Evolution: 4Q24 Business Update
Smoke versus Signal
Welcome to Speedwell Memos. Our main website is SpeedwellResearch.com.
This is a business update on a company we have previously written an in-depth research report on. To read the full research report become a member today. Members get access all of our research reports and all prior updates (most of which are paywalled). You can see a list of all the companies we have written on here.
Before we get to the update, we have a very exciting announcement!
Evolution's Todd Haushalter will be on The Synopsis Podcast!
We are very excited to announce that Todd Haushalter will be featured on our podcast next week! We are recording the episode Friday, so feel free to comment any questions you may have or email us at info@speedwellresearch.com.
Follow The Synopsis below if you haven't already.
(Speedwell Members, please click here for the Member's version of the post)
4Q24 Overview.
Evolution reported a decent 4Q24, but signaled that Asia cyber-attacks, increased investments, and to a lesser extent, the need to ring-fence certain regulated markets to appease regulators, will weigh on near-term profitability. Longer-term we do not believe any of this is materially thesis changing to Evolution.
We will comment a bit about the quarter below before moving into a general business update and valuation.
4Q24 Earnings.
Total revenues were +12% y/y, which is down about 250bps sequentially from last quarter.
In constant currency, revenue growth was +16% y/y compared to +19% y/y in 3Q.
Live growth was +13% y/y, down sequentially from last quarter's +16% growth.
Their RNG growth rate also compressed to +7% y/y, from +9%, however last quarter's comp was much softer. Q/q RNG grew +3% versus +2% q/q in 3Q, which is actually an acceleration of growth.
Operating margin is essentially flat q/q at 61%, but is down almost 3.5 points y/y.
Y/y margin compression offset solid revenue growth, resulting in y/y operating profit growth of just +8%.
They have guided 2025 EBITDA margins to 66-68%, which with about 7% of D&A translates to 59-61% EBIT margins. This suggest a headwind to operating profit growth could subsist into the next year.
If you recall from our report on margins:
We think that future growth is possibly lower margin than in the past for two reasons: 1) more growth comes from Asia, which uses lower fee aggregators, and 2) new markets increasingly require local studios which limits their leverage (i.e., one studio serving a single state in the US). Offsetting this though is growth from their existing operators, which comes at a very high incremental margin. (i.e., the cost to service another bet on Crazy Time or Ultimate Blackjack is negligible). Additionally, they have positioned themselves well to dominate the U.S. market as new states legalize, which, even with new studio builds, likely maintain their high margins.
We still believe this is true and we could see margin expansion in several years as the studio build expenses for new markets start to enjoy more operating leverage. More on this below.
For fiscal 2024 they generated about €1.2bn in FCF, which represents ~96% free cash flow conversion. They expect capex to increase next year.
In terms of capital allocation, they increased the dividend from €2.65 to €2.80 and authorized a €500mn stock repurchase. This represents a return of capital of about ~90% of 2024 free cash flow.
Business Update.
While Evolution’s stock continues to be weighed down by regulatory fears and margin pressures, these are generally short to mid-term factors that will likely ameliorate.
Regulation.
As gambling is a contentious subject, and as Evolution is an internet-based provider of gambling games, they are often the focus of regulators and investigations. This is nothing new and has been going on essentially since their founding. Depending on the market and the regulator, there is a mix of prerogatives. Sometimes regulators really want to clamp down on the total amount of gambling activity. Other times they are more focused on making sure everything is going through legal channels and that they can collect their taxes.
Regulators also know that if they are too draconian with regulation, they can push legal gaming activity into illegal sites, which not only means they won’t collect taxes, but also could mean players get preyed on as these sites typically have no safeguards (like betting limits) and could cheat winners out of payouts. Additionally, these sites may not only be used to launder money, but may be run by crime syndicates, which could fuel other criminal activity. For these reasons, once a market decides to regulate, it is in their interest, as well as Evolutions, to make sure there isn't unnecessary friction or restrictions.
Evolution is starting to “ring-fence” local regulated markets, which basically means changing the access from their games from a "default yes” to a "default no”, with an approval required to access the game. They are only doing this where required, but this could be a headwind to the extent that illicit gaming operators were using Evolutions games.
Evolution always has to stick to the letter of the law, but more unscrupulous supplier could benefit as they purposefully allow a more porous security check procedure in order to capture illegal activity. Depending on the market, some games are forced to implement betting size limits or deposit limits, which could push players to play on illegal sites without these restrictions. While regulation may further entrench Evolution as a leading supplier among honest operators, it will mean unscrupulous operators will go to dodgier suppliers.
Currently though, Evolution noted that the ring-fenced measures taken in the UK are of limited impact and they would have commented if it was significant.
Margin.
The other big factor for Evolution is that their margins have been weighed down by 1) Asia cyber-attacks, which reduces revenues and requires more costly security measures, 2) a more expensive resource mix, including building out new studios, many of which will need to house their own local versions of the gameshows, and 3) regulatory required internet blocking. They note that the first two factors are by far the biggest headwinds.
EBIT margins have compressed 2 points since peaking at 63%. Their 2025 guidance places them at around 59-61% EBIT margins. However, after they fix the Asia cyberattack situation and lap the impacts of their internet blocking, they could return to margin expansion. As CEO Martin Carlesund noted on the call, “longer term there is a good opportunity for higher margins”.
They are building out new studios for new markets now that could take a few years to reach max capacity and thus will be a margin headwind in the short-term. Additionally, many new markets (specifically each U.S. State) requires them to rebuild each of their gameshows because they generally cannot take bets across states lines for a game (see our report for details). This drives up cost in the short-term, but longer-term it is capacity they will likely utilize anyway.
