By Richard Gill, CFA

Gaming Realms (GMR) was one of the top performers on the markets on Wednesday, the shares closing the day up by 20% at 12p after the company announced the proposed sale of its UK Real Money Casino brands and business.

Conditional upon shareholder approval, the deal will see a 70% stake sold in most of the company’s UK online casino B2C businesses, to River UK Casino Limited, a subsidiary of Oslo Bors listed River iGaming, for a total cash consideration of up to £23.1 million. The brands being sold are Pocket Fruity, Spin Genie, Britain’s Got Talent Games, X Factor Games and associated business, with Gaming Realms retaining Slingo.com and the Slingo brands.

The deal terms see a minimum payment of £8.4 million (£4.2 million payable on completion and £4.2 million payable with the earn-out), along with a further maximum cash payment of £14.7 million on an earn-out basis. The earn-out is payable no later than 31st August 2019 and will be based on 70% of 5.5 times River UK Casino’s EBIT for the 12 months to 30th June 2019 minus the £8.4 million minimum payment – the maximum earn-out will be paid out on EBIT of £6 million being achieved.

For the year ended 31^st December 2017 the businesses being sold delivered £13.9 million of net gaming revenue and an adjusted profit before tax and interest (but after central costs) of £2.2 million. These figures are expected to be “significantly higher” for the 12 months to 30th June 2019.

Providing significant further upside potential, Gaming Realms’ retained 30% interest in River UK Casino is subject to a mutual put and call option arrangement which can be exercised no later than 31^st October 2020 based on an uncapped valuation of 5.5 times River UK Casino’s EBIT for the 12 months to 30^th June 2020.

The deal also sees River iGaming and Gaming Realms jointly provide a working capital loan facility of £3 million to River UK Casino to fund investment in marketing until at least 30^th June 2019, repayable no later than 30^th June 2020. The current management team of the business will run River UK Casino until at least 30^th June 2020. In addition, River UK Casino has entered into a five year B2B platform and content agreement with Gaming Realms on normal commercial terms, which is expected to generate approximately £1 million of annual revenue for the company.

The sale is in line with Gaming Realms’ strategy of focusing its resources on its higher margin international licensing and content development business, with the revenue generated from River UK Casino becoming a significant source of income for the B2B platform. The first £4.2 million of the sale proceeds are intended to be used for the continued development of new gaming content and platform enhancements, as well as providing a loan of £0.9 million to fund River UK Casino’s marketing budget. Gaming Realms will be reviewing options for the balance of the proceeds above the first £4.2 million, including a potential return of cash to shareholders.

Assessment

We believe this looks like a cracking deal for Gaming Realms and highly accretive to shareholders. For starters, we note that the maximum consideration for the 70% of the sold businesses implies a valuation of £33 million. At the current price of 9.875p Gaming Realms is capitalised at £27.95 million, thus the markets are effectively valuing the company’s remaining interests at less than nothing. By any measure this is undervalued in extremis.

To put a ballpark valuation on the company following the deal, we take a sum of the parts approach (assuming shareholder approval of the sale):

– £4.2 million initial cash consideration.

– remaining £18.9 million (maximum) consideration (£4.2 million plus £14.7 million earn-out) assumed to be received in August 2019. Discounted back one year at 12% = £16.875 million.

– the balance 30% holding in River Casino can be bought by River iGaming after 31^st Oct 2020 based on a value that is 5.5 times June 2020’s EBIT. Assuming EBIT of £6 million for the year (the figure needed to deliver the maximum earn-out in 2019) = £33 million. Multiplied by the 30% interest and discounted back at 12% for two years = £7.82 million.

– Given management’s comments regarding the licensing side, “This decision to focus on licensing has shown early success and the Board believes this will provide the Company with longer term, consistent higher margin revenues” we believe the company will have higher margins and more stable revenues going forward. Accordingly, we believe these cash flows should be valued at circa 10 times. Assuming c.£3.5 million of EBITDA is produced in 2020 (our own forecast, using EBITDA as a proxy for cash flow – net operating cash has historically been higher than EBITDA) this adds a further value to the company of £35 million.

Added together the SOTP equals £63.895 million or 22.5p per share.

As such, at the current stock price of 9.875p and considering the comment from management of a potential cash return to shareholders (“The Board will be reviewing options for the balance of the proceeds above the first £4.2 million including returning cash to shareholders“) we see substantial value in the shares at present and retain our stance of Conviction Buy.

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