Points International

Disclaimer: The information provided in this post is not to be considered as any form of investment advice. I might buy or sell shares in any companies discussed in the post without notifying readers of the blog. I currently own shares in Points International.

My latest position is in Points International, a Canadian company providing e-commerce and technology solutions to the loyalty industry headquartered in Toronto, trading both on the Toronto Stock Exchange (ticker PTS) and on the NASDAQ stock exchange in the US (ticker PCOM). Over 90% of the daily trading volume happens in the US. Market cap is around 200MUSD and the annual share turnover is roughly 80%. It is a small/micro-cap company that is fairly illiquid, and thus might have potential to be overlooked by the overall market.

BUSINESS

It is not entirely straightforward to figure out exactly what it is Points does exactly. Citing the companies filings, they are the “..global leader in providing loyalty e-commerce and technology solutions to the loyalty industry, connecting loyalty programs, 3rd party brands and end consumers across a global transaction platform.” Points do not run their own loyalty programs, and they do not provide the technology to operate such a program. Instead, they have build a “Loyalty Commerce Platform” (LCP) that loyalty programs and third parties can use for transaction capabilities, program integration, analytics, reporting, security and fraud detection. The products and services offered by Points are designed to increase loyalty programs revenue and profits by selling loyalty program currency or related services to end consumers or third parties, drive efficient cost management by offering “non-core redemptions” and to enhance loyalty program member engagement. In short, Points partner up with loyalty programs and help them make more money through the use of their platform. Points have direct integrations with over 60 loyalty programs, with the majority belonging to the airline or hospitality space. The total number of loyalty program member accounts in the network of loyalty programs integrated with Points is over 1 billion. The loyalty industry as a whole is growing rapidly with the number of annual memberships up 15% a year (according to Points investors presentation). 60% of points/miles acquired in a year is estimated to be bought by 3rd parties such as Points. Below is a snippet from the annual report showing some of the major loyalty partners.

The company operates three different business segments. The, by far, biggest contributor of revenue (and pretty much entire contributor to profits) is the “Loyalty Currency Retailing” (LCR) segment. This segment consists of products and services to buy loyalty program currency for personal use or to give away as a gift, purchase status points to reach a tier status, transfer points to another member etc. In this segment, Points has 30 loyalty program partners that use at least one of the solutions within this segment, all within airline or hospitality. In this segment, Points primarily compete with the internal technology departments of the loyalty programs, but claims to have been successful in acquiring customers that previously provided the same services in house. Two thirds of the revenue within this segment comes from deals where Points technically acts as a “principal”, selling loyalty points at a retail price that they purchase at wholesale price from their partners. However, an important distinction needs to be made. Points do not load up on loyalty program points and keep them on the balance sheet. On the contrary, using the LCP, Points can buy the loyalty points in real time from their partner as they sell them to the end consumer. Importantly, Points get paid by the end consumer immediately and will have the money in their account within a few days, whereas the payments to loyalty partners are done on a monthly basis, usually 30 days after the end of the month in which a transaction was made. This leads to Points having “float”, usually with 1.5-2 months of revenue sitting on the balance sheet in cash at most times in payables to loyalty partners. Since Points seem to have very stable revenue streams from this segment, this float is essentially a free loan from the loyalty partners that pretty much funds Points operations and has enabled Points to grow without requiring any additional capital. Growth is essentially free for Points thanks to this.

The revenue where Points acts as a “principal” is booked on a gross basis. If someone buys 10 000 loyalty points through Points for 300$,  but Points then passes 250$ along to the loyalty partner, the entire purchase amount of 300$ is booked as revenue, and 50$ becomes the gross profit on the transaction. For most other revenue within the business, what is booked as revenue is actually the commission that Points charges on transactions where they act as an agent or platform provider, on a net basis. Because of this, revenue isn´t a great measure to use when evaluating the company as a large chunk of that revenue is being passed along to loyalty partners and doesn´t belong to Points, though it is still crucial in generating the float that funds the operation. Gross profit is a better number as it is more indicative of the money earned by Points that will actually stay with the company permanently, it is essentially the “real” revenue for the business. Because of the way revenue is booked in this segment, the gross margin is quite low at around 12%.

