Analysis: The quiet revolution at The Stars Group

The opening words of The Stars Group (TSG) CEO Rafi Ashkenazi couldn’t have been a clearer statement of intent. TSG, he said, was transforming “from a poker company into a global leader in online gaming”. The words echo those of his predecessor, Amaya CEO David Baazov, who set out the growth story as one of rapid expansion into new verticals and new customer demographics. But while he talked about 86 million “consumers not just gamblers”, the new TSG appears to have its feet a bit more firmly rooted on the ground.

In a year of record results, with casino now firmly established as a major revenue generator and poker remaining in a state of apparent health despite rumours of its imminent death, you could have forgiven a bit of grandstanding. But instead the talk was mostly of improvements to UX, product enhancements and a focus on CRM and marketing spend. The ‘operational excellence’ that has been much talked about in previous TSG presentations is beginning to bear fruit and the company is starting to look to redraw its corporate image.

“The final key strategic piece in our 2017 transformation was our re-branding of The Stars Group. This rebranding has turned the page on our past, and reflects the transformation our company has undergone in the past few years. It aligns our corporate identity with our celebrated customer-facing brands, most notably PokerStars, and recognises our expanded vision to become the world’s favourite egaming destination,” Ashkenazi said in the analyst call following its annual results.

It’s a clever comment, which can easily be explained as meaning turning the page on its early history as a B2B gambling supplier but it does leave open a little room for interpretation.

The casino big bang

Some of the sheen may have been buffed off from the various struggles and share price dips from the Baazov-era Amaya, but in terms of online revenue, and particularly in terms of EBITDA, there are few firms who can be considered at the same level as TSG. Full-year revenues were up 14% (or 10% in constant currency) to $1.3bn, while adjusted EBITDA was up 14% to $600m. Growth then was in line with, or slightly ahead of, that in the wider online gambling market, but it should be noted the vast majority of TSG’s growth was from its emerging casino and sportsbook verticals.

Poker revenues have remained fairly stable since 2015. While they dropped from around $1.1bn in 2014 to $887m in 2015, and further again to $846m in 2016, they rose 4% in 2017 to hit $877m. On a currency basis, stripping out the euro gains against the US dollar, growth was just 1% but considering the shift in revenue mix in the period, maintaining poker revenues is a reasonable achievement. Casino has been taking the lion’s share of revenue growth in the past two years.

When it comes to casino and sportsbook revenues (TSG doesn’t break these out in its reporting), they were $136m in 2015, $264m in 2016 and $376m in 2017. And the vast majority of this came through casino, with it representing 81% of the casino and sportsbook vertical in Q4 2017 despite sportsbook revenues near doubling over the course of the year and sports results being very strong in the quarter. In short, TSG’s transformation into a global gaming leader is very much driven by casino, which is in turn driven by cross-sell from poker.

TSG’s casino vertical has had minimal external marketing and has focused almost entirely on the cross-sell to-date and this looks set to continue with poker and increasingly sports seen as the acquisition channels. It’s a model that is working for TSG and investment into casino will be less around marketing and more around content and product enhancements as well as ramping up its VIP programme. But the question remains as to how much more TSG can grow its casino vertical once it has captured the low-hanging fruit from its poker database and geographic expansion.

Building for the future?

Ashkenazi noted investment in casino “is designed to increase the share of wallet and yield of our existing players”, not least through new content. One interesting aspect of this was Ashkenazi drawing attention to the development of games from its in-house studio, which he said had shown good results so far. Some of the UK operators, notably Paddy Power Betfair and Coral, have previously spoken of the value of their in-house studios and the ability to improve yields through these games but it’s an area they have been fairly quiet on in recent months.

A quick glance at the major operators shows the likes of NetEnt, Blueprint, Red Tiger Gaming and Yggdrasil tend to dominate placings even at the expense of in-house games on the non-Playtech casino brands, and it will be interesting to see if TSG can buck this trend with its own games or will default to promoting third-party content. One more interesting growth potential for TSG in casino remains in the international sector, particularly on the dot.com side where it still has a strong global reach.

With the casino product now available to three-quarters of its poker players, it’s tough to see there are too many worlds left to conquer, but there is the potential to focus more keenly on improving the product for local markets. Ashkenazi pointed to more work on localisation and “specific products for specific markets”, which may give some more headroom for growth, especially in the Asian market.

