Mergers and Acquisitions in the Gambling Industry with Robert Stoddard and Paulo Andrade

Summary

This episode focuses on the financial dynamics of mergers and acquisitions (M&A) within the gambling sector. Robert Stoddard, Partner and US Tax Lead for Gaming at KPMG, and Paulo Andrade, Delivery Manager at Aurum Solutions, share their experiences both in the Gambling industry and other markets when it comes to mergers and acquisitions.

They dive into recent M&A deals and their rationale, how consolidation impacts the competitive landscape and market share, and analyse the financial outcomes and potential risks.

Transcript

Vasco: Hi guys, welcome to another episode of Bets and Balance Sheets. Today's episode is about mergers and acquisitions in the gambling industry, analysing the financial strategies and outcomes of these deals. We're going to discuss recent M&A deals in the industry and how consolidation impacts the competitive landscape and market share. With us we have Robert, partner at KPMG, with experience in M&A in gambling. On the other side we have Paulo Andrade, Delivery Manager at Aurum Solutions, ex-PwC and Deloitte, with experience in M&A outside the gambling industry, so we can have both perspectives within this space. To start, I want to go in the complete opposite direction and ask Bob: how can an operator increase its offering without actually merging with another operator?

How an operator can increase its offering without merging

Robert: Sure, great question. We've seen a lot of this through product development. With a number of operators in the US market, player experience has become increasingly important, especially since the early days after PASPA, when we saw a lot of players jumping around, following incentives and free promos. We're seeing a bit more loyalty amongst the player base now, and a lot of it is about building a better experience for your players. Some of the operators that have been really successful at this have developed their loyalty programmes in a more robust manner. We're also starting to see more engagement within the NFT marketplace, particularly with deals that have been signed with leagues and conferences. So without M&A, there's a big push to develop the experience. One other area we're seeing is operators leveraging high-performing white label providers to help enhance their product. Those are some of the trends we're seeing on the market right now.

Vasco: Do you think those trends justify the amount of money operators are spending to merge with and acquire other operators?

Robert: I think that's probably a question for the analysts to focus on. We've seen very robust discussion on some of the deals in the space, and heavy publicity around the two most recent acquisitions announced this summer. We will continue to see a lot of spend in the US market, both on the M&A front as the market heats back up, which we expect it to do, and from what you might call the land grab for customer base. There are still a lot of states that are not legalised, including some of our largest, like California, Texas and Florida. Florida looks like it will launch pretty soon, with the most recent appeal being rejected. So I think you'll continue to see some level of spend. But on that trend, we have seen investors take a much dimmer view, so it has to be a more responsible spending approach.

Vasco: What do you think would justify the spending? Do you think that to gain this market share and grow this fast, they wouldn't be able to do it without acquisitions, or it would be more expensive?

Robert: I think what's driving the acquisitions we've seen in recent months is two parties willing to go into this space together, a willing buyer and a willing seller in one case. And with interest rates and some of the market pressures, you've seen a little downward pressure on valuations. So while people are spending money, they're being a little more thoughtful about it. For the one deal announced this summer, if you rewind 12 months, the asking price for those assets was significantly higher than what was ultimately agreed, even with a late bidder coming in towards the end and driving up the purchase price. The more recent one, which is more of a licensing deal, is a heavy spend over time. But if you look at what some of the analysts have been speculating on, the return on the net present value, there's a pretty good story to be had there. If it's rolled out and integrated in the proper way, then the spend may well be justified.

Vasco: Okay. And Paulo, how do you think that compares with other industries? Like Bob mentioned, one thing that is super interesting is the licensing part. We see a lot of fintechs, for example, acquiring other fintechs in different spaces, or even in the same country, to get access to certain licences that they own. Even apart from fintech, how do you compare this to others?

Paulo: I think the reasons and motivations for M&A are quite the same. You want to maximise value for your shareholders, and that can go in an inorganic way: you can expand your growth, expand the geographies and markets where you operate, and consolidate share. The difference comes when you start drilling down into the specifics. Gambling is a heavily regulated industry, by far one of the most regulated: underage gambling, responsible gambling, fraud, money laundering, and the licensing part as well. That encourages an operator to buy a company, because the licensing can take loads of time to get and is not easy. The same goes for player databases. You can expand your customer reach easily by buying a portfolio of customers, which is much better than starting on your own. How does that compare to other sectors? If you look at healthcare, for instance a deal for a chain of clinics, say blood testing or X-ray clinics, the key things would be the key personnel, the doctors, because people go to those clinics because of those doctors. You'd look at the fixed assets, whether the machinery is old or not. In the end you buy that clinic for a price, and you need to make sure you don't have to invest more in facilities. The same goes for manufacturing. It's not a virtual business like iGaming, so you need to look at different things. You need to look at contracts with suppliers and customers, and make sure your revenue, or the people you buy your raw material from, is not concentrated. The outcome would be the same, obviously, but you need to look at different things in different industries. iGaming is quite specific, and so is, say, manufacturing. If you look at a SaaS business, for instance, you look at ARR, the customer share, and the technology, what sets you apart from other competitors. That's a bit different from what you see in iGaming.

