"There's more risk in what happens in Microsoft than I could ever bet on a poker table."
- David Einhorn, Greenlight Capital, Inc.
As far back as April 2015, we saw Amaya (NASDAQ:AYA) as the best possible bet in the online gaming space. It was the largest operator in the space, it had scale, scope and an upward earnings trend. The company was led by a super-aggressive young chairman, who had dazzled the market in acquiring the huge PokerStars and Full Tilt business for $4.9 billion. His daring move had been largely financed by Blackstone, lending significant credibility, if not admiration, from shareholders and the financial community.
We followed that post up with one on October 5, 2015, when the company announced it had passed muster in New Jersey and was poised to start operating its real money gaming sites in that state. The shares spiked 14% on the news to $21.
In addition, our view then was supported by the blockbuster rise of the sports betting sites like DraftKings and Fan Duel. Amaya had announced its entry into that sports business with an acquisition of a small site it expected to ramp up to compete head to head with the two sector giants. Both DK and FD were getting closer to IPOs, the sun was shining and the TV airwaves were drenched in their commercials.
The timing was perfect for Amaya's move.
Then attorneys general around the country began taking a closer look at the legal underpinning of the sports betting business. Long assumed that a federal carve-out, which had characterized the business as "skill-based" and therefore not subject to gaming regulation, it was challenged. State after state took legal action to call a halt on or examine the business, clearly leading to what most agreed was a legal redefinition that it was, in fact, gambling.
That change, in my view, impaired the company's future in that sector, which I believed was among its most promising. But there were other jokers in Amaya's deck. And they weren't wild cards.
We cautioned investors to still keep their eyes peeled as securities regulators in Quebec (Amaya is based in Montreal) launched a deep dive investigation into insider trading surrounding the PokerStars transaction in 2014. Last March, the hammer came down. Authorities leveled 5 charges at the company and also named several of its executives, including CEO and Chairman David Baazov, as allegedly having traded on insider information.
Baazov denied the allegations, but took a temporary, immediate leave of absence from the company with an undefined return date. Shortly thereafter, in yet another dramatic move, Baazov, who owns 24.5 million shares and holds options on another 550,000, announced his intention to take Amaya private at $21 a share. How serious this offer can be is problematical at this point, at least until Quebec authorities and the company arrives at some settlement that presumably clears the path for the company's future.
Last month, Amaya held a board meeting with shareholders that was closed to the media and the public. No comments emerged from the meeting, which, according to a company spokesman, was "appropriate" given the current circumstances.
That left one joker still not dealt from when we first looked at this gun-slinging company. However, there's another one we've plucked out of the deck, which, in many ways, poses a far greater challenge to the Amaya share price, and we think warrants a short or at least folding your Amaya hand now until the jokers move to the discard pile.
- Amaya's ring games (live real money stakes in which players can enter or leave at will) business is rapidly drying up. Average 7-day traffic on PokerStars ring games, the world's largest, has plunged to a 9-year low. Over six years, the site has dropped to 11,500 players, off 50% over 6 years. Since January 2016, cash game liquidity has declined 31.5%, a continuation of an already negative trend.
- The company's Spin 'n Go feature, basically a lottery prize added randomly to pots as the game progresses, has damaged liquidity badly, according to our sources in the online gaming community.
- Regulatory complications are increasing across Europe. Taxation has increased (Greece), regulations are being restructured in Eastern Europe, business risk in Israel is increasing and new restrictive regulations are under review in Poland and the Czech Republic, which encourages flight business to illegal sites in those countries.
- U.S. legalization efforts have slowed to a trickle, if not stopped. Right now, online real money gaming is legal in New Jersey, Delaware and Nevada. Last year, promoters in legislatures, lobbyists and companies in as many as 8 states were touting that support was growing rapidly, and in some cases, legalization was around the corner. Most, if not all, of these initiatives have either stalled or gotten into near-death spirals. As of this writing, a consensus of online gaming observers we know agree that only Pennsylvania has a "realistic 50/50 shot" at legalization within the next two years.
- Amaya has phased out its VIP Club loyalty program, which, though expensive, has lost strong play.
- The company has capped its rakeback at 30%, down from 70% in 2015. High-stakes players no longer receive rakebacks, the rough equivalent of cash comps based on play. (The basic "rake" that poker sites get is 5% of the amount played off the top.)
- Amaya has eliminated players' ability to hide hole cards during all-in confrontations. This was a popular feature whose loss has hurt volume.
- We checked with professional industry sources who share a belief that PokerStars revenue fell 11% yoy from Q1 15 to Q1 '16.
Despite these strong negatives the company's Sunday Million tournament is up yoy, but not enough to offset losses in other games.
- Though it's not supported by any comprehensive study yet, from the results, according to our industry sources, it is clear that online poker as we know it is beginning to show signs of age. Interest is waning, the category's meteoric growth has stalled and Millennials, who comprise the bulk of its customer base, are showing their penchant for shrunken attention spans that is likewise reflected in other forms of gaming. Amaya's key strengths, in our view, were its existing universe of players, its ability to expand to new sectors like sports betting and its really good product. But the company's basic business model, it seems to us, is now under challenge as well.
At the Moment
Amaya trades at $15.38, and its 52-week range is $9.67-26.35. Trading volume is thin at an average 135,233 shares a day, with a market cap of $2.06 billion. Its P/E ratio (ttm) is 8.99, and its diluted EPS is $1.71.
None of these numbers, per se, are terrible. Underlying the negative outlook here, we still believe Amaya has a platform with intriguing potential over the long run. However, given the jokers outlined here, we see a case building for a possible short play on the stock, which could send it lower until, at least, Quebec authorities and the company reach some kind of settlement.
Baazov and his people have signed NDAs to examine Amaya's numbers as part of what they claim to be a still serious effort to take the company private. Whether that continues in process or not could be largely academic, since it's hard to fathom how the deal could be done before a settlement is arrived at with Quebec authorities.
Beyond the Settlement
Amaya is still a company with good bones. Yet, we are still hesitant to call it as a hold or neutral entirely based on the two jokers yet to be played. Until that time, the continuing decline in its core poker business remains a deep concern and, in our view, kills much of the rationale for investing in the shares at the moment.
We think that going forward there is a case to be made for as much as a 30% downside on the shares, regardless of what numbers may follow. We appreciate that the interim managers of the company are making every attempt to combat lagging demand, innovate marketing programs, shore up margins and meet debt obligations: 57.30% of EV, near double that of its reasonably settled peers. Yet, at this moment, we remain skeptics at $15.
There is another scenario if you are inclined to hold - that is, if Quebec settles insider trading charges that Baazov and his associates can live with. It appears that Blackstone, though quiet through this maelstrom, could step to the plate again and finance the private sale, reorganize management, put stronger compliance structure in place and reset the company back on a strong runway to growth. If you want to bet on that, you can sit on the shares at $15 and wait it all out. If not, in our view, this could also get worse and it's time to fold 'em. Otherwise, bet on a further drop.
About the author: Howard Jay Klein is a 25+ year C-level executive of the casino industry and a consultant. He is the author of Mastering the Art of Casino Management and publisher of The House Edge marketplace site on SA. His own gaming stocks are held in a blind trust to avoid conflict of interest with clients.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.