One reason for the dramatic share price slide can be attributed to the company failing to make clear in its press release the actual underlying financial performance at the pre-tax level. In fact, it took me some time to reconcile the IFRS reported numbers with the underlying figures. So, investors have assumed the company missed guidance when in fact the adjusted reported pre-tax profits increased by 50 per cent from £3.2m to £4.8m as analysts had predicted. This figure was nowhere to be seen in the RNS announcement made to the London Stock Exchange, a glaring omission for a company with a significant retail following.
Moreover, by simply giving the reported full-year pre-tax profit figure of £2.28m, up from £2.04m the year before, many investors have wrongly assumed profits have lagged massively behind analysts’ full-year profit forecasts of £4.8m when in fact the company delivered on its promises. To reconcile the IFRS reported pre-tax profit line with the underlying pre-tax profit line in the accounts used by analysts you need to adjust for: a non-cash amortisation charge of £587,000; a non-cash charge of £326,000 for share option costs for directors; a £184,000 exceptional credit relating to the litigation costs and damages won against William Hill (WMH) for infringement of copyright; add back a £422,000 bonus issued to directors for the successful court win against William Hill; account for one-off costs of £160,000 for legal costs relating to the UK government's proposed point of consumption tax and new regulation; and finally add back a £1.2m loss on the Italian start-up operation. Tot up those amounts and you will arrive at adjusted pre-tax profits of £4.8m.
On this basis, adjusted EPS increased by almost half from 4.1p to 6.1p, rather than the 10 per cent growth reported in basic EPS. Or put it another way, underlying EPS were actually almost double the reported EPS of 3.1p, so if investors were taking the reported numbers as the underlying numbers, as clearly some have mistakenly done so, then it’s hardly a surprise the shares sold off heavily.
I have a clear message to the board of 32Red: if you would like investors to value your company on the basis of its underlying performance, then make a point of spelling out the adjusted pre-tax profits and EPS figures in the release and how investors should arrive at them. Otherwise there is potential for your company’s financial performance to be misinterpreted, something that clearly has happened with this latest set of results.
Higher UK government tax looming
The other reason 32Red's shares sold off was the aforementioned £160,000 charge for legal costs occurred in relation to the Gibraltar Betting and Gaming Association's (GBGA) challenge to the UK government's planned introduction of point of a remote consumption tax for online gaming companies. Introduced in the UK parliament in August last year, where it passed its first reading, the proposal includes a 15 per cent tax on the gross profits of companies that have UK customers. The tax is due to come into effect in December this year and some industry experts predict that it could generate around £300m in extra tax revenue for the UK Treasury. All offshore gambling companies will be taxed on their gambling profits from UK customers, and that includes Gilbraltar-based 32Red.
Gaming companies will be liable to pay remote gaming duty, general betting duty or pool betting duty, all of which will be taxed at 15 per cent. Currently, Gibraltar-based companies enjoy a tax rate of just 1 per cent and this is capped at £425,000. The standard rate of corporation tax in Gibraltar is only 10 per cent which also helps to explain why The Rock has proved so attractive for the offshore gaming industry. That is likely to remain so irrespective of the introduction of the remote gambling tax. Indeed, a large amount of the £2bn of annual revenue by the remote UK gaming market is generated by Gibraltar-based gaming companies. The change will affect some of gambling's biggest names including Ladbrokes, Bwin.party and William Hill, all of which have online operations in Gibraltar.
That said, we have known this for a long time and a 15 per cent tax take on 32Red's gross profits of £7.9m last year would still only equate to a quarter of its adjusted pre-tax profits of £4.8m. Moreover, it’s still beneficial for the company to base its operations in Gibraltar given the miniscule corporation tax rates.
Low rating
It's also worth flagging up that after the share price sell-off the company is hardly expensively rated given that analysts' cash profit forecasts of £6m, up from £5m in 2013, should be achievable. This assumes net revenue rises by a round a fifth to £30m this year. The current year has got off to a decent enough start with net revenues up 5 per cent in the past couple of months. That's a decent outcome considering net revenues were up 13 per cent on the same stage last year, so the comparatives are hardly easy.
On this basis, expect adjusted pre-tax profits to rise to £5.7m and produce EPS of 7.3p. In turn this underpins a normal dividend of 2.2p a share, up from 1.8p in 2013, implying the shares are trading on less than 10 times earnings estimates and offer a forward yield of 3.2 per cent.
Cash generation remains robust even though net cash was down by £1m to £3.4m last year. That was because in the second half 32Red invested over £1.8m in capital spend and had a £2.6m outflow from financing activities, partly reflecting the payment of a special dividend of 2.5p a share.
The ongoing capital investment is money well spent given the growth being seen in the business: active players in the core 32Red casino business rose by almost a quarter to 71,266 last year and yields were pretty robust at £500 per player, down only slightly from £485 in 2012. And the take-up of mobile customers is as impressive as ever, representing a fifth of casino revenues overall, having more than doubled last year. Ultimately, this segment will account for the majority of the business in the future.
Marketing spend continues to reap decent rates of return including a three-year deal with ITV whereby the hit programme '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 sponsors Channel 4's 'Late Night Film' on Film4 around both the 11pm and 1am film slots every night of the week. Investment in all 32Red’s partnership agreements highlights a proactive approach by management to widen the potential net of new customers. Indeed, over 20,000 new depositing players were recruited by the 32Red casino in the second half of the year alone.
Still undervalued
To put 32Red's modest valuation into some perspective, the rating is only 10 times this year's likely earnings and that ignores a cash pile worth almost 5p a share. Clearly if 32Red generates £6m of annual cash profits, or the equivalent of 8.3p a share, then the current £3.4m cash pile is going to swell even after the payment of the 2.2p a share of dividends forecast. In fact, that cash pile could easily double by the year-end to around £7m as analysts predict. In other words, net of forecast cash at the end of December 2014, the shares are trading on a miserly eight times earnings estimates.
So, even after factoring in the new government tax next year, that rating more than discounts the likely impact on earnings in 2015. Interestingly, the shares have retreated back to their 200-day moving average around 65p. In bull markets the best time to buy is on a dip back to this long-term trend line and with the 14-day relative strength indicator (RSI) showing a massively oversold reading of 20, the time to buy is now. I maintain 32Red’s shares have a fair value of 100p, almost 50 per cent above current levels. On a bid offer spread of 68p to 69p, and ahead of the next trading update in July, the shares rate a buy.
I would also point out that the accompanying sell-off in shares of Aim-traded Netplay TV (NPT: 17.75p) is a great buying opportunity in advance of the company's financial results on Tuesday 8 April. The 14-day RSI is even more oversold than that of 32Red's - showing a reading in the high teens - and the share price is now at a support level and also back to its 200-day moving average. Trading on a bargain basement 2014 PE ratio of 6.5 net of cash, Netplay TV's shares are not only a great trading buy, but offer significant upside potential to both analyst target prices and my own. 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 TV, the shares are hugely undervalued on a bid offer spread of 17.5p to 17.75p. Offering 58 per cent upside to my own target price of 28p, they rate a strong buy and I can only reiterate my previous positive recommendation ('Punting on new highs', 16 January 2014).
Please note that I am currently working my way through a large number of announcements from companies on my watchlist and which I plan to update. These include: LMS Capital (LMS), BP Marsh Partners (BPM), Eros (NYSE: EROS), First Property (FPO), Trading Emissions (TRE), Polo Resources (POL), Global Energy Development (GED) and Raven Russia (RUS).