In 2018, almost 98% of total revenue was generated in the LCR segment, and over 100% of operating profits. In the LCR segment, Points actually guarantees annual revenue to some of their major partners. For instance, in 2020, Points has guarantees to various partners to sell at least 150 MUSD worth of loyalty points in total. If they do not manage to do this, they will have to buy the loyalty points themselves from the partners, creating a potential liquidity risk. Revenue in this segment is likely to end up somewhere between 350-400 MUSD in 2019, so the total liability isn´t that great in comparison to total revenue. These liabilities are very likely to be spread out over several partners, so even though Points revenue in total is likely to stay way above the guaranteed 150 MUSD, they may still miss the guaranteed revenue targets for a particular partner and be forced to buy loyalty points from this particular partner by the end of the year. As far as I can tell from the annual reports, this has only happened once in the last ten years or so.

The other two segments are “Platform partners” and “Points Travel”. In the “Platform partners” segment, Points allows loyalty programs, merchants and other consumer service applications to use the LCP to distribute loyalty currency and loyalty commerce through multiple channels. Several third party applications are enabled by the LCP. They range from redemption based services that offer cost management solutions to loyalty partners, to earn-based services where merchants can partner with Points to buy loyalty currency to offer to their customers as awards. The revenue in this segment comes from commission fees, a set fee per transaction, revenue sharing or monthly recurring revenues, and gross margins are generally very high. In 2018 the segment generated revenues of just under 8 MUSD and a gross profit of 7.4 MUSD, with an operating result around 3.8 MUSD. I expect similar numbers in 2019.

The “Points Travel” segment is a white-label online travel service specifically designed for loyalty programs. Here, Points partner up with loyalty programs to enable members of the loyalty program to easily earn and redeem loyalty points by making hotel or car reservations online. By year end 2018, Points had 12 partners using at least one of their services in this segment generating a total of 1.8 MUSD in revenue (mostly from commissions) and an operating loss of 3.8 MUSD. The competition is fierce within this segment, as major online travel agencies are among the competitors. The development of this segment has been slower than anticipated by management, but according to a recent earnings call, the economics for the partners are great in this segment, as well as the unit economics for Points.

The contribution of “Platform partners” and “Points Travel” to the bottom line is very close to 0 for the time being, but even if they aren´t adding profits on their own, they might still be very useful. As mentioned, Points have a total of 60 loyalty partners, and offers a wide range of products and services within each segment. Whenever a new partner is signed, they usually just sign up for one or a few of the products that Points offers. Points then works on up-selling and cross-selling additional products and services to partners over time. If I´m reading correctly between the lines, both these segments, and maybe “Points Travel” in particular, is a great way to establish a relationship with a new partner that can be expanded over time. According the investor presentation, the current “opportunity matrix” within existing partners is only 30% penetrated, leaving ample space to grow with existing partners as well as new ones.

In December 2018, Points signed a strategic partnership with Amadeus IT, a giant IT provider for the global travel and tourism industry. Amadeus offers pretty much everything you can image, including loyalty programs,  to airlines, airports, tour operators, insurers, ferry and cruise lines, travel agencies etc, and had revenues of almost 5 billion Euros in 2018. Citing the press release, the partnership “… will enable airlines to integrate Points’ solutions within existing Amadeus Loyalty Management and Awards solutions at the click of a button.” Amadeus have relationships with over 150  airlines across the globe, so if things turn out well, this could be a major driver of growth in the future, as Points look leverage Amadeus’ global presence and co-develop new services with them.     

FINANCIALS

The financial results of the business has been pretty spectacular in the past. Revenue has gone up every single year since at least 2008 (this is the earliest year I have gathered data on), indicating that more and more loyalty points are being sold through the company every year. Adjusting for a one-time non-cash write down on a JV investment in China, gross profit has increased every year as well. EBITDA increased every year up until 2016 and 2017 when it decreased for two years straight, before increasing rapidly to record levels in 2018 with the company on track for another record year in 2019.

