson and Netent. At the same time, it has failed many times as well, but if you are willing to learn by your mistakes then success is a natural
consequence. With its own games developer Yggdrasil, it is set to expand in a large market and the extend the gaming scene online gambling.
Continued Strategic Internal Investments and Acquisitions Historically, the company has performed several value-accretive
acquisitions such as Web resorts and Automatgruppen. Net Entertainment and Betsson are two other well-known internally created brands which have been spun off. Now, Yggdrasil is an internally created growth. Almor is what we deem to be a value accretive acquisition over the long-term, helping to support further growth in Europe. We can expect more of these
acquisitions, only if the potential far exceeds the cost, even in a negative scenario – this takes time but will happen eventually. This strategy has helped the company to survive over the years and we do not see these fundamentals to transition to the negative for the shareholders in the future.
New Frontier Arenas – Live Casino, Sports Betting and B2B As the company has extensive experience in handling live casino, a possibility would be to launch a live-casino in the future on Yggdrasil’s platform, providing a strong and competitive base to the current Net Ent and Evolution Gaming’s offerings.
The SBTech’s sports betting platform was launched in Q2, bringing Cherry to the forefront of the sports betting arena. First, the loyalty amongst existing casino customers may improve as it would provide a choice for betting, but may also improve customer acquisitions of casino customers as new betting players gradually commence playing on the online casino. Cherry with a strong base brand may likely take advantage of this to create a solid brand for its new betting operations. This is of course a long-term investment that needs time to yield significant results and resources must be spent on this to achieve such results.
Another area of interest is its platform systems which it could sell as a B2B model, as an operator as well as affiliate system that in the longer term can be supplied for startups or established operators. All these options above can contribute significantly to the long-term value proposition and we see that one more of these verticals is not out of the question in the next few years.
Small Cap Listing
The company is now preparing and is expected to list its stock on NASDAQ OMX small/mid cap during 2016. Institutions will naturally appreciate the “risk” diversification of Cherry’s current three primary segments,
impressive growth rate and trajectory along with the strong management and ownership. This will be one part of closing the price/value gap.
Yggdrasil Surpasses Expectations
Yggdrasil consists of people with passion for developing fun games. With the increased number of operators and the gradual increase of employees the likelihood of an AAA-slot does not seem implausible. An AAA-slot can overwhelm the revenues during a significant period of time due to
continued high-ratings. Widening its portfolio of these games along with operators will pose a strong revenue contributor for many years to come. Operationally, the company has surpassed our current expectations. Regulatory Positioning
If the company succeeds in avoiding margin contractions due to
competition, it will result in a strong position in the case of a re-regulated market. It is possible that the company can achieve a multiple expansion as the company then succeeds in sustaining a large market share in
Scandinavia, which would then also be perceived as even lower risk compared to a company with smaller market share and a company with non-regulated revenues. We think that the company will, as above, diversify within its markets and the revenue dependency will incrementally shrink over the coming years. Acting in non- re-regulated markets is a risk and can spiral into lawsuits, where a major reaction of this sort, can be a substantial opportunity for the investor.
Aligned For Strong Growth
This chapter will present the market dynamics of the three segments that Cherry have operations in.
The Online Casino Industry – Large Potential For
Growth
Cherry can utilize some promising opportunities to obtain a part of the projected growth in the online casino market, which is expected to grow by a CAGR of 5.4 percent in net gaming profits until 2018. The company has a small share of the European market which accounts for 23 billion kronor in net gaming profits, which should make it possible for Cherry to take part of the projected growth due to a greater investment rate than the average market rate.
