EVVTY - Evolution Gaming: Part 1 Of Deep Dive Into A Live Casino Gaming Powerhouse

Summary

• Evolution AB (publ) is a powerhouse of live casino games in Europe and the U.S.
• Industry tailwinds, including increasing legislation and online casino penetration rate, are crucial drivers of the company’s growth.
• The combination of operational excellence, and management’s product innovation DNA forms the bedrock of the company’s current success and going forward.
• Its "pick and shovel" business model allows Evolution to follow its customers into new regulated markets and incur little-to-no marketing expenses.
• The online casino industry is proven to be resilient during a recession.

Investment Thesis

Evolution AB (publ) (EVVTY) ("EVO") is a leading B2B live casino game provider in Europe, and more recently, they have been gaining traction in both Asia and the U.S. The casino industry is undergoing a dramatic shift in terms of the increased number of legislations and the tailwind from land-based casinos to online casinos, which are playing out in the favor of Evolution AB (publ).

As a "pick-and-shovel" company, EVO provides end-to-end live casino solutions that enable incumbents to operate online. EVO's focus on operational excellence and product innovation has helped to drive better casino experiences for players in the industry, and it formed the bedrock of its success.

Talented individuals, most prominently, Chief Product Officer ("CPO") Todd Haushalter, have played a crucial role in the company's success, and this can be seen from the portfolio of award-winning live casino games well-recognized by operators and players around the world.

With the large and growing addressable market driven by increasing legislation, along with its operational excellence, and product innovation backed by the talented management team, EVO is well-positioned to grow for many years to come.

Business & Revenue Model

EVO works with casino operators, ranging from land-based casinos to sportsbooks, and online casino operators to provide their self-developed live casino games to the end users. Live casino games are live game shows that are broadcast online. The beauty of this is that EVO incurs little to no sales and marketing expenses as casino operators, who own direct relationships with end-users, market and distribute EVO's games to their existing user base. And at the same time, EVO also follows operators into newly regulated markets.

Other than being a B2B game provider, its greater value proposition lies in its value-added services that help land-based operators to digitize their operations. Important to know that land-based operators are incumbents that have existed for decades, and running live game shows successfully requires a completely different set of operational capabilities. EVO's end-to-end solution includes hiring & training dealers (i.e., game presenters), video streaming tools, risk & surveillance tools, tables to host live casino shows, and other services an operator needs to run a successful live game show. In return for these services, EVO derives its revenue through commission, which is obtained from a percentage of operators' gross gaming revenue ("GGR"), and fixed monthly fees.

Casino Industry

The casino industry consists of 2 main segments: (1) land-based casinos; and (2) online casinos. Land-based casinos are brick-and-mortar operators and online casinos are online platform providers. Specifically, the online casino market consists of a few sub-segments - poker, slot games, sportsbooks, and live casinos (where EVO resides).

Ongoing Industry Tailwind: From Land-Based Casino To Online Casino

A report done by European Gaming & Betting Association ("EGBA") in partnership with H2 Gambling Capital shows that online casinos are expected to take market share away from land-based casinos, which now hold the bulk of the market share in Europe. Europe was one of the first where legislation was first introduced, and due to the attractiveness of little-to-no competition back then, EVO entered the market and established a significant presence there.

Above is a list of regulated gambling markets in Europe, where EVO has most of its operations in. Europe is an overall mature continent with more than half of the markets already having more than 40% of online penetration rate. I believe that market share is going to come from Asia, the U.S., and Latin America ("LatAm"), where there is an increasing number of regulated markets, and lower online penetration rates. According to management, Asia's market is 10x bigger than Europe's. Mature markets are, however, important because consumers are more receptive to new game releases, and therefore, new games play an important revenue driver for EVO.

The market drivers include the rise of technology, including the birth of data cloud, AI/ML, fast and reliable broadband Internet speed, increasing Internet consumption, and smartphone penetration. Historically, it was simply impossible to host online casino games due to the limited ability of hardware, technologies, and poor Internet speed. Of course, this isn't the case today.

The rise of mobile devices comes with a growing number of gambling apps, and these are changing the way players are gambling. Many players today want access to online casino games at their fingertips, in the comfort of their own homes, without the need to be physically present. They are constantly searching for new games and experiences, and this is driving the growth of the overall market.

By going online, operators get to reach new users on the internet, who historically have not been to land-based casinos or have never played a casino game. So as EVO's games get distributed to these customer bases, they are also riding on the secular tailwind. This digitization has, in fact, taken place before the pandemic, although Covid has accelerated it.

What Drives A Player's Casino Experience

Live casino has its own set of challenges, and whether casino operators/EVO can encourage repeat business and brand loyalty depends on the players' gaming experiences. Many factors contribute to a great gaming experience, but the crucial ones are: (1) trust; (2) a seamless game; and (3) product innovation.

(Not exhaustive to this list) Players generally have a few requirements when it comes to live casino:

• Are these licensed casino operators?

• Fast and easy payout

• Consumer protection law (e.g., Where can they turn to if they are treated unfairly?)