Looking back over the five year period of 2013-2018, gross profit has compounded at an annual growth rate of 10%, EBITDA at 14% and the companies favourite measure, Adjusted EBITDA at 16%. However, the company has bought back shares consistently since 2014, generating even greater growth rates per share with gross profit per share compounding at 21% annually for the period, EBITDA at 27% per share, and Adjusted EBITDA at 33%. If we look the period 2015-2018 instead, growth has been quite a bit slower with gross profit per share compounding at 11% annually, EBITDA 11% and Adjusted EBITDA 17%.

The business is generating a lot cash. In fact, it is one of the rare type of businesses that consistently generate more cash flow than earnings. Average after tax profit in 2013-2018 was 4.9MUSD. Average free cash flow (defined as operating free cash flow – all cash expenses for acquisitions of property & equipment and additions to intangible assets, as well as cash costs for the Restricted Share Unit-program) over the same period was 11.9MUSD. For the period 2015-2018, average after tax profit was  4.9 MUSD, and average FCF 11 MUSD. For the period 2013-2018, total after tax profits were 28.1 MUSD, total FCF was almost 60 MUSD.

The company achieved all of the above without carrying any interest bearing debt at all during any of the years I have data on, and they still don´t.

2019 is on track to become a record year in terms of both gross profit and adjusted EBITDA. Management has guided for gross profit to be between 58.5-64.5 MUSD which would mean 9-20% growth YoY, and adjusted EBITDA between 20.5-23.5 MUSD which would equal somewhere between 10-26% growth YoY. Additionally, during the year, the company announced long term goals of generating gross profits in the high-90 million dollar range by 2022, as well as more than doubling adjusted EBITDA to the mid 40-million dollar range. This is the first time that management has gone public with long term goals as far as I can tell.

MOAT

The financial performance of the company certainly seems to indicate some sort of moat. On a recent earnings call, one of the few analysts covering the call asked whether the company experienced any change in the competitive client regarding the LCR segment. Management reiterated that they did not, and that they mainly compete with the internal technology departments of their loyalty partners. For some reason, Points has managed to increase profits pretty much for 10 years straight, without seeing their returns competed away. Why is this?

If we consider the situation from an airlines point of view, they want to sell as many points as possible as rewarding and selling points has turned out to be a very lucrative business. Loyalty programs increases customer retention rates, which leads to a higher Lifetime Value (LTV) per customer. The more you can engage your customer, the higher the LTV over time. This has triggered loyalty programs to come up with new ways to generate revenue, for instance by offering members the opportunity to rent cars or make hotel reservations using their loyalty currency. So airlines wants to drive revenue in this segment, and they are faced with the choice of either building a product in-house and do all of the marketing themselves, or they could hire Points to do it for them. If they choose to build their own products to try and drive revenue, they are going to have to employ both capital and man hours to do so, with no guaranteed return on the investment. If they instead hire Points, they have no costs associated with this, and are instead guaranteed a steady stream of revenue as well as access to Points growing network of loyalty partners in other industries, primarily in hospitality.

Additionally, Points have access to transactional data and anonymized customer data from many different loyalty programs in the same industry. Without knowing for sure, I think it is reasonable to assume that this is an advantage when it comes to marketing as they should have more information to use to optimize any marketing efforts and generate a higher return on the investment than a single airline would on its own.

There´s also a scale component. An airline would have to spend X dollars to develop the products on their and market them. Points probably have to spend a similar amount, though I´m assuming the number is bigger for Points due to the fact that their customers might have different needs and requests, but they can then derive revenue from many different clients using the same technology, whereas the airlines would only derive revenue within their own loyalty program.

Lastly, there´s probably some network effects going on here. Points have established relationships with many partners in different sectors that an airline (or any other loyalty program) will get access to by partnering up with Points, meaning they don´t have to spend any time or money developing those relationships themselves. Developing new ways to earn or redeem loyalty currency is crucial to drive customer engagement, and getting access to Points network of merchants is a quick way of doing this. As an example of how this can work in practice, during the year Points signed a deal with Home Chef, one of the largest meal kit delivery companies in the U.S, that enables United Airlines loyalty program members to earn frequent flyer miles when they sign up for Home Chef. This way, Points benefits from any additional engagement from United’s loyalty members by selling more loyalty currency, as well as a commission from Home Chef whenever someone signs up using United miles.

Another example is the possibility for members of the Hilton Honors loyalty program to use their loyalty currency to pay for their Lyft rides, by leveraging Points LCP platform.

