GMVHF - Entain: Long-Term Value And Short-Term Headwinds

2023-11-28 22:16:38 ET

Summary

• Entain's Q3 update showed weak revenue growth, but the negatives are already priced into the stock.
• The company presented measures to improve performance, including portfolio optimization and a reduction of M&A activity.
• Activist investors may push for a change in leadership, which could help unlock value for shareholders.
• While we are concerned about recent performance and the various mishaps, we believe the stock has been oversold, and the risk/reward is currently attractive.

We have published an initiation note and a follow-up note on Entain (GMVHF) with buy ratings, highlighting the hidden value of the US JV: BetMGM, the significant discount to sum of the parts valuation, and speculative appeal. However, the company has faced a range of challenges including profit warnings, management mishaps, expensive M&A deals, and a massive fine. Subsequently, Entain shares have lost nearly a third of their value since our initiation. We will revisit the investment case, discuss the business update and activist investors’ involvement, and revalue Entain’s shares.

We recommend readers to check our previous notes to get a deeper understanding of the firm, its business, and key value drivers.

Q3 update

Q3 results were weak, although not as weak as alluded to in the pre-release in September. Online net gaming revenue growth came in at negative 6% and retail net gaming revenue declined by 4%. Negative online growth guidance was confirmed for the year and full-year EBITDA guidance was further downgraded due to negative sports results. Moreover, the company expects low-single digits online NGR growth in 2024 and a 24-25% EBITDA margin, which should progress into 28% by FY2028. We have a negative view of the results, and we reflect the new guidance in our changed estimates. On the other hand, we believe the equity has been already penalized and the negatives are priced in.

Business update presentation

Entain presented a range of measures to improve performance and turn the situation around. Apart from setting the mid-term targets discussed above, Entain announced a reduction in M&A activity going forward to focus on simplification, performance optimization, and portfolio rationalization i.e., exiting minor non-core markets. The new portfolio will focus on growth and return on investment. Moreover, the company emphasized the need for a stronger push in the US (as well as other smaller growth markets), with future investment in marketing and product increasing to regain market share and drive growth. Entain aims to capture a market share between 20% and 25% in the US. It is important to note that BetMGM remains a top 3 player in the US, is present across 28 states, and was EBITDA positive in Q3. In addition, Entain expects the struggling UK business to start growing again in H2 2024.

The company announced the creation of a capital allocation committee and expressed its aims to reduce leverage to 2x net debt / EBITDA and increase shareholder distributions. We appreciate the clarity of the business update presentation, but we believe Entain should only get credit for this once the results of the plan start being achieved.

Ongoing Activism

Entain has attracted growing investor concerns as two other US-based activist investors (in addition to Ricky Sandler’s Eminence Capital): namely Sachem Head Capital Management (founded and led by Scott Ferguson, ex-Pershing Square) and Dendur Capital have accumulated shares and expressed their disapproval of the current CEO’s performance. As per FT journalists, according to persons familiar with the situation, it is likely that the CEO will be dismissed soon, and activist investors prefer Mr. Sandler to be appointed to one of the board seats and also help with scouting the new board members. While there is no public statement on this, we would certainly view this development positively. We believe a team of seasoned activist investors with a successful track record could certainly help turn things around and unlock value for shareholders at Entain. We are currently neutral on the CEO, but if Entain keeps disappointing any further, we believe a new CEO will be needed. More pressure from activists would be necessary if the board doesn’t act accordingly in that instance.

Valuation and investment case

We value Entain using a SOTP valuation (given the complexity). We have revised our projections to better reflect current challenges. Our revisions are in line with sell-side analyst consensus and company guidance. Our estimates also include the £585 million fine payment over the coming years. We forecast £4.9 billion of sales and £1 billion of EBITDA in FY2024, and £5.2 billion of sales and £1.2 billion of EBITDA in FY2025, implying an EV/EBITDA of 8.2x and 7.4x respectively. We moreover project an EPS of 45p per share and 62p per share respectively in 2024 and 2025, implying a forward PE of 17x and a two-year forward PE of 13x. Entain is trading at a big discount to its major peer Flutter.

We moreover apply a lower multiple to account for the sentiment and uncertainty. We decreased our price target by a further 15% to 1360p/per share. This implies an upside of more than 60%. While we are concerned about recent performance and the various mishaps, we believe the stock has been oversold and the risk/reward is currently attractive. It is, however, important to note there may be still volatility ahead before value is unlocked.

Risks

Risks include but are not limited to a potential failure of the management team to turn the company around, continued operational underperformance, lower/no growth for longer, deteriorating macroeconomic conditions, slower adoption in the US, market share losses in the US, adverse regulatory changes, penalties on legacy operations in unregulated countries, suboptimal capital allocation, etc.

Conclusion

While we lower the price target once again to reflect a more challenging outlook, we find Entain shares compelling at this valuation, and we forecast a low twenties IRR over the mid-term. We believe long-term value will eventually be unlocked despite temporary headwinds. However, we believe investors will continue to face some volatility.

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