I have also been targeting the online gaming sector for this very reason since I believe the scope for companies to beat earnings expectations is still not factored into the shares prices of my two top picks, Aim-traded 32Red (TTR: 81p) and NetPlay TV (NPT: 23.75p) even though we are now sitting on huge gains since I initiated coverage: shares in 32Red are up 60 per cent since I first advised buying at 51.75p ('Game on', 8 Jul 2013) and the share price of NetPlay TV has risen 88 per cent on my recommended buy-in price of 12.5p (‘A share to hit the jackpot’, 11 February 2013). Since then I have repeated my buy advice at regular intervals to comment on the latest trading updates, and subsequent earnings upgrades, so there have been multiple buying opportunities for both companies. With shares in both trading at multi-year highs you should all be well into profit.
The good news is that both on valuation grounds, and from a technical perspective, I can see significant upside in the shares of both companies, so much so that I have no hesitation at all repeating my positive stance. That’s because both companies are showing all the right characteristics to maintain the positive share price momentum: strong balances sheets, substantial and rising net cash positions, robust cash generation from operating activities, rising dividends, low earnings multiples, healthy dividend cover and, importantly, the risk to earnings expectations remains firmly to the upside. The two businesses are also growing their user bases at quite some pace, which given their higher-than-average operational gearing, means the outlook for earnings growth rates is robust. Despite these positives, shares in both online gaming companies are still rated on bargain basement earnings multiples.
Odds on to hit the jackpot
The latest spurt in 32Red’s share price to a seven-year high has been driven by news of three new sponsorship deals the past three months. The first is a three-year deal with ITV Brand Extensions whereby one of the broadcaster's biggest brands, I'm a Celebrity... Get Me Out Of Here, features as a slot machine game exclusively at 32Red.com for casino, poker and bingo players.
32Red also sealed a deal with Channel 4 to sponsor the broadcaster’s 'Late Night Film' on Film4. The 12-month partnership sees 32Red's branding feature around both the 11pm and 1am film slots every night of the week. And a couple of months ago, 32Red announced the company's bingo brand,32redbingo.com, is sponsoring the new series of The Paul O’Grady Show on ITV. Investment in all these partnership agreements illustrates the proactive approach of the Gibraltar-based company in marketing the business and widening the potential net of new customers. To recap 32Red operates eight websites including: casino site 32red.com; 32redpoker.com; 32redbingo.com; 32redmobile.com; and 32redbet.com, a sportsbetting website. It also has three other casino sites: nedplay.com, goldenlounge.com and dashcasino.com.
Reassuringly, a trading statement this morning confirmed that the strong momentum seen in customer acquisitions and revenues in the first nine months of 2013 has been maintained in the final quarter of last year and also into the start of the new financial year.
Working out the numbers
To recap, in the first half of last year 32Red’s casino revenues rose 14 per cent to £16.5m, total revenues hit a record £19m and active casino accounts increased by a third to 42,500 customers after 32 Red recruited 17,500 new players. Importantly, in the first 10 weeks of the second half of 2013 underlying revenues was actually accelerating and that was before factoring in the upside from all the new sponsorships in the final quarter.
In the event the company has reported a 21 per cent rise in revenues to £38.8m, so is bang on course to at least achieve Numis Securities' 2013 pre-tax profit forecast of £4.7m, up from £3.2m on revenues of £32.1m in 2012. On this basis, EPS rise by almost 50 per cent to 5.9p and means the shares are now trading on 13.7 times 2013 earnings. But, as I pointed out earlier, this type of business is highly cash generative and I estimate 32Red's pro-forma net cash is currently around £6.5m, or 9.2p a share, after adjusting for the 2.5p (special) and 0.8p a share (normal) dividends paid out in the second half of last year. Strip this cash pile out and the earnings multiple falls to 12.2 times which is hardly an exacting valuation considering Numis predict that 2014 pre-tax profits will rise again to around £5.7m to produce EPS of 7.2p.
Moreover, there is a decent income stream too as analyst Ivor Jones at Numis is expecting the full-year ‘normal’ dividend to be lifted 30 per cent to 1.82p a share. There is ample scope for an even greater increase because that payout would be covered 3.5 times by net earnings. The respective dividend forecasts for 2014 and 2105 are 2.2p and 2.5p a share, implying a prospective yield of 2.8 per cent, rising to 3.1 per cent. These payout estimates could yet prove conservative because Numis is pencilling in EPS of 8.6p in 2015, implying annual earnings growth rate of around 20 per cent over the next couple of years and in turn offering scope for more net earnings to be returned to shareholders.
Indeed, if 32Red hits analyst forecasts for this year and next, and after factoring in the cost of paying out the dividends, the company's cash pile is going to surge to around £10.2m (14.5p a share) by the end of this year, rising to £14.6m (20.7p a share) by December 2015. These estimates are based on 32Red turning in cash profits of £6m this year, rising to £7.2m in 2015 which seems a sensible assumption based on revenues of £44.4m and £50.2m for the two financial years.
Still undervalued
To put 32Red’s lowly valuation into some perspective, net of the forecast year-end cash piles, the forward rating is only 9 times this year's earnings estimates, falling to a bargain-basement seven times 2015 earnings forecasts. In my opinion, a rating of around nine times 2015 earnings estimates net of cash is more appropriate for this type of business, implying a share price closer to 100p, or 25 per cent above the current price. This is my newly upgraded price target.