I am not sure quite how wide Points moat is. In theory, airlines and other loyalty programs might certainly in-house this type of products, but since Points generate more revenue and sign up more partners year after year, the trend seems to be the exact opposite. In theory, companies such as Amadeus with a massive network of partners in the airline industry and lots of resources that already run loyalty programs could easily build their own product to compete, but they didn´t. Instead they signed a partnership with Points. Other marketing businesses or transaction platforms could also be a potential threat, but the type of relationships Points has would probably take some time and resources to replicate, and it might not be worth it to an outside competitor as it is a very niche business. Really, it´s more like a part of the business of running a loyalty program, that Points has specialized in running on behalf of loyalty programs. Overall, it´s probably not the widest moat I´ve ever seen, but there are no signs at all that it is eroding at the moment.

MANAGEMENT & CAPITAL ALLOCATION

Management has generally been with the company for a long time. President Christopher Barnard and CEO Robert MacLean are both co-founders and have been in charge throughout the very successful history of the company, or at least as far back as I have gone in my research. While it is very nice to see continuity and a founder-led company by seemingly competent people, this makes the fact that insider ownership is quite low all the more puzzling. Barnard and MacLean owns just over 200 000 shares each, or approximately 1.5% each of the shares outstanding and are still the biggest shareholders of the board or management.

Since 2017, executives no longer gets cash bonuses. Instead, their entire bonus is paid out in stocks in a “Restricted Share Unit”-program.  Rather than diluting shareholders, the company has decided to appoint a trustee to administer the program and purchase shares from the open market that are then passed on to management as bonuses. This creates a very real and recurring cash expense but keeps the number of outstanding shares lower, and should increase insider ownership over time. If you look at recent insider transactions, you see a lot of selling and not much buying. This probably is partly due to the fact that no one is given cash bonuses, so if you want any cash other than the base salary as an executive, you need to sell shares. With that said, if the company truly is reaching an inflection as management has said, it would be very comforting to see them load up on stock and put their money where their mouth is, or at least not sell any of the stock that is handed to them in bonuses.

Management is not exactly conservative in their communication. The adjusted EBITDA used definitely include some things I consider real expenses that impacts cash flow, particularly equity-settled share-based payments, and the language in general is very bullish. The company gives guidance for each fiscal year, and the measures used in guidance have varied a little from year to year in the past, though they have remained the same since 2017 at this point (gross profit and adjusted EBITDA). The definition for adjusted EBITDA was changed in 2016 in a way that, surprise surprise, rendered a larger number, as the equity-settled share-based payments has been added back to net income (along with all the usual EBITDA adjustments) since. Since 2013, they have had to revise their guidance of adjusted EBITDA downwards once (in 2016) and up twice (in 2018 and 2019). The combination of very bullish commentary alongside low insider ownership is a bit weird to me, if they truly believed in what they are communicating, why wouldn´t the executives (especially the co-founders) want to own more stock?

With regards to capital allocation, the company has never paid a dividend, and they don´t intend to in the near future. Instead, they have been aggressively buying back stock through a “Normal-Course Issuer Bid”, a Canadian term for a company repurchasing its own stock from the public in order to cancel it. The NCIB needs to be approved by the TSX yearly, and the company has the authority to buy back up to 5% of the shares outstanding in 2019, and did so in 2018 as well. Since 2014, shares outstanding has gone from 15.4 million to 13.5 million, a total reduction of 12%, or -2.6% compounded annually, with the pace of the buybacks picking up in recent years. The buybacks are perhaps a bit too automatic for my liking, as I like to see management being very opportunistic in their allocation of capital, but given how cheap the stocks been historically, I think buybacks have been a fine option. At the very least, it is perfectly in line with management being bullish on the future of the company.

The company has made two acquisitions in the last five years, the most notable one being the acquisition of Accruity Inc, the operator of the PointsHound hotel booking service in 2014 that seems to have cost 16MUSD judging by the cash flow statement. The services in the “Points Travel” segment has been built upon the PointsHound technology, and with the segment still showing negative earnings, this investment isn´t looking to hot today.