• Mistake-free and smooth live games (e.g., poor video streaming can destroy players' experience)

• Professional and friendly dealers

• Fraud-free

Driver #1 - Trusts

Historically, the casino industry was filled with bad actors that engaged in fraud and illegal activities like money laundering due to the lack of regulations. A common saying is, "the house always wins." However, that has drastically changed since then as there are an increasing number of regulated markets today. The main differences between unregulated and regulated markets include the presence of a regulatory body, licensed operators, audited operators' games/sites, and many other rules that operators must follow to maintain the game integrity to provide a safe space for players to engage.

EVO conducts strict know-your-customer ("KYC") checks on customers to ensure they are licensed. Likewise, operators also run checks on EVO. Recall that these operators have been around for decades, and they have developed strong customer loyalty and relationships. They are equally (or even more) stringent than EVO to protect their brands, reputation, and customer base. In the worst-case scenario, failure to comply with regulations can result in license revocation. Both EVO and operators contribute to upholding the highest industry standards and weeding out bad actors.

As games are hosted online, players can indulge in illegal programs (e.g., such as bots or algorithms to predict where the ball goes) to cheat during a live game. EVO runs 2 mission-control rooms ("MCR") in Latvia and Malta that performs 24/7 monitoring to identify such bad behaviors. There is also AI/ML software such as shuffle tracking (to identify weak shuffles), and wheel clocking (to identify players predicting ball and wheel speed). Running its own in-house risk and surveillance tools gives EVO the advantage of retaining maximum control over its operations, though this comes at the cost of high personnel costs. Their self-developed shuffling procedures are used by land-based operators as it proves to be the most secure shuffle.

This also creates a strong feedback loop as the more bad acts are identified, the quicker they can identify them in the future to provide a safer environment for players and operators.

EVO prides itself to uphold the highest international standards by attaining all the licenses and certifications required for regulatory compliance and security. For instance, the license granted by the Malta Gaming Authority ((MGA)) is a first-rate international gambling permit. Licenses, especially in developing or unregulated markets helped to build trust and lower the barrier to entry for players to try out its games.

Driver #2 - Running a Seamless, Live Casino Game

"...isn't it just this simple? You just put a camera in front of a roulette wheel…actually, yeah, it's that simple, but nobody's going to play the product…it's incredibly difficult. Doing live streaming videos, from 1 to many players, it just wants to break all the time…new versions of chrome…ios…we're 16 years in this, and we're still struggling every single day with it… (Emphasis Added)" - Todd Haushalter, CPO of Evolution Gaming, during the iGaming NEXT New York City 2022 Keynote Speech .

CPO Todd Haushalter started out his 2022 keynote speech by talking about how incredibly challenging it is to run live casino games. Regulations require EVO to build out production studios, where EVO hosts live casino games, a training center for employees to learn how to operate a live game show, and a tech center where they developed and run their in-house risk and surveillance tools. The size of the studio depends on the capacity (e.g., how many tables are needed by operators), and the training process is tedious and resource-intensive for a company with high turnover as the same training process is repeated for every staff that is hired.

The biggest challenge, yet, is having to stream to thousands of players across different devices and browsers globally, and they have over 30 teams just to optimize for different devices. Poor-quality streaming/synchronization, poorly trained dealers, and game frauds are demises of a player's casino experience. Sounds easy, but it is tough.

EVO draws from its years of extensive experience to help operators run a smooth and seamless live game show. While EVO runs live game shows on behalf of operators in their own studios, it also offers a dual-play solution that allows operators to run their own live game shows from their land-based studios. Keep in mind that land-based casino operation differs vastly from live casino as it requires specific know-how, and outsourcing it to EVO allows them to focus on running land-based casino games. So while operators may choose to replicate this in-house, it'll take lots of resources (i.e., labor, video streaming tools, studio developments, etc.) and an extremely steep learning curve. This great value proposition has helped EVO to land many tier-1 operators. To give a sense of how challenging it is, NetEnt, one of EVO's acquisitions, has struggled to gain meaningful traction against EVO despite entering the market in 2013.

For incumbents, going digital is extremely crucial because of: (1) the need to remain relevant by going online, or else they risk lagging behind competitors; (2) the huge opportunity cost of not going online as many new players reside on the internet; and (3) the benefit of economies of scale as live games enables more players to participate in a game as compared to land-based games which are limited by the number of players they can host. For that very reason, the live casino has very high margins.

Driver #3 - Product Innovation, EVO's DNA

"The strong growth trend over recent years for live casino has encouraged more systems providers to develop live casino solutions. The barriers to entry are relatively low, while the barriers to success are considerably higher." - EVO FY21 Annual Report .

Perhaps, one of the most crucial and underrated competitive advantages of EVO is the product innovation that lies in the management's DNA. I do not claim to be an expert, but I do know that coming up with hit games takes a highly innovative culture, talented individuals with deep industry expertise (i.e., knowledge & skillsets), data insights, and a deep understanding of players' preferences.