Land-based acquisitions in gambling

Vasco: I don't know if you have experience in the land-based side as well, but do you think these concerns would also carry over to land-based acquisitions?

Robert: I think in general they do. What's a little unique when you compare iGaming and sports betting acquisitions to land-based is that there are different motivations for doing those transactions. One of the trends we've seen in land-based is monetising the real property assets. You've seen large players purchasing the real estate, so in those transactions there'll be a bifurcation of the assets. In the US, a real estate investment trust is often the buyer for the land and the buildings, and an operator is the buyer for the actual casino operations. So the motivations there are a little different. But many of the same trends apply, and you still have to look at the underlying fundamentals of the business to make sure it's a viable transaction for everybody involved.

Vasco: Do you think it is equally good for both sides of the deal, or is there always one side that earns more from it than the other?

Robert: I think it really depends on the deal and the assets involved. On land-based, where you have the real estate investor buying the assets and the operator buying the casino operations themselves, there has been a compelling story for that being successful. Operators are often exceptionally good at running a casino business, but perhaps not as good at monetising the value of the real property. So with split transactions you can see that value maximised, in some cases for both buyers.

Vasco: Do you think companies outside the gambling industry operate on the same principles when they do M&A?

Paulo: I think most of the time the interests, or the strategic vision, should be aligned. Both sides normally need to have their best interests aligned, so I think that's something that happens. In terms of other industries, if you look at five years ago, you had two different financial landscapes: pre-COVID and post-COVID. Pre-COVID, you had technology, healthcare, financial services and energy booming. After COVID, technology companies like Google and Microsoft, in the beginning, would probably invest more in their own technology and try to spot the next technology or the next trend. Now you have more fintechs and more startups developing AI and machine learning technology. For a company like Google or Microsoft, you'd rather try to spot where the golden goose is. If you invest in a lot of these companies, you just need to spot one and you'll be done. In healthcare, you could look at the pharma business: with COVID there was a massive boom in pharmaceutical companies because of the vaccines. You have two sides to that. You need man power to fabricate more, and you need more local clinics to expand customer reach. So there was a shift where you started to buy many more local businesses to expand your growth. In principle, the interests of both buyers and sellers should be aligned, and I see that going along with iGaming.

How to align interests in M&A in gambling

Vasco: What is the process of making sure your interests are aligned? How should they make sure the deal is going to be in their best interest? Do you have any suggestions?

Paulo: If you're talking about best practices in M&A, first of all, as I was saying, the strategic visions need to be aligned. You should also have valuation experts, because there are different valuation models for different industries. Having the right model for your industry, and understanding how you can monetise your unique value proposition, is very important. And probably Robert is going to like this one: you shouldn't skimp on advisers. You should bring to the table experts in the industry you're analysing. For due diligence, for instance, you can have multiple due diligence workstreams running at the same time: financial, tax, legal, environmental, technical. The more confidence you build through those due diligences, the more comfortable you'll be with the decision on whether the deal happens, and at what price. Another thing that probably gets missed by the common person who doesn't know M&A that well is that you should start the integration as soon as possible. People feel that when you put pen to paper, the deal is over, but there is a big chunk of work still to do. There are systems to integrate. Before, you had two CEOs, and now you probably only need one. You have to merge the executive teams. I'd say those best practices are transversal to any industry.

Vasco: And in iGaming, we see, for example, a lot of operators in the US starting small businesses that can then be acquired by bigger ones. What do you think they should care about to make sure both sides get the best out of these deals?

Robert: Sure. I actually agree with everything you said there on some of the key factors for a successful deal. In the US, and really any other market, in sports betting and iGaming, a lot of this will ultimately come down to proper valuation. Over the last few years we've seen valuations get a bit out of control, quite frankly because money was cheap. It was very inexpensive to borrow to do a deal, and valuations were pretty inflated. They've started to fall back, in most industries including gaming, to a probably more realistic level. So the valuation piece is still very critical, as is understanding what you're getting from an asset perspective, whether you're buying assets directly or the actual company, with proper diligence. In iGaming and sports betting in particular, legal, financial and tax diligence are extremely important. But then, to your point on integration, I think people tend to not forget, but deemphasise things like IT risk. This isn't about cyber or AML, I think everybody's attuned to those risks in gaming, but the operational IT component: how successfully can you actually integrate systems and operations post-deal? System integration is absolutely critical, and we have seen acquisitions in recent years that fell apart a little bit because somebody paid too much for the asset, then wasn't able to integrate it successfully, and you wind up walking away from something you paid a lot of money for. So I think it's absolutely critical to make sure those areas are successful on both sides.