Overall, any concerns I might have regarding management is more of a gut feel regarding low ownership and non-conservative commentary, rather than anything that is evident in the quality of the business, that by all measures, seems very high.

GROWTH

Compounded annual growth rates are lower across the board if you look at the 2015-2018 period vs the 2013-2018 period, and even lower still compared to the 2008-2018 period. So growth has slowed down, but it seems like it could be picking up again in 2019, and for managements long term goals to be met, it has to pick up quite a bit. The company has identified three core growth drivers going forward:

  • Sign new partnerships
  • Up/Cross-Sell Existing Partnerships
  • Drive growth in existing partnerships

These are all self-explanatory. Furthermore, the company has also identified three growth accelerators:

  • Geographic expansion
  • New verticals (financial services and retail mentioned in investor presentation)
  • Corporate development (by acquisitions and strategic partnerships).

The majority of revenue is coming from North America and Europe today. Here, growth is expected to mainly come from cross-selling existing partners and moving into new verticals, with financial services (the company has existing partnerships with Chase & Citibank) and retail being the primary targets. According to the investor presentation, the company has a growing footprint in the Middle East and are targeting large carriers and financial services in that area. The same is true for South America and the APAC region, and in H2 2019 Points has opened a new office in Singapore to better serve this region.

Regarding acquisitions, the investor presentation states that the historical approach has been opportunistic, but that the company is moving to a more proactive approach given balance sheet strength. Personally, I´m not sure I´d like to see any acquisitions at all given the history with PointsHound and how well the core business is doing.

The strategic partnership with Amadeus could present a great opportunity for growth as it should enable Points to establish relationships with new potential partners that are currently customers of Amadeus. During 2019 Points have added a couple of new partners through the partnership with Amadeus, but the extent to which this had affected overall gross profit is unclear.  

VALUE

So we have a seemingly very predictable, profitable business carrying no debt that throws off a lot of cash. Market cap as I´m writing this is 199MUSD and the company had 54MUSD in cash at the end of Q3, with another 6MUSD expected to be paid back from the tax authorities in Q4, rendering an EV of 139MUSD. If we expect that adjusted EBITDA for 2019 will be in the middle of guidance at 21.5MUSD, and that my definition of EBITDA will be 16.5MUSD (subtracting equity-settled share based payments) we get an EV/EBITDA of 8.4. The company has actually generated more cash flow than EBITDA historically, but that does not seem to be the case in 2019. Using my definition of FCF and looking at the average for 2015-2018 to even the lumpiness of free cash flow out a bit, we get 11MUSD in FCF and an EV/FCF multiple of 12.6 or a FCF yield of 8%.

Using enterprise value might be a bit optimistic, as an outside buyer of the company wouldn´t be able to just pocket the cash that is sitting on the balance sheet as it is going to be paid to partners. If we look at P/FCF instead (adjusting for the 6MUSD tax rebate), we get a multiple of 17.5 and a 6% FCF yield. This is very conservative measure as I exclude the expected record year of 2019 in the calculation of free cash flow, and give no value to the cash on hand. To exceed the average market return over time, we need growth to be over 4% annually. Given that the company has grown gross profit with a CAGR of 10% over the last five years, that the loyalty industry is growing at a double digit rate as a whole, and that management has guided for faster growth in the years to come, a long-term growth rate of over 4% seems very doable.

The long term financial goals are gross profit in the high-90 MUSD range by the end of 2022, accompanied by an adjusted EBITDA in the mid-40 MUSD range. To achieve this, gross profit needs to grow at a CAGR of around 15%, and adjusted EBITDA needs to grow at 25-30% annually. So the gross profit needs to grow faster than it has been for the last couple of years (10% CAGR over the last five years), adjusted EBITDA needs to grow even faster (16% CAGR over the last five years), indicating that management expects considerable operating leverage working in a positive direction going forward. Indeed, the company targets an “effective margin”, defined as adjusted EBITDA / Gross profit of 45% in 2022. The 3 and 5-year average “effective margin” are both 30%. These are, in my opinion, quite aggressive targets, and I would not like to depend on them for an investment to be profitable, but let´s pretend for a second that management is spot on and that we end 2022 with an adjusted EBITDA of 45 MUSD. EBITDA would be more like 40 MUSD, and if we slap a generic 8 times EBITDA multiple on that (if the company would reach these ambitious goals the real multiple will likely be quite a bit higher, but let’s be really conservative), we get a value of 320 MUSD (and remember, FCF is likely to be at least the same as EBITDA or higher). Comparing this to today’s 199M market cap we get a CAGR of 17% in capital gain. If we assume that the company keeps reducing the share count with 3% a year, you´re looking at an annual return of 20%, not counting any cash that has piled up on the balance sheet or potential dividend. If management meets the long term financial goals, the stock is very cheap. To make a market beating return of 10-12% a year, the company can miss the long term financial goals by some margin provided an average market multiple to EBITDA or cash flows.

