An update on Game Account Network (GAN)
You may remember I did a few podcasts with Jeremy Raper on GAN this past year.
Links:
Coronavirus Investing Series, Part 7 | Jeremy Raper | GAN Plc
Jeremy Raper | Credit-Based Equity Investing | Japanese Stocks | Shinoken | Gan | Nio
Since then, Jeremy has moved on and has become quite cynical about the company. I’ve become more bullish than ever. That being said, I have a ton of respect for Jeremy, he’s one of the brightest minds I’ve had on my show, and he’s someone I’ll be planning on doing more interviews with in the future.
A lot has happened since then and the stock price has been all over the place. At one time, the stock was up 10x from its lows on the AIM exchange in London and is now down 50% from its highs. The last few quarters have created quite the divide in the investment community. As mentioned, Jeremy Raper has gone short the stock where he was once long (pretty sure he’s short GAN as a hedge for long another gaming stock).
The Original Thesis
One of the original parts of the thesis was that you were buying a “Software as a Service” (SaaS) company where there was rapid revenue growth from real money internet gaming (RMiG) and where all incremental growth going forward would go straight to the bottom line. While revenues continue to grow, costs this past quarter have ballooned and many investors believe this is cause for concern. Looking at Q3, 2020 numbers, admin costs are now 100% of revenues.
Concerns Are Overblown
I could be totally wrong and look like a dumbass in hindsight, but I believe these concerns are overblown and have put my money where my mouth is. Here is why. Part of the way the GAN business model works is that all labor is front-loaded with new growth. For example, GAN’s headcount started with 140 employees and they are now well over 200 employees as of the time of this writing. That’s a headcount increase of ~50%. GAN puts in development hours, planning, development bandwidth, custom source code writing, and custom development with every single client. They do all of this before collecting a penny from a new client in RMiG. The SaaS portion of the business kicks into gear once the RMiG business is up and running. From there, there’s a ramp which you can see from prior examples in both Pennsylvania and New Jersey. In contrast, a state like Michigan already has 3 major clients in 3 months yet no new revenue yet while lots of front-end costs. Michigan will be similar to Pennsylvania due to its similar size and gambling demographics. Casino and sports will go online at the same time meaning the full ecosystem will go up all at once. All that is happening here is that admin costs are going up prior to SaaS revenue coming in. We will see this time and time again as more states go online with RMiG.
The Context for Expenses
Currently, the company models internally a long-term EBITDA margin of 30% - 40% at scale. The company was nearly there and then that margin fell way off. The ramp-up in expenses covers some of this huge increase in costs this past quarter. In addition, there are also costs for their IPO, heightened expenses this past quarter with bankers and advisors on acquiring Coolbet. However, there is something else here at play that should normalize after Q1 2021. While the company is now listed on the NASDAQ, they are still technically a foreign private issuer. They are reporting IFRS and not GAAP. Share-based compensation is a different kind of computation on a non GAAP basis. There are also outstanding tax liabilities for some obscure UK legislation where they were paying some of the tax bill for some of their employees based off options expenses from around 2017. So some of these costs were also simply paying off tax bills and unwinding this.
The Coolbet Acquisition
The Coolbet acquisition also left some people unsure of GAN’s capital allocation strategy and overall viability of their business model. Due to the fact that Coolbet is Business-to-Consumer (B2C), many investors were wondering if GAN is now going downstream to compete with their “would be” customers. Of course, this would be a horrible sign of things to come and could be seen as the company dicking around with Wall Street to show consistent growth in revenue despite the fact their business model is broken and they are being forced to pivot. I believe this could not be farther from the truth. Here is why. The B2C aspect of the business is International. Coolbet has developed a pretty nifty piece of technology.
For some context, the European online gambling market is mature and has been around for about 20 years. A lot of the tech stacks over there are easily over 10 years old. Coolbet was only founded in 2016, and founder Jan Svendson had built out a similar piece of technology before selling it to Nordic Bet. All of the key players from that went out and built new technology from scratch in more recent history and won some pretty significant awards. They have applied a B2C model yet there is near zero overlap other than Italy. Basically, there is no international geographic business overlap in what GAN is effectively doing with Coolbet.
