NeoGames S.A. (NASDAQ: NGMS) is targeting a massive market of nearly $180 billion with impressive growth. The company also signs long-term contracts that include recurring revenue, and the business model seems quite scalable. In my opinion, the future free cash flow would justify a valuation which seems richer than the current market value. Yes, there are risks associated with customer concentration, but I don’t see them as worrisome.
NeoGames: large TAM and scalability
NeoGames is a global leader in iLottery solutions and services. The company intends to be a long-term partner of national and state-regulated lottery providers.
With businesses in select states of the United States, NeoGames’ areas of business do not just include iLotteries. The company also intends to develop successful new operations in sports betting, iGaming and casino games. Given the expected growth in these target markets in the United States and abroad, I believe most investors would be interested in knowing a little more about the company’s business prospects.
We are talking about an industry leader, which controls nearly 69% of the iLottery market share in the United States. Additionally, the company is targeting a large market of nearly $180 billion. Finally, in my opinion, NeoGames, above all, scores recurring revenue and easy scalability.
Analysts expect 26% EBITDA margin and 13% FCF margin
Analysts forecast 2024 net sales of $344 million, as well as net sales growth of 8%. In addition, EBITDA will likely be close to $89.2 million with an EBITDA margin of 26%. EBIT should also be close to $44.6 million with an operating margin of 13%. Finally, analysts expect net profit of $31.1 million for 2024, the highest figure since 2019.
When it comes to the cash flow statement, in my opinion, what matters is the growth in the free cash flow margin. In 2024, analysts expect free cash flow of $46.2 million and FCF/sales of 13.4%. Furthermore, capital expenditures would amount to only $20.5 million with a capex/sales of 6.0%. I don’t think the company needs a lot of capital expenditure to report profits.
As of June 30, 2022, cash and cash equivalents were $129 million, with restricted deposits worth $0.449 million. Trade receivables were approximately $38 million, with a corporate tax receivable of $11 million and total current assets of $190 million.
With regard to long-lived assets, property, plant and equipment amounted to $4.354 million, intangible assets to $348.259 million and rights of use to $9.132 million. Management also reported a capital note of $1.591 million, the company’s share of a joint venture of $3.924 million and deferred taxes worth $2.147 million. Finally, the total non-current assets obtained were $373.565 million, with total assets worth $563.937 million. With an asset/liability over 2x, in my opinion, NeoGames is in solid financial shape.
I don’t think the list of passives is worrisome. Trade and other payables were $46 million, trade liabilities were $6 million, and corporate tax payable was $9 million. The company’s most significant liabilities include a deferred payment on the business combination worth $96 million and a contingent consideration on the business combination of $26.550 million. I have included contingent consideration as debt in my financial models, which I believe is conservative. Finally, with employee-related accounts payable and accrued liabilities of $7.2 million, total current liabilities were $193 million.
Non-current liabilities include borrowings worth $3.45 million and borrowings from financial institutions worth $203.451 million. Management also reported lease liabilities of $7.519 million, deferred taxes worth $8.496 million and total non-current liabilities of $224 million. In my opinion, the total amount of financial debt does not seem high. Keep in mind that I’m assuming a future 2024 EBITDA of almost $106 million.
Internationalization and more contracts could bring fair price to $37.1 per share
I think under normal circumstances, NeoGames will probably be able to sign contracts with more customers in the United States. According to the latest annual report, many customers use lotteries in the United States, but do not have access to iLotteries. If NeoGames expands its services to more territories inside the United States, revenue growth will likely increase. The 20-F stated the following.
While the lottery is offered in 45 states and the District of Columbia, iLottery Instants or DBG are currently only offered in nine states. As a result, 70% of the US population in states that offer lotteries currently do not have access to iLotteries.
With the know-how accumulated in North America, I think it will be easy for NeoGames to offer iLoteries in new territories in Europe or Latin America. In this case, the target market would most likely increase, leading to greater free cash flow growth.
