NeoGames: New Contracts Could Push The Price Up (NASDAQ:NGMS)

NeoGames S.A. (NASDAQ:NGMS) is targeting a massive market of close to $180 billion with impressive growth. The company also signs long-term contracts that include recurrent revenue, and the business model appears quite scalable. In my opinion, future free cash flow would justify a valuation that appears richer than the current market value. Yes, there are risks from the concentration of clients, but I don’t perceive them that worrying.

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 providers of national and state-regulated lotteries.

With businesses in some states in the U.S, NeoGames’ business areas do not only include iLotteries. The company also intends to develop successful new operations in sports betting, iGaming, and casino games. Considering the expected growth of these target markets in the United States and abroad, I believe that most investors would be interested in learning a bit more about the company’s business prospects.

We are talking about an industry leader, which controls close to 69% of the iLottery market share in the United States. Besides, the company targets a large market of close to $180 billion. Finally, in my view, NeoGames, most importantly, notes recurring revenue and easy scalability.

Analysts Expect 26% EBITDA Margin And 13% FCF Margin

Analysts forecast, for 2024, a net sales of $344 million, together with a net sales growth of 8%. In addition, the EBITDA will likely be close to $89.2 million with an EBITDA margin of 26%. EBIT is also expected to be close to $44.6 million with an operating margin of 13%. Finally, analysts are expecting 2024 net income of $31.1 million, which is the highest figure since 2019.

With respect to the cash flow statement, in my view, what matters is the growth of the free cash flow margin. In 2024, analysts are expecting free cash flow of $46.2 million and FCF/sales of 13.4%. Besides, capital expenditures would stand at only $20.5 million with a capex/sales of 6.0%. I don’t think that the company needs a lot of capital expenditure to report profits.

Balance Sheet

As of June 30, 2022, cash and cash equivalents were equal to $129 million, with restricted deposits worth $0.449 million. Trade receivables were equal to approximately $38 million, with corporation tax receivable of $11 million and a total of current assets of $190 million.

With regards to long-term assets, property and equipment was equal to $4.354 million, with intangible assets worth $348.259 million and right of use assets $9.132 million. Management also reported a capital note of $1.591 million, a company share of 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 of more than 2x, in my view, NeoGames reports a solid financial shape.

I don’t believe that the list of liabilities appears worrying. The trade and other payables were $46 million, with client liabilities worth $6 million and the corporation tax payable worth $9 million. The company’s most significant liabilities include a deferred payment on business combination worth $96 million and a contingent consideration on business combination of $26.550 million. I included the contingent consideration as debt in my financial models, which I believe is conservative. Finally, with employee related payables and accruals of $7.2 million, the total current liabilities were equal to $193 million.

The non-current liabilities include loans worth $3.45 million and loans from financial institutions worth $203.451 million. Management also reported $7.519 million lease liability, deferred taxes worth $8.496 million, and total non-current liabilities of $224 million. In my view, the total amount of financial debt does not look elevated. Keep in mind that I am assuming a future 2024 EBITDA of close to $106 million.

Internationalization And More Contracts Could Bring The Fair Price To $37.1 Per Share

I believe that under normal circumstances, NeoGames will likely be able to sign contracts with more clients in the United States. According to the last annual report, many clients do use lotteries in the United States, but have no access to iLotteries. If NeoGames extends its services to more territories inside the United States, revenue growth will likely increase. The 20-F stated the following.

While lottery is offered in 45 states and the District of Columbia, iLottery Instants or DBGs are currently offered in only nine states. As a result, 70% of the U.S. population in states that offer lotteries do not currently have access to iLotteries.

With know-how accumulated in North America, I believe that it will be easy for NeoGames to offer iLotteries in new territories in Europe or Latin America. In this case, the target market would most likely increase, which would lead to larger 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 around the world. (Source: 20-F)

That is just one of the factors that leads to the conclusion that the igaming market will grow at a CAGR of 10.11%. This estimation puts the projected 2027 worth of the market at $128.154B, nearly double the 2020 value. (Source: Global iGaming to Grow at 10 Percent CAGR)

Under 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 at around 14% and FCF/Sales close to 10%-16%, the free cash flow would be close to $34-$94 million. Also, with an EV/EBITDA multiple close to 9.7x-10.3x, the exit value would be $1.26 billion.

If we sum the resulting free cash flow with a conservative discount of 7% and include cash of $129 million and debt worth $232 million, the equity valuation would be $949 million. Finally, the fair price would stand at $37.1 per share, and the IRR would be close to 6.7%.

Less Contracts Or Lack Of New Contracts May Drive Revenue Growth Down

The company reports a significant amount of revenue concentration, which I believe is one of the largest risks for NeoGames. If management does not sign contract agreements with new clients, negotiations with large clients may lead to a decrease in free cash flow margins. In the last annual report, the company noted that one client was responsible for as much as 45.3% of the total revenue.

We act as a subcontractor to Pollard with respect to its agreement to provide development, implementation, operational support and maintenance to the Michigan State Lottery. The Michigan iLottery accounted for 45.3% of our revenues in the year ended December 31, 2021 and 54.5% of our revenues in the year ended December 31, 2020.

NeoGames has made acquisitions in the past, and may engage in new M&A activity in the future because management counts with cash in hand. In my view, new transactions may not be profitable, or may not deliver the synergies expected. As a result, NeoGames may lose money, or may have to impair intangible assets, which may drive the company’s fair valuation down. NeoGames discussed about this risk in the annual report:

In connection with any such acquisitions, we could 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 prove to 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 any future synergies, which could adversely affect our business and financial condition.

NeoGames may also not sign new contracts as fast as in the past. In sum, lack of new agreements may lead to lower sales growth. As a result, certain investors would lose their patience, and may sell their stakes. In the worst-case scenario, if sufficient journalists write about the decrease in sales growth, the stock price would decline.

We may not continue to procure new customer contracts at the same rate as in the past, or at all. There can be no assurance that additional 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 turnkey solution provider. (Source: 20-F)

It is also sad that the invasion of Ukraine by Russian military forces damaged the company’s economic activity in Ukraine. In my view, relocation of software developers may be quite expensive. In sum, future attacks from Russia may lead to a significant decrease in future free cash flows.

As of December 31, 2021, we had approximately 211 employees and 1% in assets in Ukraine. We do not have revenue generating activities in Ukraine. We have also invested significant resources in Ukraine over the last several years. As a result, warfare, political turmoil or terrorist attacks in this region could negatively affect our Ukrainian operations and our business. On February 24, 2022, Russian military forces invaded Ukraine. (Source: 20-F)

Under my worst-case scenario, I assumed sales growth close to 5%-2.5%, an EBITDA margin of 25%, an FCF/Sales ratio of 12.5%, and an exit multiple of 10x. If we use a WACC of 15%, my results include an equity valuation of $267 million and a fair price of $10 per share.

Takeaway

NeoGames operates in markets that grow at a very decent rate, and the target market totals close $180 billion. In my view, if management successfully signs new agreements in more states in the U.S., and perhaps launches international programs in Europe, revenue growth will likely stay elevated. The scalability of the business model and the recurrent nature of NeoGames’ agreements make the company quite interesting. Considering future expected free cash flow, in my view, NeoGames is quite undervalued at the current market price.