I can see how this is not a particularly exciting stock to own for a lot of people. The business is pretty boring and niche, there´s no catalyst, and it is not incredibly cheap. I just think it is a very nice and solid business that is being overlooked and undervalued due to it being small and fairly illiquid.

RISKS

With a large exposure to travelling in general and airlines in particular, a downturn in the economy would likely be negative for the business, and any event that has an adverse effect on how much people fly would likely be very negative as well. Carbon emissions are certainly a real thing, and if the environmental movement will gain traction worldwide and make people fly less, that could pose a long term risk. This has certainly happened to some extent in Sweden with “flight shame” actually becoming a thing in 2019, and was probably one of the reasons that the number of passengers who flew through Swedish airports decreased 4% YoY. A terrorist attack including planes is also very likely to make people fly less, at least for some time.

Customer concentration is also a risk. The top three partners make up 70% of revenue, but as discussed earlier, revenue is a bit misleading due to how it is booked. Management does not disclose how much these three partners contribute to gross profit, but 80% of gross profit comes from 14 different partners, at least indicating that gross profit is a bit more spread out over several partners. Still, it would be nice to get a number on how much the three largest partners contribute to gross profit to further evaluate the customer concentration risk.

I can´t help but feel that management is a bit of a risk as well. To be clear, there really isn´t anything in the way the business has been run to cause any concern at all as far as I can tell, but the combination of a very bullish outlook for the company, combined with very low insider ownership makes me cringe a little. It is very possible that management is overly optimistic with their long term financial goals, we have no history of them making these type of long term forecasts to compare with, so I really do not want to rely on these goals to make a market beating return on my investment. This is why I´m being very conservative in my valuations and future growth prospects of the business. I am also going to be weary of any acquisitions going forward. The existence of the float that funds the company is crucial to my investment, and any move on managements part that would eliminate the float would be an immediate sell decision for me.

Then there is the very significant risk of me misjudging things. I might be underestimating the level of competition in the LCR segment going forward. The lack of historical competition is in no way a guarantee of low competition in the future, neither is company commentary on the subject. I might also overestimate how predictable and safe the business really is. The development since 2008 has been outstanding, but so has the economy as a whole, and the company has certainly been riding a secular tail wind with the overall loyalty market growing faster than the economy. There really is no telling how the company will do in a shakier general economic environment.

FINAL NOTES

I am very grateful for the feedback I received on my post mortem-post on Aspire Global. Thank you all who contributed! I welcome any critique or feedback on this post as well, both regarding the way it is written, but more importantly, the actual analysis of the business and its valuation.

Annons

Post-mortem: Aspire Global

Disclaimer: The information provided in this post is not to be considered as any form of investment advice. I might buy or sell shares in any companies discussed in the post without notifying readers of the blog. I currently do not own shares in Aspire Global.

I recently sold all my shares in Aspire Global. The company is active in the ”iGaming”-industry, or to put it more bluntly, online gambling-industry. It was founded in 2005 in Israel, but has been listed on the First North Growth Market in Stockholm since July 2017, while simultaneously being headquartered in Malta.

Aspires revenue is split into two segments, B2B and B2C. In the B2B segment, the company provides a complete platform for iGaming operators, taking care of every aspect of running the daily business except for driving traffic, which is left to the operator. If you wanted to start an online gambling site today providing casino, sports betting and bingo, reaching out to Aspire Global and slapping your brand on their platform is probably one of the easiest ways to get started. Most of the revenues in this segment comes from revenue sharing with the operators. In the B2C segment they have their own brand, Karamba, directly facing consumers.