In addition, it is also expected that the mobile market will become a decent catalyst for Cherry’s future growth which is on average growing by 32% per year in Europe. This would make a higher growth rate possible for the company, which is now the expectation for the next few years. We should also mention that it is not certain that the growth in this mobile segment will cannibalize the growth in the PC segment, nor how large this segment will become; we expect that cannibalization will not be an issue for Cherry as it is still a relatively small innovative player. Despite the growth,
competition is highly intense in the Nordics and competing at a high level is likely a certification of success in expanding to Europe where markets can be a bit less intense. There is however a possibility of further increase in the Swedish turnover growth rate in relation to and with the competition, without international establishment, strengthened by the ongoing
transition from physical to online casino (at present only 9 percent of games are conducted online).
We expect that the company can and should achieve growth in Scandinavia as well as to be able to act aggressively in the market when (less if) the regulations are altered. The company may be able to acquire an additional market share of 10-15 percent in Scandinavia, which according to our calculations represents approximately 500-800 million kronor, which enables the company to position itself for further growth in existing markets.
It will also be strategically important to achieve a greater turnover as to both minimize the staff expense levels as well as the marketing level without significantly impacting the operating margins. An important question concerning the effects of the impending regulation changes, is in regards to the eventuality of decreased sales and lower margins in its wake, where larger competitors gradually enter the market and acquire market share. Cherry still only has a
fraction of the market share of the total online casino market in Scandinavia and Europe
greater penetration of the online casino market and sustains a highly competitive industry. The regulations will lead to lower margins regardless, but it is likely that it will be compensated by a higher turnover level due to the opening of marketing channels and perception of gaming as legal. EU has accelerated its process for licensing in Sweden by having the Swedish regulations examined at the EU-Commission. With the
government expressing the need for re-regulation, a license will likely be granted in 2018-2020, as legal changes tend to generally take longer than consensus expectations.
It is important for Cherry that if it is to achieve sustained high growth rates through organic growth, partnership or acquisition, it needs to expand its operations to other European markets. The regulatory change trends have continued in a few markets during the quarter, such as the Netherlands,
Spain, Great Britain as well as North America.
The Restaurant Casino - Industry Challenges Ahead
The Swedish restaurant casino industry is regulated and Cherry acts under the jurisdiction of the Swedish Gambling Authority. The restaurant casino market represents approximately 1 percent of the total gaming industry, which is a contraction of almost five percent points compared with the millennium shift (before the online casino and Casino Cosmopol’s entry). The potential for Cherry lies in the opportunity to continue consolidating the market and expanding the opportunity for customers to play. A catalyst for turnover growth and multiple expansion for the restaurant casino will likely occur at the time of regulatory change in 2018/2019 – which may lead to an increase of the max bet from 70 to 200 kronor. As the question
concerning the increase of the maximum bet, may not be of the same priority as that surrounding the change of online casino regulations, we expect that it may take additional time before that motion is passed. The employer contribution raise is also a factor which can come to increase staff expenses, which in turn would reduce operating margins somewhat, but compensated by sharing the cost with the restaurant owners.
The Game Development Market - Promising Outlook
Yggdrasil, which is connected to the game operator Cherry, is similar to many other game developers, which have historically been linked to game operators to only be sold off later. Examples of game developers (suppliers) are Net Entertainment, Playtech, Scientific Games, IGT, Bally Games, and Betsoft. The market for game developers is expected to grow alongside the online casino market. The game developer market is not as competitive as the game operator market, which can be explained by higher barriers to entry. It is important that Yggdrasil continues to remain competitive in the future in regards to both quantity and quality of games, as the gaming operators may otherwise lose confidence in the distributor. Yggdrasil is subject to advantageous competitive-climate and opportunities which willCherry’s restaurant
casino can still grow through acquisitions as well as through easier payment solutions.
Cherry’s Yggdrasil
allow it to become a significant game developer, considering its experience in the game development market.