The strategy with GAN buying Coolbet is very simple. Essentially what I believe they’re saying is, “Hey guys, you have built some great technology with high growth. We will take your best of breed technology and make some slight tweaks and development and then leverage it into our existing B2B business in the United States.”
Yes, GAN is staying a B2B business in the US market which is primarily where GAN exists. GAN was and still is a B2B SaaS model. Coolbet is simply allowing them to make inroads into other international markets when/if they go into those. Part of GAN’s due diligence in buying Coolbet was getting feedback from clients saying “we like this technology” and that if you bring it over here we would be interested in implementing this into our sports-book technology. GAN will essentially take the technology and build it out into the US market.
GAN’s Competitive Moat
Another concern is whether GAN has any competitive advantage or whether the business is an easy business to replicate and doesn’t deserve a high market multiple. For example, when Barstool sports ended up not going with GAN to do the backend for their sports-book, many investors became concerned. One could argue that much of the recent drop in the stock price is due to investors fleeing after this news. However, GAN brands itself as a premium product and continues to win business. I believe (and the market tends to agree) that their technology offers more value and can be competitive at a higher price point. That doesn’t mean some companies won’t use another tech at a lower price point. GAN is a premium product and the Churchill example is a perfect example of this.
With the Churchill example, originally GAN had reputational risk due to its small size and AIM traded stock. This has since changed and has been a catalyst in helping them with winning clients such as Churchull and Wynn. It seems that Churchill took the position that they liked GAN but due to the fact that GAN only had 60 employees and traded on the AIM exchange, they weren’t sure that GAN was big enough to handle them so they went with SB Tech. SB Tech was later bought out by Draft Kings. To this day, there is no mobile functionality where most of the bets are taking place and are now being held up by ransomware. Due to this, they damaged their brand.
First off, to say you don’t have mobile functionality is literally an industry joke. What Churchill was not aware of was that any company can make a bunch of promises. European operators have a terrible track record of coming over to the United States, getting approval from the regulators, understanding business ethos, and deploying at scale and quickly, and then operating in a consistent way where the client can get a good yield on their marketing spend. What GAN has done, and what gives them a significant competitive advantage in the marketplace is that they have proven more than any other operator that they can work with a client, launch them on time, be optimized for a US regulatory environment, and fulfill on their agreements. SB tech, for example, never got a 1% market share after being promised success in these areas. In this industry, having a track record of successful implementation and delivering on promises means a lot at this point. This is why GAN will continue to grow their business and get more clients at a premium price point.
Barstool Sports
So the question you might be asking is if GAN is so wonderful, then why did Barstool not go with GAN? It’s simple. If you look at the landscape, there’s GAN and Scientific Games. There have been a number of partnerships where a European operator gets in bed with major a major US brand. There are large cash incentives to do so. To date, these partnerships have gone very poorly. Although GAN won the sim gaming business for Penn, the RMiG business was won by a small operator out of Malta called White Hat Gaming. Part of the process for an RFP was a contractual obligation to sell the source code outright which was a nonstarter for most of the “usual suspects” in the United States. White Hat, however, did agree to those terms. It will be interesting to see how it plays out. So far, in my opinion, the initial push has gone quite well. How it scales remains to be seen. As noted, the track records of European providers have been awful.
Conclusion
Overall, there is nothing wrong with the business model and things are going according to plan. Long-term the internal company estimates are still exactly the same, a 30% - 40% EBITDA margin at scale. I believe the company can hit $100m in revenue by 2023 and that at scale, GAN should be generating somewhere between $350m - $500m in revenue somewhere between 2025 and 2030 depending on industry growth.
Basically, buying GAN stock comes down to whether you believe in the business model. If the model doesn’t work, the stock is clearly overvalued. If the model works and they get to scale somewhere between 2025 and 2030 — at a 15-20x EBITDA multiple you’re looking at returns at low double digits all the way up to 50% annualized. There’s a huge range of outcomes here. However, if the business model works, there are many ways to win here, and win big.
Of course, due your own due diligence. For full disclosure, I am still long GAN for both myself and my clients at my company.
