Exclusive: Secretive short-seller report wipes €2.5bn from Evolution market cap, but is the report as explosive as it seems?

Evolution’s share price sank by more than 11% on Thursday 27 January, temporarily wiping away more than €2bn in value.

The dip was caused by a new short-seller report that suggested the supplier’s unregulated revenue should be valued on a much lower multiple than the rest of the business.

iGaming NEXT has obtained a copy of the report which was produced by The Analyst and sent to select investors.

What does the report say?

It advises the Evolution stock is overvalued at 40x full-year 2021 EBIT due to the fact 62% of its overall revenue is derived from unregulated markets, which could be at risk due to future regulatory clampdowns in areas including Asia and the US.

Evolution’s stock rebounded by 3% the following day and sits at SEK1,119 per share at the time of writing.

“We believe only the profits from regulated markets can be valued at this multiple,” said the report. It concluded that 10x full-year 2021 EBIT was a more suitable valuation for the portion of unregulated revenue as it would bring Evolution closer in line with other online gambling companies that are similarly exposed to potential headwinds.

Evolution said many reports discuss the company from an investor’s perspective and that these are often likely to present different opinions.

Evolution roughly trading at 25x revenue. At exit: Relax Gaming 13x, BTG 14x, NetEnt 11x.
Unless there is a convincing argument that Evolution's core biz-model is _fundamentally_ different than the one's mentioned, there's going to be more corrections.

— Robert Lenzhofer (@robertlenzhofer) January 28, 2022

The 62% unregulated revenue figure is no secret and is published on page six of the supplier’s Q3 2021 report.

Risk by region

According to The Analyst, the biggest risk to Evolution by far comes from US regulators.

For example, the New Jersey Division of Gaming Enforcement is still to publicly comment on a complaint filed by Costal Network in November 2021, which alleged that Evolution engaged in illegal gambling activity in markets subject to US sanctions, including Iran and Syria.

At the time, Evolution published a statement of response on the Stockholm Stock Exchange to reassure investors, but the complaint had already caused a 16% share price downturn and erased roughly €5bn from the value of the company.

Evolution’s defence that day focused on the fact it is not responsible for verifying the identity of an end-user, with KYC duties purely in the hands of its operator clients.

The Analyst argued this was not an appropriate position to take for the second most valuable public gambling company in the world (behind Las Vegas Sands).

Evolution reiterated its stance to iGaming NEXT. Head of IR Carl Linton said: “Everyone who understands the eco-system of the online casino industry knows that the identity of an individual player remains with the operator and that our product is not stand-alone as it requires an operator to add features such as payment methods and identity verification applications before it can be available to players.

“Evolution has customer relationships with gaming operators, who in turn own the relationships with the end users. Evolution does not own or control any of the aggregators or operators it works with. We have no direct relationship with the underlying player and no involvement in handling of players’ money.

“We only sell content to operators and aggregators with a valid licence in jurisdictions where online gaming is legal.”

The Analyst points out that the lawyer in charge of that November complaint, Ralph Marra, was formerly general counsel to the New Jersey Sports and Exposition Authority and would likely not have put his name behind a case without strong merits.

“If an investigation by a US gambling regulator does proceed and become public then it may become harder for Evolution to become approved by regulators in any new states that legalise online gambling,” said the report.

Crypto complacency

The author behind the report goes on to suggest that the growing popularity of cryptocurrency casinos also presents a major regulatory risk to Evolution.

No cryptocurrency gambling operator has been licensed to operate in any US state, including Stake.com, which is believed to be the largest online crypto casino in the world.

As a result, Curaçao-licensed Stake cannot be accessed via a US IP address. However, the report links to data that shows Stake gets more than 7% of web traffic from the US and more than 13% from Canada.

That is a potential problem for Evolution, writes The Analyst, because its games are available on the Stake website, which also has dedicated tables run by Evolution that are often showcased by US influencers and affiliates on streaming platform Twitch.

For more on this topic, see Coffeezilla’s six-part YouTube investigation, House of Cards.

When asked by iGaming NEXT to explain its relationship with cryptocasinos, Linton said: “We have no influence over what currency an operator accepts for a specific game.

“Stake.com is a customer of one of our customers. It is a licensed provider of online casino services and as such subject to monitoring by the relevant regulator.

“Should a regulator reach out to us with any suspicion of licence breach, we will as always work with the regulator and our customer to investigate and address accordingly,” he added.

Asian exposure

Asia was also highlighted as an area of major concern for Evolution stockholders in the report due to the fact most countries in the region would fall under the “grey” or “black” market definition.

The research again linked to the sites of various Asian operators (many of which currently sponsor Premier League clubs) where Evolution’s games are available to customers.

Around 28%, or €76.7m of Evolution’s Q3 2021 revenue came from Asia. The Analyst used London-listed supplier rival Playtech as an example of what could happen if regulators or politicians decide to adopt a stricter stance in the region.

A 2017 crackdown by Malaysian authorities on illegal gambling in the region saw Playtech list a number of profit warnings after its Asian revenue halved in less than a year. The share price, unsurprisingly, fell with it.

In context

The fact the biggest suppliers in online gambling derive a portion of their revenues from unregulated markets will not come as a surprise to those familiar with the industry.

Stockholm-listed Evolution publishes that fact in black and white in its quarterly and annual reports.

Committed investors with a comprehensive working knowledge of the sector should also be familiar with the “grey” market activity of companies within their portfolios by now.

Some members of the investment community were quick to pour scorn on the report, suggesting its findings are common knowledge and should already be factored into valuations and serious stock positions, while others have suggested this is all part and parcel of backing a multi-billion-pound stock in a hugely volatile industry.

«The Analyst» sends out a $EVO short report» Monday 24th, to their clients and inst. Nada new in the report -> the grey market/VPN/Mandarin well discussed stuff, Inst. are just shrugging their shoulders and EVO floats with the segment. Retail hear rumours -> sends it down 11% 🤓

— OrakelO (@Orakel_O) January 28, 2022

The 11% daily downturn demonstrates that not everyone is convinced, however, especially as the report has not been released far and wide.

This could suggest an influential fund with a weighty position in Evolution was persuaded to offload. Then again, it may have been retail investors spooked by rumours of another short report, deciding to jump off before it caused the stock to spiral further.

Balancing act

The report is well-researched and is not one-sided, in stark contrast to some short seller hit pieces we have seen over the last 12 months.

In a section titled Risks to the Short Thesis, The Analyst admits that Evolution games are viewed by players as the best in the market and that management is operationally strong.

It said Evolution studios regularly put out a high quality of product and that annual revenue growth of more than 30% is difficult to find in European companies with a similar size market cap.

In conclusion

Despite these plus points, The Analyst settled on a Short recommendation and SEK620 target price, insisting investors could be forced to eat a 50% decline should any of the hypothetical scenarios as listed in the report become a reality.

“Based on our research, Evolution is clearly exposed to revenues from what we believe to be illegal gambling activities, including cryptocasino betting in the US plus operators targeting gamblers in China, Vietnam and Singapore,” the report concluded.

“This could put them under further scrutiny of US regulators, particularly in New Jersey, where a complaint has already been filed in respect to the ability of people in US-sanctioned countries to access their games,” it added.