Financial Estimates
The most significant revision made, which was earlier hinted for was in relation to Yggdrasil - that we are now willing to bet on that the results will be strong in the coming years leading to a revision of revenues from SEK 32 million to 59 million in 2016. This can be simplified in to a few reasons that are well-connected; first, we have incorporated a margin of safety in our previous estimates and there is no longer rational ground to maintain such an approach with two consecutive quarters with above expectations financially and even more so operationally. Moreover, there will be some key factors driving revenue growth during 2016 and in the future, a) continued extension of the games portfolio b) deriving more high quality games titles reaching popularity and gaining access to more promotional campaigns c) expansion to larger UK related operators and largely unpenetrated operator-base in general. We think that the short-term revenue trajectory does well in relation to the operational development but it will not be a game changer if the company underperforms in a single quarter by 20-30 percent. Although, at some point such a deviation will have an impact especially when at some stage in the future when Yggdrasil will be fairly valued considering its long-term prospects.
We estimate that for the online casino segment the will further accelerate to 582 million by 2016 (previously 573). These are all ex-M&A which we deem are most likely to happen but at what time point and to what magnitude is impossible to pinpoint. Rest assure, that the management and owners will most likely, as history has clearly indicated, they will wait until they find the right fit rather than to satisfy short-term value. Forsaking short-term
satisfaction for long-term value is a rare trait in the industry. The growth is sustained on a high level due to the entrance into new
European markets while operating at a more mature stage in the Nordic markets, the mobile growth and decreasing bonus payments. Thereafter, as markets mature, the growth rate will decrease progressively to
approximately 25-20 percent in 2018. To ensure that this growth is
possible, a high investment rate and conquest of market share of the online casino market is required; we believe that the conquest of market share should be possible given the size of Cherry, market growth, experience and
innovation along with the capability of the management team. As the table below indicates, revenues for the online casino is expected to
grow rapidly, but the yearly growth is again still quite conservative at around 30 percent for 2016 (approximating the Almor acquisition impact on revenues for full year 2015). As mentioned earlier, the accounted revenues are somewhat
underestimated as Cherry has high bonus payouts, which in a mature stage should lead to a greater positive revenue change which will have a direct impact on EBIT in the longer term. Making players play longer at the site High growth is sustained
over time by the mobile venture, the Nordic market potential as well as the establishment in overseas markets.
increases the amount of gamewin, we believe the company is able to stay innovative in this arena, personalizing the experience to retain players over time. We still think the company has room to surprise considering that we think that the company can further accelerate its marketing, both through direct channeling and affiliate. It should be noted that these figures are fully consolidated figures with Almor minority interest included unless otherwise stated.
For Q1’16 we expect an EBIT of SEK 11.4 million driven by continued high investments. These are figures including minority interest of Almor except net profit, thus these figures are somewhat overrepresented but we expect that Almor will be retained by Cherry in the longer term and that its key owner will be retained and rewarded by Cherry shares.
From a margin perspective, we expect improvements in the coming years, led by scalability through Yggdrasil’s contribution given its relatively meager market share in most of its markets. It is also possible that in the near future that the margins will increase due to the fact that the fixed expenses are retained at current levels (personnel expenses) which will
decrease progressively in relation over time. It will likely increase its presence through a variety of strategies during 2016
e.g. M&A, Affiliate or direct brand establishment. One ought to, when valuing Cherry to consider the maturity of its top contributing brands
across several geographical regions to understand the value of this segment.