The other core question is to what extent poker can continue to provide a source of new players. Active players declined year-on-year in Q4, although this was explained away due to TSG pulling out of Australia and Colombia as well as a focus on higher-value player types, and poker revenues were effectively flat year-on-year on a constant currency basis. The firm once again said how it was investing and experimenting with new poker products to appeal to a new demographic, but we’re yet to see any convincing results of this. And a lack of growth in poker will place more risk on cannibalisation with the big casino machine now a hungry beast that is capable of chewing up and spitting out players at some rate.

The big Russian elephant

The biggest talking point, however, was around Russia, with TSG stating it could face payment blocking from May and the share price dropping suddenly as a result. The Russian market is believed to be responsible for as much as 10% of group revenues and management confirmed it was one of their top six markets. “We are currently reviewing recent Russian regulations that will likely restrict the number of Russian payment processors who elect to engage with offshore online gaming operators. We are actively monitoring this situation, and proactively developing a strategy to address any potentially negative outcome,” Ashkenazi said.

Ashkenazi added the potential ban was factored into guidance and there was a “robust” mitigation plan prepared with a Plan A, Plan B and Plan C for various scenarios, but it’s hard to think the loss of Russia won’t be a big hit to revenues. It is particularly ironic considering the $400m deferred payment it made in May 2017 to the original owners of the PokerStars business that was contingent on no change in the Russian regulatory environment. The Russian issue also illustrates the potentially volatile position TSG is in with a number of its grey markets.

Management noted 57% of its revenues were “locally taxed”, although this includes the German market where further changes to regulations are expected in the short term. But the company also operates in markets in Latin America and Asia as well as other international markets that are not without regulatory risk. Brazil looks to have parked its online gambling legislation for another year, but the rate of change in any of these markets can be sudden and not often positive for operators in the region. We don’t see any specific near-term risks for TSG, but it’s notable Russia has gone from being a potential positive for the operator to a large negative in a relatively short space of time.

A market that looks a lot more regulatory-friendly is Australia, where TSG has invested heavily in acquiring the CrownBet and William Hill Australia business. Ashkenazi said the deals were “consistent in our stated strategies of increasing our sports betting revenues and diversifying our revenue base”. He added there would be synergies from the combined businesses and it gave TSG an advantage of scale in a market facing considerable regulatory change. As a local market play, it clearly holds some growth potential but there is limited crossover into its existing business and it seems Matt Tripp and his team are mostly going to be left to run the business as a separate unit.

BetStars’ growing pains

An area they did hint at was the use of the CrownBet platform for any potential expansion into US sports betting, although they were keen to point out it would not be used for its BetStars operation. There was also no comment on what brand would be used for the combined business, simply that there would be a rebranding process later in the year, although it’s unlikely BetStars would be the brand adopted. In short, it seems like a bolt-on deal and one that has good potential to be profit-enhancing in the longer term, although we’d expect it to have to remain in an aggressive growth phase in the short term.

Poker revenues have stayed relatively flat since 2015, with much of TSG’s growth from casino and sports betting

But Australia is far from the end of TSG’s sports betting ambitions and what happens next to BetStars is perhaps more interesting than the future health of its Australian business. TSG’s sports betting vertical was just 6% of group revenue in Q4 2017 despite revenues growing nearly 90% last year. The firm said it expected sports betting to become a more meaningful contributor in 2018 and wanted to make sports betting “a second engine for customer acquisition”, but it still feels like there is a lot of work to be done here.

Ashkenazi said the firm was investing to get to “product parity”, and it’s fair to say the current BetStars app is not up to the level of some of its currently listed peers. But closing the product gap seems like the action of a firm with an existing sports betting database, not one chasing one or trying to encourage players to switch their activity from their existing brands. The TSG presentation said further sports betting acquisitions will be considered, and this must remain a consideration bearing in mind the gap that needs to be closed.

But make no mistake, there is an opportunity here. Outside of bet365 and GVC, there are no major operators with the depth and breadth of international reach TSG has with payments already functioning in those territories. If it can get its product and marketing right, then it has the potential to gain revenues in countries and territories where it has a huge inbuilt head start. And the World Cup clearly provides it with a great acquisition opportunity. But there are a lot of ‘ifs’ within that and solving sports remains the biggest task TSG faces. It’s here we may still see it need to look again to M&A as it strives to make one more big leap forward.