Evolution In Regulatory Crosshairs After Illegal Gaming Accusations

Summary

• Since a U.S. law firm accused Evolution of operating in illegal gambling markets, the stock has fallen almost 30%.
• I believe Evo's future secular growth story is intact and they're still producing excellent numbers.
• Evolution is claiming the accusation was intended to intentionally discredit its business meaning if they're able to clear the accusation, the stock may potentially experience a swift catalyst.

MARHARYTA MARKO/iStock via Getty Images

Thesis

The thesis I published for Evolution (OTCPK:EVVTY) (Evo) back in October is still completely intact in my opinion. I believe the online gaming industry, specifically live casinos and random number generator casinos will continue experiencing secular growth over time. In my opinion, much of this growth will be attributed to further acceptance of the online casino legitimacy as well as legalization internationally. I also believe if Evo is able to capture a greater percentage of the industry's market share, acquisition-related growth will be a key catalyst.

After accusations from a U.S. law firm came out explaining Evo was operating in unsanctioned gaming markets such as Iran, the stock declined sharply. Adding fuel to the fire, a U.S.-based competitor of Evo also recorded themselves playing on online Evo casinos in Singapore and Hong Kong, where online gambling is illegal. Evo quickly made a public statement explaining the accusations were made to intentionally discredit their business. If Evo proves these accusations were false, the stock price may experience a swift upside.

If Evo is unable to disprove the statement in an adequate time frame I still believe current valuation levels are attractive for potential long-term future growth for the company.

Background

If you're unfamiliar with Evo's business model, I urge you to read the 'Background' section of my previous coverage posted on the company. I will mention in this article that Evo focuses extensively on compliance. Through rigorous game presenter/shuffler training programs and a focus on reliability and transparency, there is a basis for Evo claiming these accusations to be false. I also want to highlight the current licensure Evo holds in specific jurisdictions:

Source: Evolution Annual Report

Thesis Support

Short-Term Focus

On November 24th, a U.S. law group complained to the New Jersey Division of Gaming Enforcement [NJDGE] regarding potential Evo live casino operations in Iran, a violation of U.S. sanctions. Bloomberg also reported last month that a U.S.-based competitor leaked recordings of them playing on Evo casinos in banned international markets, Singapore and Hong Kong. These combined news drops sent Evo's stock down -45% since October 27th:

Source: TradingView

Short-Term Risk Mitigants

I believe there are a few mitigants to both these news drops that may present an opportunity for Evo. First off, Evo immediately responded to NJDGE and made a public statement explaining that the reports were false and produced with malicious intent. Obviously, just taking the company's word for it would be naive but I believe there is reason to believe them.

Evo is currently in the very early stages of online gaming adoption in major markets like North America. Jeff Millar, Evo's North America Commercial Director, reiterates this when he stated in the SBC North America Summit:

We've only scratched the surface on the content we are offering. We have live dealer and online slots. We think there is a lot of room for growth and now is the time to prepare operationally.

Source: Play Pennsylvania

To think Evo would throw away potential North American growth to scrap extra revenue out of illegal markets like Iran seems very unlikely, in my opinion.

I also think it's important to analyze the U.S.-based competitor to Evo who dropped news explaining that Evo was operating live casinos in Singapore and Hong Kong. Again, while this news hasn't been disproven, short reports like this are not uncommon in the online gaming industry. Back in December 2016, Paysafe & Bet365 were attacked with a similar short-style report claiming they were facilitating illegal gambling and Chinese capital control evasion. The day after reports came out, Paysafe fell -17.56% on the news:

Source: Created By Author Using Data From ADVFN

From 10/1/2016 - 12/13/2016, Paysafe fell -31.5%. After they distinguished the report and proved it falsified with malicious intent (similar to what Evo is claiming), the stock rallied back 95% in 7 months and was acquired soon after.

If these reports regarding Evo are proven false, the alleviated pressure could provide potentially quick upside possibly similar to Paysafe back in 2017, in my opinion.

Long-Term Outlook

Given a longer-term approach, I believe even without short-term pressures being alleviated this is potentially an alpha-rich spot to pick up Evo. As shown in my previous article, I forecasted Evo to grow revenue and EPS at annualized rates of 64.2% and 67.7% respectively:

Source: Created By Author Using Data From Evolution Annual Report

Price Targets

Using the same earnings and multiple projections I used in October, I conducted Evo FY '25 price targets and returns using the current stock price:

Source: Created By Author Using Data From Koyfin

(EPS-based PTs are calculated by multiplying EPS of $16.28 [€13.57 * 1.2x exchange rate] by the P/E multiples of 30x, 25x, and 20x. Revenue-based PTs are calculated by multiplying revenue of $5.543 billion [€4.619 billion * 1.2x exchange rate] by the EV/S multiples of 12.5x, 10.0x, and 7.5x subtracting net debt of -$147.25 million and dividing that by my projected 2025 diluted shares outstanding of 202.93 million. % Return and CAGR columns use a present value share price of $96.58. CAGR is using an n=4.25 years.)

Risks

While I believe there is a solid chance Evo will be able to escape this situation without a damaged reputation that lasts, I do still think there are major risks on the table. If these reports are true regarding Evo operating in unsanctioned jurisdictions, I believe expanding licensure across North America will become increasingly difficult. While the growth runway for Evo is excellent in my opinion, a lot of that growth potential could dissipate if legality issues present a challenge for them moving forward.

Summary

While future outlook and price targets for Evo look exceptionally rewarding, I believe potential returns won't come without risks. If Evo is unable to disprove the claims made by the U.S. law group and their competitors, the stock may continue trading down, in my opinion. On the other hand, if Evo disproves the claims, I believe the stock could snap back quickly and their long-term growth trajectory can stay intact. I believe the best way to look at this play is with cautious optimism. Management's execution thus far has been excellent and if they're telling the truth in their allegation responses, that execution may continue forward.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of EVVTY either through stock ownership, options, or other derivatives. 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.

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