Estimates
MSEK Q1'15 Q2'15 Q3'15 Q4'15 2015 Q1'16 Q2'16 Q3'16 Q4'16E 2016E 2017E
Restaurant casinno 35.2 39.6 42.5 44.1 161 37.2 36.8 39.4 43.3 157 160 Growth 6% 13% 13% 5% 9.2% 6% -7% -7% -2% -3% 2% Online Casino 58.3 65.5 107.6 118.6 350 127.0 139.7 150.1 165.1 582 780 Growth 49% 61% 131% 109% 91% 118% 113% 40% 39% 66% 34% Yggdrasil* 1.8 1.6 4.1 8.2 16 10.0 13.0 17.0 19.0 59 100 Growth >100% >100% >100% >100% >100% >100% >100% >100% >100% >100% 70%
So urce: Redeye Research, Cherry - * = Excluding Internal Revenues
Estimates, 2016 - 2017
SEKm Q1'16E Q2'16E Q3'16E Q4'16E 2016 2017
Revenue 174 189 206 227 798 1041
EBIT 11.3 12.3 22.7 25.0 71.4 135.3
Net profit* 6.2 6.7 15.6 17.8 46.3 104.7
Revenue growth rate 83% 78% 34% 33% 51% 30%
EBIT-Margin 6.5% 6.5% 11.0% 11.0% 8.9% 13.0%
Explanations on Important Valuation Parameters
The approximate 26 percent marketing rate at the moment is albeit lower than the competitors, we still expect this figure to ramp up when the company sees opportunities in its existing and prospective markets. When the company continuously reaches scale it should converge to 20 percent. Competitors such as Unibet and Betsson have marketing expenses relative to turnover of 20-30 percent. This goes through all channels affiliate and direct marketing. To be able to acquire further market share in Sweden, the company will need to intensify its marketing efforts to later be in a position to utilize the opportunities of the changed regulatory environment, in other words to be able to consolidate or to be an attractive consolidation target. This we believe is necessary due to the fact of taxation and thereby turnover growth, stand-alone will become more difficult in the changed regulatory climate.
COS are also expected to shrink in relation to the revenue when the net online casino revenues gradually increase over time. Royalty rates of its games is usually tied to the amount of revenue. With higher amount of revenue each customer become more profitable all other assumptions being equal. It should however be added that if outgoing bonus payments
decrease, turnover will not need to have a positive relationship and decline since one would lose prospective customers due to revoking bonuses. It is therefore about fine-tuning to customers who enjoy playing and frequently so at the platform without doing excessive risk arbitrage on the bonuses. Customized and personal playing experience is furthermore important. Competitors such as Mr. Green for example incur staff costs of 20 percent against Cherry’s approximately 25 percent. When the online casino and Yggdrasil takes a larger chunk of the total revenues the personnel expenses should continuously decrease.
Continued development of the mobile venture is likely to impact the net cash, but it is supported by higher margins in the long term given favorable position in the regulatory changes.
We chose to focus on EBIT as we believe that depreciation will not compensate for CAPEX investments to establish a margin of safety, which are estimated to be higher, which means that we most likely overestimated the long-term earnings power if we had focused on EBITDA. All in all, we do not see any reason as to why the company cannot sustain an EBIT margin of 20 percent even with increased regulation and increased
competition at the maturity stage. Although it is expected to concentrate on profitable revenue growth the coming three years.
The relative part of the marketing and COS will shrink in relation to income over time
Valuation
A discounted cash flow analysis and a sum of the parts (SOTP) valuation are used to determine the value of the company.
Discounted cash flow analysis
The turnover growth rate is expected to be approximately 40 percent for the upcoming two years on average – this has increased sales in 2016 from SEK 762 to 798 and 2017 from 952 to 1041 million. Furthermore, the long-term EBIT-margin has been increased to reflect the margin expansion that will occur in the more mature phase of the company, led by Yggdrasil the online casino and Yggdrasil. Furthermore, long term growth is adjusted upwards to reflect the fundamental development of the company. The reasoning behind this is the fact that Cherry has experience, strategy and the market circumstances necessary to achieve these estimates. The company will also be in a decent position to consolidate or be consolidated for the upcoming regulations in Europe.
We estimate that the turnover growth rate will decline progressively from the current 30-50 percent the in next coming years, to 25-20 percent from 2018 onwards. The high growth rate is supported by the higher growth rate experienced by the online casino. The growth rate is also motivated by the fact that the company is absorbing parts of the strong growth experienced by the mobile segment. It is also likely that the company will need to be prepared for further establishments in overseas markets, to be able to reach a maturity stage by the end of 2018.