The iGaming Podcast on "Innovate or die" provides really good insights into EVO's culture. During the podcast, CPO Todd Haushalter talks about how the company is emulating Amazon's first principle of customers first. The product division team is constantly thinking of what would players like and how to make games more interesting and fun. To run an innovative culture, he is always open to ideas from his team and encourages his team to talk during meetings to challenge existing ideas. CEO Martin Carlesund, who he was very grateful, gives Todd and the product team the freedom to innovate and often challenges them to innovate for the future.

This has led to an established track record of being awarded the "Live Casino Supplier Of The Year" at the EGR B2B Awards for 12 consecutive years (2010 - 2021). Among its portfolio of live casino games, games like "Lightning Roulette," "MONOPOLY Live," "Crazy Times," and "Deal or No Deal Live" are extremely popular among its audiences. In 2019, "MONOPOLY Live" was the "Game of the Year" at the EGR Operator Awards, and the multi-award-winner "Lightning Roulette" won the Game of the Year at the American Gambling Awards 2022, Product Innovation of the Year at the Global Gaming Awards, G2E Las Vegas and EGR's Game of the Year 2018, voted by the operators.

Operational Excellence Drives Better Customer Experience and Repeated Visits

The management takes pride in maintaining operational excellence to provide end-users with a trustworthy and seamless customer experience. The combination of EVO's extensive experience in operating seamless live game shows, strong emphasis on game integrity, and product innovation contribute to an overall better customer experience for players, which in turn, drives repeat visits for casino operators, and ultimately, higher revenue for EVO.

Strangely, The Industry is Recession-Resilient

"I have not seen any apparent signs of consumer slowdown but we need to acknowledge that the world is in a very unstable situation…it's important to state that the investments will continue to be high." - CEO Martin Carlesund in the 3Q22 Earnings Call

It sounds counter-intuitive to say that the casino industry is a recession-resilient company, but it really is. For instance, NetEnt was unaffected during the 2008 financial crisis:

"Although the financial unrest has not yet had an effect on Internet-based gaming, it should not be ruled out that a long-term recession could lead to a decrease in gaming per capita as household incomes fall. - NetEnt's 2008 Annual Report ."

This could be attributed to a few reasons:

• Ease of internet access has made it easier for internet users to access gambling apps and sites as land-based casinos are temporarily shut down.

• Games like jackpots require low initial stakes and the possibility of winning a large jackpot sounds alluring.

• Gambling is treated as a leisure activity (e.g., strategy-based casino games) for players to de-stress.

Regulations Are Crucial For the Industry and the Increasing Number of Regulated Markets is Driving EVO's Growth

EVO aimed to be the first live casino provider in each country when permitted as an increasing number of regulated markets in the future play a crucial role in its growth.

This is typically what a regulation process could look like:

1. A new market gets regulated, and the licensing process starts

2. Gaming authorities review the operators

3. Games then get certified and tested (often require multiple iterations and extremely tedious process)

4. Tech providers (such as EVO and NetEnt) need to obtain licenses to operate

As markets get regulated, operators obtained licenses and market EVO's games legally to players in those markets. Regulated markets forced industry players (i.e., game providers and casino operators) to uphold the highest game integrity, sifting out bad actors and creating a safer environment for players who historically are hesitant on engaging due to the lack of regulatory bodies, and fear of losing their money. Regulations mean there must be in-game measures, such as play limits, and operators/game providers are to work with industry bodies to prevent players' gambling addiction and unlawful activities. This helps to attract high-quality players that are willing to spend, and thus, provide higher quality and more durable revenue growth. As EVO's business model allows them to follow licensed operators into newly regulated markets, its addressable market is constantly growing.

Here are some of the recent developments disclosed by the management surrounding the newly regulated markets from 2021 to 2022, which act as a growth driver for EVO:

• Dutch - Opened in Oct 2021, they had already secured various licensed operators, and more licenses are expected in 2022.

• Canada- Ontario market for commercial operators to open in April 2022, and it has a larger population than any other state in the U.S.

• U.S. - an increasing number of states in the U.S. are expected to open up in the future.

• Latin America - They were the first to market in Argentina in 4Q21, and more provinces and countries are expected to be regulated.

An increasing number of regulated markets helps to beget more markets to be regulated in the future. When countries/markets get regulated, countries get to draw and learn from each other experiences. This also strengthens cooperation between regulatory bodies in each country, paving the way for more countries to be regulated. Since 2006, an increasing number of markets in Europe have been regulated, and I believe this trend might be playing out in regions like the U.S.

Conclusion

I touched on multiple aspects of the business and the broader casino industry, namely the beauty of its "pick and shovel" business model, the ongoing industry tailwinds, drivers of casino experience driven by management's operational capability, the importance of regulations and the trend of an increasing number of regulated markets across regions like U.S that are driving EVO's growth.

With all of these, I do think EVO deserves to be on investors' watchlist. Rather than categorizing it as a "sin stock," I implore investors to look deeper to understand the changes that are happening in the industry, which makes EVO well-capitalized to grow in the coming years.

In part 2 of the deep dive, I will be diving more into the acquisitions made, financials, management team, valuation, and risks. So stay tuned. Finally, what are your thoughts on the company? Let me know in the comment section below.

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