As was the case with most stocks I bought during the time around which I bought Aspire, I did not do enough research on the company, as I just didn´t spend that much time managing the portfolio. The thesis was quite simple though: the entire gambling sector in Sweden was trading at low multiples due to the new legislation that was put into effect at the start of 2019 that requires licenses for all operators and put serious limitations on what kind of advertising and bonus schemes the sites can run. Aspire, with very limited exposure to the Swedish market, was the cheapest of them all (or at least the ones I considered), despite growing revenues at a very high pace (45% YoY Growth in revenues 2017 -> 2018). I fet like the gambling sector as a whole, and Aspire in particular, was just temporarily out of favor and way to cheap.

Over the course of 2019, the stock has performed very badly dropping around 40% to a point where it now trades somewhere between 6-7 times earnings, while total revenue is probably going to have grown somewhere along the lines of 30% in 2019. On the face of it, this seems incredibly cheap (and it might very well be), so why the heck am I selling?

There are several reasons. One is that the business doesn´t seem to be scaling well. While I expect the company to report annual revenue increase of around 30% YoY in their upcoming annual report, EBIT and EBITDA numbers for 2019 will probably be up more like 10%. Margins are down across the board. If we zoom in on the B2B segment, on the face of it, things seems to be going fine with revenues likely to be up something like 45% YoY, and EBITDA up around 35% YoY. Pretty massive numbers, but also a pretty big divide between increases in revenue and EBITDA. This confuses me quite a little, as I would expect margins to actually increase the more this segment grows. Regardless of whether the growth comes from old partners increasing revenue or signing new ones (they did sign quite a few over the last couple of years), this should improve margins as a lot of the costs (overhead, technology etc) should remain fairly flat. If we combine this with the fact that ”Distrubtion expenses”, the post on the income statement that contains royalties paid to operators, has gone from 56% of revenue in 2015, to 63% in 2018, to 68% in Q1-Q3 2019, it seems like Aspire is gaining new business by offering better terms to potential new operators and keeping a lower share of revenus themselves, rather than by providing a superior product. This has also been implied in the comments made by the company, where they claim that they are ”offering operators incentives to grow”, which again, seems weird to me. Operators should have all the reason in the world grow, regardless of their cut on the revenue.

Aspires own B2C-segment has done poorly in 2019. Revenues are likely going to be up by a few percent, whereas EBITDA is likely to be around 35% lower in 2019 than 2018 by my estimates. According to the company this is due to higher marketing expenditure and temporarily low activity in the UK and Netherlands. Maybe this is just a temporary blip, but I can´t seem to fight this feeling that this might happen to several of Aspires clients over time.

To expand on that, Aspire mainly caters to smaller, less known operators. Compared to most other operators, Aspire is a little bit different in that they have managed to have a higher Hold% over time, meaning that for every dollar of net gaming revenue, they have paid less back to the players and kept more to themselves and their partners. They also have a lower retention rate than the sector average. As markets gets regulated and the ability to advertise freely and use bonus schemes to retain players might be compromised, it seems likely to me that brand awareness and customer satisfaction will be of increasing importance. Aspire and their operators generally scores poorly on both. Over the next couple of years, I think it´s likely that we´ll see considerable consolidation in the sector, where large operators gets even bigger and the smaller ones get even smaller, to a point where they might even disappear. Since none of Aspires operators are big ”premium” operators, I think this development is likely to be negative for Aspire. Even if an operator using Aspire gets acquired by a larger operator, it is likely that Aspire will loose this business.