The EBIT margin will converge to 20 percent on an entity level when the company begins to reach higher maturity of its marketing expenses, along with regulatory expenses, when it reaches scale. Simultaneously, the restaurant casino’s impact upon the EBIT margin will decrease over time as the online casino’s growth rate increases, which will see COS as well as staff expenses decrease relative to turnover. This will enable it to be possible to achieve an EBIT margin of 20 percent. Even Yggdrasil is thought to provide a positive effect, but we do not asses that it will be major in the close short-term horizon.
We believe that the company tax will be around 5 percent after 2018 when the company reaches maturity, since the relative part, after profits, from the online casino in relation to the restaurant casino (where they cannot take part in tax advantages) will become substantially larger in the future. Consequently, the tax is expected to progressively decrease to 5 percent. The essential circumstances
necessary to achieve our estimate are in full force
EBIT margins are progressively nearing 20 percent (entity level) in the long term
The Yggdrasil trajectory has pleasantly delivered and is now on the way to barrel through a phase of enhanced growth with games progressively reaching new grounds and operators coming on continuously. As previously explained, the prerequisites, operational development and future trajectory resembles an emerging high growth games developer. It is seldom you get to observe a company that seems to have the right prerequisites.
Intrinsic value, which is more of an art than science, should be seen in the light of a dynamic environment, we are primarily putting emphasis on strong growth, but also under profitability to some extent in the future for both the online casino and Yggdrasil as they are fulfilling the prerequisites. It’s important to note that this valuation is based on a long-term view of the fundamental trajectory of the company. Individual quarters can be worse than expected but as long the operational fundamentals do not change significantly; an investor’s perception of the company should not change. Given that the right long-term framework of fundamental development has been figured out.
The Fundamental Considerations Behind Another Re-Valuation We have been following Yggdrasil since its inception, where at that point the market completely ignored its potential – the market is now
understanding parts of the potential. But still the market seems to know more about the price than the value of the company with associated high volatility (which is highly preferable as it creates opportunities for those who know that they do really know). As Oscar Wilde puts this irrational and beneficial phenomenon in a great perspective “Nowadays people know the price of everything, and the value of nothing”. Indeed, as time passes price should converge to its intrinsic value and in the short term it’s more of a voting machine than anything else.
In relation to intrinsic value, the market is not properly discounting the 2-3 years’ revenue potential from Yggdrasil , our estimate of between SEK 200-300 million, at which point the company should be valued with a 30-40 multiple (50 percent YoY growth cuts the multiple in half every year) at 25-35 percent EBIT margins stretching the valuation between SEK 1.5-3 billion.
Indeed, the market has now gained eyesight on the segment, but it’s more of a short glance than anything else. It has far from properly evaluated the majority of value potential that is yet to reveal itself when the growth trajectory gradually establishes itself – essentially this will lead to the market being more willing to accept the future growth trajectory. Think in 1 year with consecutive quarters of growth – should the market still not discount the value of Yggdrasil three/four years out (as it arguably does today)? Should the impression of the company not tilt to a high-growth company with decent prospects? Moreover, the questions one should ask himself, is to find the answers as to why Yggdrasil has achieved Perception change of
the growth it has done to this point? Is the competitive climate going to change for the worse over a year and will Yggdrasil lose its touch during the way? Indeed, if you invert, and see what is behind the actual expectations of the pricing today you will gain the understanding that the market is merely counting on Yggdrasil to become a tiny bit bigger than what it is today. A stagnant company with dim prospects in terms of growth basically. Can that reasoning be reasonable? Well, it ignores the dozens of operators yet to have Yggdrasil games, the small games portfolio that company has amongst its clients, new innovative new AAA games that are able to climb operator popularity amongst the most innovative operators in the business e.g. Leovegas, Hero Gaming and associated games features. We can be wrong – but have as of yet not seen
any argument that suggest that we can be wrong. Perhaps the largest issue, is when the market realizes the above and starts
discounting Yggdrasil properly (for what it actually fulfills and deserves) which will at some stage likely levitate towards unwarranted optimism too fast and at that point even when Yggdrasil delivers on expectations: it’s not enough.