With a history of successful iLottery offerings developed for the North American market, we believe we have the ability to expand our offerings worldwide. (Source: 20-E)
This is just one of the factors leading to the conclusion that the igaming market will grow at a CAGR of 10.11%. This estimate puts the projected value of the market in 2027 at $128.154 billion, nearly double the value in 2020. (Source: Global iGaming to grow at 10% CAGR)
In this scenario, I assumed sales growth close to 10.1% from 2025 to 2029 and an EBITDA margin close to 29%. With an operating margin of around 14% and FCF/Sales close to 10%-16%, free cash flow would be close to 34-94 million dollars. Moreover, with an EV/EBITDA multiple close to 9.7x-10.3x, the exit value would be $1.26 billion.
If we add the resulting free cash flow at a conservative 7% discount and include cash of $129 million and debt worth $232 million, the equity valuation would be $949 million. Finally, the fair price would be $37.1 per share and the IRR would be close to 6.7%.
Fewer contracts or no new contracts can lead to lower revenue growth
The company reports a significant revenue concentration, which I believe is one of the biggest risks for NeoGames. If management does not sign contractual agreements with new customers, negotiations with large customers may result in reduced free cash flow margins. In the last annual report, the company noted that one customer was responsible for 45.3% of total revenue.
We are acting as a contractor to Pollard under its agreement to provide development, implementation, operational support and maintenance to the Michigan State Lottery. The Michigan iLottery represented 45.3% of our revenue during the fiscal year ended December 31, 2021 and 54.5% of our revenue during the fiscal year ended December 31, 2020.
NeoGames has made acquisitions in the past and may engage in new M&A activity in the future as management counts with cash in hand. In my opinion, new transactions may not be profitable or may not generate the expected synergies. As a result, NeoGames may lose money or have to write down intangible assets, which may cause the fair value of the business to decline. NeoGames mentioned this risk in the annual report:
In connection with such acquisitions, we may face significant challenges in managing and integrating our expanded or combined operations, including acquired assets, operations and personnel. The integration of Aspire, if completed, could be complicated and time-consuming for our management. We may not be able to successfully integrate Aspire and may not be able to realize and benefit from future synergies, which could adversely affect our business and financial condition.
NeoGames may also not sign new contracts as quickly as in the past. In sum, the absence of new agreements may result in lower sales growth. As a result, some investors would lose patience and might sell their holdings. In the worst case, if enough journalists wrote about declining sales growth, the stock price would fall.
We cannot continue to win new customer business at the same rate as in the past, if at all. There can be no assurance that other U.S. states will seek to implement iLottery offerings or that U.S. states seeking to implement iLottery offerings will do so through a process in which NPI can compete to be the solution provider turnkey. (Source: 20-E)
It is also regrettable that the invasion of Ukraine by Russian military forces has adversely affected the company’s economic activity in Ukraine. In my opinion, relocating software developers can be quite costly. In sum, future Russian attacks could result in a significant decrease in future free cash flow.
As of December 31, 2021, we had approximately 211 employees and 1% assets in Ukraine. We do not have income generating activities in Ukraine. We have also invested considerable resources in Ukraine over the past few years. Therefore, wars, political unrest or terrorist attacks in this region could adversely affect our business and operations in Ukraine. On February 24, 2022, Russian military forces invaded Ukraine. (Source: 20-E)
In my worst case scenario, I assumed near 5% to 2.5% sales growth, 25% EBITDA margin, 12.5% FCF/Sales ratio and 10x exit multiple. If we use a 15% WACC, my results include an equity valuation of $267 million and a fair price of $10 per share.
NeoGames operates in markets that are growing at a very decent pace, and the target market totals nearly $180 billion. In my view, if management successfully signs new deals in more US states and perhaps launches international programs in Europe, revenue growth will likely remain high. The scalability of the business model and the recurring nature of NeoGames’ agreements make the company quite interesting. Given expected future free cash flow, in my opinion, NeoGames is quite undervalued at the current market price.