Obviously, if Aspire would keep growing at the current rate and it´s earnings would follow along, it is a screaming buy at this valuation. However, I do have some concerns regarding the sustainability of their growth. From 2015-2017, the company didn´t grow nearly as fast. Revenus grew 1% in 2016 and 8% in 2017, before taking off in 2018 growing 45%, and by my estimates will grow close to 30% in 2019. This is probably very closely tied to the fact that during 2017, the company signed 15 new partnerships and launched 22 new brands (the same partner might have several brands), and followed this up by signing another 8 partners and launching 13 brands in 2018. In 2019, the company has added a net of 4 brands, making the total amount of brands somewhere above 65 spread across 45 partners. Since there is usually a lag from the time of signing a new partnership to recognizing any significant revenue, the deals struck in 2017-2018 seems to have been the major growth driver in revenue for 2018-2019, and the addition of new partnerships seems to have slowed down quite a bit in 2019. As the market is only so big, and there are only so many operators, it seems hard for Aspire to grow nearly as fast in the same markets going forward by adding new operators. Instead, to grow in these markets, they are going to have to grow either by increasing revenue from proprietary and partner brands, or by increasing margins, and as I expanded on earlier, I am not particularly optimistic about either of those things happening, though I might very well be wrong. On the flip side, they are looking to enter markets outside the EU, have signed a deal with 888 to enter the U.S. in New Jersey, and recently acquired gaming aggregator Pariplay in what looks to be a promising deal that should increase revenue with 5-10% in 2020 at higer margins than the core business. It´s not like the company is going to stop growing its revenue completely, but I struggle to make any sort of prediction with a reasonable degree of confidence as to the pace of future growth, and the margins attached to it. It should also be noted that at 7 times earnings growth might not be necessary to justify the price, but the combination of slower growth and potentially lower margins in the future isn´t very appealing.

Finally, the company does seem to end up in disputes with authorities more often than the competitors I follow. During 2019 they were fined twice by the Swedish gambling regulator, the first one relating to a failure to connect with the self-exclusion database Spelpaus, and the second one for breaking bonus rules. They have also been sued by the Swedish Consumer Agency who claims that Aspire Globals proprietary brand Karamba are violating the gambling act when it comes to moderation and use of bonuses and free spins as a marketing tool (Aspire is disputing this claim). To round of the year, the company announced on New Year´s Eve that it had reached a settlement with the Isreali Tax Authority that will have Aspire pay 13.7M€ over tax issues for the fiscal years 2008-2018, effectively wiping out the entire profit for the 2019 fiscal year. The peculiar timing of this announcement does nothing to enhance my faith in company management. As a side note, the cash raised from a bond issuance in 2018 that has inexplicably been sitting on the balance sheet for well over a year now, will now be put to use paying of the settlement.

SUMMARY

To summarize, the main reasons I sold out of Aspire Global are:

  • The business model doesn´t seem to be scaling the way I expected it to.
  • I don´t believe management commentary on why this is.
  • I am uncertain of the long-term durability of the business model when markets gets regulated and stronger brands likely will be favored. This makes it hard for me to predict the future with any kind of confidence.
  • Growth in revenue will likely slow, and margins are already declining so earnings growth might taper off substantially.
  • Lawsuits and disputes with tax authorities combined with a very weird timing of the latest announcement has led me to question the cander of management.

To be clear, it is the combination of the reasons listed above that made me sell out. Had I only held one or two of these concerns, I would have likely kept the stock at its current valuation. There are certainly things I like about Aspire. It´s a consistently profitable capital light business that used to have net cash (before the tax settlement), and by owning Aspire you get some diversification on the operator level compared to owning a single operator. I am trying to dodge a value trap here, but I have to admit that I´m not certain at all that the stock isn´t severely undervalued still, but I just don´t feel confident enough about the company quality and future outlook to bet on it at the moment. I will continue to monitor the company, and should any of my above concerns be settled, I might find myself owning it once again, as I am very attracted to the valuation (normalized for the one-time tax expense).

Lastly, I would like to touch on potential biases affecting my decision to sell. The stock has been doing incredibly poor since I bought it, so there is a risk that I might be overly negative about the future of the company as a consequence of this, rather than relying on what the financials looks like today. It is also possible that I am reading way too much into comments made by management and the timing of the announcement regarding the tax dispute. Biases are very hard to protect against, so it´s very hard for me judge whether I´m biased in my assumptions here or not (ask me again in a year and I will probably have a better idea of whether I was biased in this decision or not), but I did not sell in panic or anything like that. I have pondered the case for a long time, and spoken to several of my investing friends that are very knowledgeable in this sector, and they largely agree with my conclusion. I was leaning towards sell but was taking the holidays to decide, and then the weird announcement regarding the tax dispute happened, which was just enough to push me over the edge.

As always, any feedback on my reasoning and analysis is greatly appreciated!