Secondly, the market is not considering the large shareholder-agenda Cherry is actively pursuing. We do not count M&A in our models, that is one of the additional margin of safety if one assumes more than expected trouble ahead of increased competitive climate and negative regulatory effects. One has to remember that the industry is constantly evolving and so for those who are innovative and remain agile will always be able to nurture its business well. Why has Cherry done this well in terms of M&A and can they be expected to continue to do so? As explained previously there is clear ownership mentality rather than employee mentality with extensive
patience by Cherry itself. Secondly, Cherry is open for businesses to
continue to operate by the persons who often knows a great business best – key owners. This should be seen in conjunction with the company pursuing a substantial margin of safety on the price relative to its value. It’s really much harder than what it seems to perform this over longer periods of time – as it requires extensive evaluation and patience to really understand the value one will receive. Indeed, it is enough to have one of the above reasons not fulfilled to destroy shareholder-value.
Thirdly, let’s consider the online casino segment fundamental value pillars – when the company reaches maturity stage in its markets and is able to cope with regulatory impacts through scale, there is a high probability that the dividend yield at SEK 1 BN+ in revenues for the online casino (we expect Cherry to hit SEK 1bn in sales by 2018) will result in the company trading for the online casino segment at a 15-20 times earnings power multiple(we deem the perception not to change significantly for the worse than today) and assuming a 75 percent payout ratio along with a margin by 15 percent of the revenues. The dividend yield of 6.5 percent still seems to
valuation on SOTP). Indeed, the market at that point will start discounting the next year’s potential and thus offers larger upside than the
aforementioned which acts as a margin of safety. Furthermore, this is without the potential of Yggdrasil.
Furthermore, there has been rating changes during the quarter due to the immense fundamental development experienced last year in reference to management, and ownership being sharpened and aligned. Profitability was upwards adjusted along with financial strength being downwards adjusted reflecting the relatively small but growing cash position. Now, we think the profitability will be gradually adjusted as the profitability arises. Because of these changes the overall effect is a discount rate change from 10 percent to 9.3 percent.
The DCF value therefore now indicates 200 kronor in the base case (previously 140) where the new scenarios can be observed as below:
Scenario summary
For more information regarding the scenario analysis, see page 25.
Bear case scenario: Our estimated value is 90 kronor per share with an estimated probability of 25 percent.
Base case scenario: Our estimated value is 200 kronor per share with an estimated probability of 50 percent.
Bull case scenario: Our estimated value is 320 kronor per share with an estimated probability of 25 percent.
Sum of the parts valuation
A Sum of the parts valuation (SOTP) is used to determine the unique segments values. The aim is to provide a realistic intrinsic value range accompanied with a margin of safety.
The fundamental earnings power of the company is likely to improve during intense growth the coming few years +30 percent as the company reaches scale. All of our growth rates are based on ex-acquisitions which should be interpreted as a margin of safety. This is also led by Cherry’s relatively low market share which we expect is about to gradually improve. The company is reaching critical mass which have now been clearly visible, both by growth and profitability in tandem.
As previously, we are now even more convinced that Yggdrasil is a challenger in the slot gambling developer industry and will likely be a strong force within the industry in the next few years. The previously set intrinsic value reflects the conviction of us being right in at least one of the two. Now, we appreciate further Yggdrasil and the online casino value further as the long-term fundamentals are properly aligned but we still do not fully appreciate them. Due to unforeseen risks, shrinking margins over time for operators, we must utilize a rational margin of safety. Indeed, soon the cash-flow generator will not be the original restaurant casinos but the majority will likely esteem from the online casino in the coming few years and/or Yggdrasil.