A higher rating is also well supported by the technical set-up. The 14-day relative strength index (RSI) is not overly extended with a reading of 70, the share price is trading only 10 per cent above its 20-day moving average (currently around 72p) so is not that overextended, and a move through January’s high of 83p would be a repeat swing buy signal. Beyond this there isn’t much in the way of technical resistance until the price hits a range between 97p to 102p, dating back to the summer of 2006.
So, ahead of the the full-year results on Tuesday, 6 March, and with revenues in the first 14 days of the new financial year already 10 per cent ahead of this stage last year, 32Red shares rate a buy priced on a bid-offer spread of 80p to 81p.
Game On
32Red is not the only company whose share price is on the verge of a repeat buy signal. So too is interactive gaming company NetPlay TV. Interestingly, the company’s share price hit resistance twice at 22.1p in November, but yesterday it finally closed above this level to signal a major triple top break-out and one that should be acted upon. Offering 18 per cent potential upside to my target price of 28p, I continue to rate the shares a strong buy on a bid-offer spread of 23.5p to 23.75p.
My confidence is not misplaced either as a fourth quarter trading update late last week, ahead of full-year results on Tuesday, 8 April, delivered the upbeat news I was anticipating and led to a raft of analyst upgrades. NetPlay TV announced that cash profits for 2013 will be at the top end of analyst expectations at around £5.2m, up strongly from £4.3m in 2012.
This result was in part driven by an increased contribution from both the mobile and tablet segment which delivered a 121 per cent rise in fourth quarter revenues to account for 30 per cent of NetPlay’s total revenues in the period, up from only 18 per cent at the same stage of 2012. The growth reflects greater brand awareness and online marketing efforts, including a major sponsorship deal of Big Brother and Celebrity Big Brother on FIVE, which is currently being aired and is being sponsored by the company’s SuperCasino brand. To recap, the company operates a number of interactive gaming services under an Alderney gaming licence including Jackpot247.com.
These deals have proved very successful and contributed to a 12 per cent increase in new depositing players to 15,648 customers in the three month period. Customer retention and acquisition rates are equally positive: average quarterly active depositing players increased by 27 per cent to 32,163 accounts, inline with the growth in the third quarter; and quarterly net revenue surged by a third to £7.9m.
Sensible use of cash pile
NetPlay's acquisition of Vernons.com, the e-gaming division of Sportech (SPT), is a smart looking deal too and one that will boost NetPlay's earnings per share in its 2014 financial year. The company acquired a registered use base of 367,000 customers across Vernons.com online casino, bingo, poker and sports books, not to mention an important brand to add to the company's own Supercasino.com and Jackpot247.com brands which are operated under an Alderney gaming licence. The £3m bolt-on deal also enables NetPlay to diversify its product range. For instance, the company will market its existing live roulette TV product to the acquired Vernons' customer database once the integration is complete (expected shortly). NetPlay has also signed an agreement with the vendor which will enable it to offer Sportech's football pools to its customer base.
Factoring in the benefits from the acquisition, analyst Amisha Chohan at brokerage Sanlam upgraded 2014 cash profit estimates by 9 per cent to £6.4m, based on net revenue of £33.3m, up from £5.2m and £28.5m for 2013. On this basis, expect 2014 pre-tax profits of £6m and EPS of 2p, up from £4.6m and 1.5p for the year just ended. And with cash generation better than expected the year-end cash pile is estimated to be around £13.5m, or 4.6p a share. It will rise even more this year assuming NetPlay hits analysts’ estimates; Sanlam is predicting net funds of £18.2m, or 6.1p a share, by the December year-end.
Anomalous valuation
Factoring in this awesome cash generation effect, NetPlay shares are now only trading on a prospective PE ratio of 9.5 for this year net of cash. This lowly valuation seems anomalous to me given NetPlay is wholly exposed to regulated markets. It’s also unjustified once you factor in the impressive cash generation of the business and the scope of the board to make further earnings enhancing acquisitions or return excess cash to shareholders. A 2014 prospective yield of 2.1 per cent, based on a payout of 0.5p a share according to Sanlam, is attractive even without the potential for special dividends. Analyst Michael Campbell at Daniel Stewart is even more bullish, predicting a dividend of 0.6p a share in 2014 to give a dividend yield of 2.5 per cent.
The shares are also attractively priced, trading well below analyst target prices. Daniel Stewart has a target of 26p; N+1 Singer has a valuation range of 28p to 32p, and Sanlam has fair value at 28p. No matter which way I look at NetPlay the shares are very undervalued trading on a bid offer spread of 22.75p to 23p. Offering 22 per cent upside to my target price of 28p, the shares rate a strong buy.
Finally, shares in Aim-traded Pilat Media Global (PGB: 92p) rocketed 24 per cent to an all-time high this morning after a major shareholder, SintecMedia, launched a 95p a share cash bid for the company. This is good news if you followed my advice to buy Pilat shares at 49p seven months ago ('Buy the break-out', 3 Jun 2013), advice I reiterated last month when the price was 67p ('Bumper upgrades for software maestro', 2 December 2013). I am currently assessing the offer and will be issuing another update once I have completed my analysis.