Zoom-Out.
If we zoom-out from these shorter-term factors, we still have a business with ~60% operating margins, generating ~€1.2bn in free cash flow, and growing double digits. While competition weighing on their take-rates was very top of mind a couple years ago, this fear seems to have dropped from investors conversations as Evolution continues to dominate the charts with the best games and rolls out far more new, popular games than any other supplier.
CEO Martin Carlesund notes that they are going to release 110 new games in 2025 and have the best product road map in their lifetime. Chief Product Officer Todd Haushalter has previously noted at past events (ICE and NEXT) that they are developing one of their largest games ever for release in 2025. RNG, which was not working a year ago, has since put up mid to high single digit growth.
New markets like Brazil and various U.S. states continue to legalize, which presents new growth opportunities. New partnerships, such as with FanDuels and Atlantic Lottery, show they are continuing to still win over new large operators.
Not only could they lap these three factors mentioned (Asia cyber attacks, more expensive resources, internet blocking), but they also will lap a doubling of their tax-rate this year.
Furthermore, they are focusing more on IP protection, which could result in competitors, many of which have largely succeeded with blatant rip offs, being pushed further away from Evolution.
With normalized 2024 earnings of €5.25 per share (backing out liability gain and applying a full 15% tax rate), Evolution is trading around 14.5x earnings, or right under 14x backing out ~€4 per share of net cash at todays price of €76.
While Evolution is certainly not without risks (see our research report), it is up to an investor to judge whether they believe the potential risks are worth the potential returns. To see exactly what the potential returns could be under various assumptions, Speedwell Members can enjoy our updated Reverse DCF.
We share our notes on the call below.
Call Notes.
Asia growth weighted down by cyber attacks
“We are still hampered by the cyber-attacks and fraud in the Asian region. We have launched several countermeasures that improve our situation, but growth is clearly affected in the quarter.”
Last quarter they said it would take a few quarters to fix the situation and they reiterated that timeline.
Year ended with 1,700 tables
Added 300 tables, but Georgia studio shrinkage meant a net add of only 100, +6% y/y.
Revenue running ahead of table additions helps support their claim that they are capacity constrained (however, higher value growing markets like the US skews this).
Georgia Strike
No longer an issue, but still not going to grow capacity there.
Shut down ~200 tables.
Regulation
Brazil regulated market opened in January
“In the past quarter, we have introduced additional technical measures that aim to more effectively ring-fence markets with the local regulation and ensure that our games are only available with locally licensed operators from markets where such license exists. “
Margin
EBITDA margin for full year 2025 in the range of 66% to 68%.
“However, until we see improvement in Asia, our expectation on margins is slightly lower than our own current level.”
“We have a very good scalability in our business model and longer term there is a good opportunity for higher margins.”
“For this year given our focus on expansion, slightly more expensive resource mix, current situation in Asia and a strengthened focus on regulated markets; we see an effect on margin.”
“For 2025, the expansion will come with a resource mix that's a bit more expensive than in recent years.”
Take-rate? “Also a question that's been with us for a long time. I mean it's always a challenge when a customer doubles and doubles again, you always want to have a better price. There's always negotiations. I wouldn't say that we have a general pressure on take rate.”
Capital Allocation
EUR 2.80 dividend.
$500mn stock buyback authorized.
Product
Halfway through their Product Leap Year that started in 2024.
“The core of Evolution is to create truly fantastic playing experiences, simply delivered great games. In the debate of many other topics, I'm sometimes afraid that it gets lost”.
Focusing more on defending IP rights.
“The past week we showed parts of our road map at ICE in Barcelona. It's the strongest road map we have ever created”.
Focusing in localization of games: “ One change for 2025 will be more games tailored to regional preferences”.
Studios
3 to 4 new studios in 2025
“ Major studio projects 2025 will include Brazil and Philippines and I expect to open 3 to 4 new studios during 2025.”
“We're also now using our large scale footprint to reshuffle our operation to reach an optimal setup at the same time as expanding. I expect to see those effects in the second half of 2025.”
Valuation.
Here we update our reverse DCF below and show what potential returns could be under various revenue growth and margin assumptions. Members Plus may download our excel to make their own assumptions.
The rest of the valuation section is paywalled.
If you are a Speedwell Member, please click here to read the rest of this post.
If you want to become a Speedwell Member, click below to get access to the rest of this post, our 74-page Evolution Research Report, and a large library of other reports!
As a reminder, we named our research firm Speedwell Research after the ship that helped ferry passengers to the Mayflower. The idea is that we want to help you take your journey, but ultimately you are on your own in the decisions you make. An investor must judge for themselves whether they believe these returns are worth the potential risks that could materialize with Evolution.
You can read our 3Q24 Evolution update here and on Evolution’s History here.
The Synopsis Podcast.
Follow our Podcast below. Evolution’s Todd Haushalter will be featured next week!
For those that are new to our podcast, we have four episode formats: “company” episodes that breakdown in-depth each business we write a report on, “dialogue” episodes that cover various business and investing topics, “article” episodes where we read our weekly memos, and “interviews”.
Become a Speedwell Research Member to receive our Evolution report and all of our other in-depth research reports, shorter exploratory reports, updates, and Plus members also receive Excels.
(Many members have gotten their memberships expensed. If you need us to talk with your compliance department to become an approved vendor, please reach out at info@speedwellresearch.com).
*At the time of this writing, one or more contributors to this report has a position in EVVTY. Furthermore, accounts one or more contributors advise on may also have a position in EVVTY. This may change without notice.