The sum of the parts valuation is followed below with a chapter following detailed explanations of the reasoning behind the new valuations:
Sum-of-the-parts valuation
Segment Value EV/EBIT'16E Ownership
Online casino 1526 14 100% Restaurant casino 109 8X 100% Yggdrasil 1200 80%** EV 2834 Net Cash* 20 Equity value 2854 Intrinsic value 200 Market value 1716 Stock price 120 Upside 66%
**Full Redeye Research Dilution Estimate Source: Redeye Research
The online casino division for 2016E is in principle the foundation of the current MCAP today
The multiple has gone up for the online casino by approximately 3 points since last report reflecting the subsequent de-risking of this segment along with the increased M&A probability. Yggdrasil de-risking is continuing fundamentally and has expanded from 600 million to SEK 1.2 billion which reflect the warranted long-term perception that will gradually reveal itself to investors. Still, we believe we have significant margin of safety as will be discussed below. As we can see, the figure below illustrates that the company will start to be valued and rightfully so as a high-growth company in likely 2016/2017 where the growth rate and expanding margins will help immensely in letting the market understand the fundamental position it is currently building up and expected to further enhance and thus account for more of the expect growth trajectory.
Yggdrasil Growth Trajectory
What if the company does not deliver according to these forecast? What about a 30 percent revenue deviation in 18’? Well, then one is arguably not inverting correctly here – as the value should not be based on a single year’s performance but again the long-term growth trajectory. Thus, even if the growth trajectory deviates quite substantially from the above in the short-term, our intrinsic value still holds as we still take have accounted for the effect of for example enhanced competition which is included in the margin of safety.
So, how are we exactly mapping out the future value? Well, being sure on the fundamental prerequisites is key – solution is simple but often harder than it seems. One needs to be completely honest to oneself to know when you really don’t understand the underlying fundamental value drivers. What is driving Yggdrasil revenues, how is it doing that and can it continue to do so in the future? If you can answer these questions with honesty and
reasonableness, then you are probably heading in the right direction. This is most likely not enough, as you need to think deep about the scenarios that can transpire in different
59 100 171 290 435 0% 5% 10% 15% 20% 25% 30% 35% 40% 0 50 100 150 200 250 300 350 400 450 500 2016 2017 2018 2019 2020
situations, to assess whether those improbable situations really are improbable and those who are probable really are probable. If you have these under control and have the rare skill of being patient – there is very little that should change your view on the
company unless fundamentally warranted. Then there is the question, when will the market start grasping the
potential? Well, you can run several scenarios here but it is likely the former scenario we ran that the company will initially be valued with a higher multiple from the first year it delivered along with the basis upon previously significant growth (2016). The markets perception will likely take this growth into account and start extrapolating the continued high growth as soon as it is further confirmed on a consecutive basis - which will cause a significant re-appraisal of the segment as the “risk” of the company, with the multiple reflecting this high-growth trajectory with the “risk” being interpreted by the market as less than it was a few months before. Price and
operational development rarely coincides directly in other words. One could say that the company will slowly become interpreted relative to
what it really should be valued as; a “growth-company” rather than a highly discounted one or a start-up company with a cloudy future. This seems to fit the most-likely category of scenarios, and it is not seldom that such re-appraisals make the market bounce over to over-optimism where investors should become more hesitant but not too early either – one has to pinpoint the longer-term intrinsic value. Indeed, Yggdrasil will have operational bumps and quarterly bumps – which can cause such over belief post the above re-appraisal phase to cause significant but warranted price corrections especially in the optimistic perception bias scenario.
In 2019 the company would likely have an intrinsic value of 3 billion and discounting this further to 2 BN for an extra margin of safety, but it is highly important to remember that the market will likely already by the second half or year-end start discounting the next year potential. As certainty in growth reveals itself, the valuation should gradually become more appreciative and stable.