The best practices for post-merger integration in gambling

Vasco: What do you think are the best practices for the post-merger integration?

Paulo: I'd say that probably, before the integration, you need to be aware of the risks of the transaction. As soon as you start engaging in due diligence activities with the target company, you should know by now what systems they use, who the key personnel are, who you wish to maintain in the future and who do you think needs to go. Otherwise you can't calculate synergies. The whole point of merging one company with another is economies of scale, building more on fewer people. So you need to be aware of the risks before you start the process. Robert was talking about systems, so as a practical example, imagine two big companies, where one uses SAP as its financial system and the other uses SAGE. The simple fact that you need to understand how to migrate records from one company to the new company, or that you have a pool of licences you probably need to renegotiate to get a better deal on systems, means you're talking about massive amounts of money. The same goes for key personnel. If you have an executive board of five people on one side and five on the other, you probably don't need ten, you probably can live with seven. It's about understanding which people are going to add what to the new business. And quite frankly, at some point there are people who just need to go after the buyout. So doing your due diligence before the post-merger phase is quite important, and I'd say it saves you a lot of money and concern in the long run.

Why operators choose to sell not grow in new markets

Vasco: We talk a lot about the buying part, but I think we should also mention the selling part. What do you think is driving these people to sell their businesses? For example, you start operating in a new market, and what makes it more appealing to sell than to actually grow it?

Robert: Great question. We've seen instances where it's not the same answer, depending on the company. As we all know, there are folks who have founded a company, in gaming or otherwise, and taken it to a scale where their goal is to sell it, to monetise it and maybe go on to the next thing, especially a serial entrepreneur. If it's somebody who's very passionate about a particular industry, they may be growing it looking for a strategic exit, or they may feel they're a disruptor in the industry. We're actively seeing that now with some of the fantasy sports operators in the US. Just this past week, if you look at the daily downloads, the top two or three in fantasy sports are not household sports names. They're much more in the emerging growth space. So I think some folks have a passion for disrupting an industry, and others are looking to build something to ultimately find a strategic buyer or to take it public. There are very different motivations depending on the seller.

What buyers are looking for in gambling

Vasco: What are the best suggestions we can give to people looking to sell their companies? What do you think buyers are interested in, and what sparks their interest?

Paulo: From what I remember of working in the industry, there were at least two or three things I found key. One is to prepare your financial records. You need to be sure that when the time comes, you have everything ready on time. People are going to ask questions and analyse every amount in your business, so you need to be able to back it up with evidence and information. Probably even more important is understanding your unique value proposition: what sets you apart from companies in the same industry, what you have that the others don't, and what makes you appealing in comparison. And a third thing, which doesn't look that important but is, is having a virtual data room when you start coordinating several due diligence processes. That's basically a secured shared folder that only a few people can access, with all the necessary information segregated by department, such as financial and tax. When you're coordinating large deals, you're probably coordinating five or six different teams, with different timings, and a deal has a deadline. So you need to be sure everything is in place for them to do their work. Having that data room is key, and I think it's somewhat’s underrated; not most people think of it like that, but it's quite important.

Robert: I'd agree. A lot of that comes back to having your strategy developed as the operating company: what is your strategy to grow the company and be an attractive target for a buyer? And also having the organisation behind it that's able to go through a proper process. In this case we often recommend an internal sell-side due diligence, or vendor due diligence, process to take you through that cycle, especially if you've not been through it before. It can be very valuable going into a transaction, particularly one with multiple buyers involved.

Paulo: And I'd say you can see a lot of difference in the sophistication of the information when, for instance, private equity is involved. If they have a stake in a company that's going to be acquired by a major player, the questions you're going to ask as the buyer, they've already thought of. They already know more or less what you're going to ask, so they have an answer, or something to give you, to say "I knew you were going to ask this, here it is." You see a difference, and a different pace, in transactions where there's private equity or funds involved, rather than just individuals.

Robert: Absolutely, particularly if the target already has private equity backing. They'll have been through that process at least at some level once before, so they're probably more prepared this time around. 

Paulo:You'll probably see more pressure, too, just because the private equity firm wants to get out of the [deal] quicker. Yes, it's opportunity cost, after all. Yeah, I agree with you.

Vasco: Okay, well, I think that's all the questions I have for you today. Thank you so much for coming on the podcast. I think it was very insightful, and I hope you found it insightful too. Make sure you follow us on social media so you can get all the other episodes. And yeah, that's it, I'll speak to you soon. Thank you, bye.