Analysis: Kindred setting sail for the new world

It’s an odd thing to wonder about the health of a company which finished 2018 with revenues up 21% to £908m, but there are looming question marks hanging over Kindred at the moment. In a vacuum, its record results with £203m in EBITDA suggest a business surging, with Western European revenues up 34% year-on-year and the business finally beginning to feel the benefits of its UK acquisitions. But with growth slowing in the second half and its peer group operating at an ever-increasing scale, there remains more than a few nagging doubts about its future.

After a torrid year of near-perpetual share price decline in 2018, the financial markets seem to have fallen back in love with Kindred, however, and at the time of writing the shares are up around 30% from a low point at the turn of the year, although still a fair way down on this point in 2018. A better than expected Q4, double-digit growth in Q1, talk of M&A and expansion in the US are all probable reasons behind this uptick. But it remains one or two acquisitions off the very top tier and the organic growth story from here is less obvious and certainly less compelling than in previous years with a number of significant challenges to overcome.

The first and most obvious is the Swedish market, which is already looking unlikely to generate near-term growth, and the rest of the Nordics remain a confusing picture. Beyond that there is the UK market with its ever-increasing regulatory scrutiny; the difficult Belgian market, where this year Kindred dodged a bullet in terms of a VAT hit; the Netherlands, where legislation could cause as many problems as it solves; and smaller growth markets such as Germany and Italy with their own issues. In short, the growth story is not super clear outside of M&A and the brave new world over the Atlantic, and it appears management have their eyes firmly fixed on both.

Looking stateside for future growth

While much has been said about William Hill, Paddy Power Betfair and GVC’s ambitions in the US markets, Kindred has been widely ignored so far, but it used its Q4 results to plant a large stake in the ground. “This is potentially the largest market globally and a very big opportunity for us,” Kindred CEO Henrik Tjärnström said in Kindred’s Q4 results presentation. “We are building our presence and we are looking to go live in New Jersey in early March and later on this year in Pennsylvania,” he added, with the firm having signed deals with Resorts and Mohegan Sun in the respective states.

Defining how “huge” this opportunity is doesn’t come easily though. NJ and PA are the two core markets for any online operator looking to crack the US, but the real opportunity will come outside of these over the next few years as more populous states regulate. There are no guarantees mobile will be part of initial legislation, however, nor that operators without existing market access details will be able to compete on a level playing field. As Chris Grove from Eilers & Krejcik Gaming notes, this is a market tending more towards protectionism than openness at the present time. But that shouldn’t mean we should rule out Kindred at this point and there is some notable upside for them here.

A research note in the summer from Nordic financial services firm SEB said Kindred could generate as much as £500m from the US market by 2025, although we imagine management’s expectations are a bit more modest and a lot more realistic with the US “in line with a small European market” for CY19, according to management. This is without doubt a long-term plan for Kindred. “The investments will be spread out over several years and we have confidence we have what it takes to be successful in the US,” Tjärnström said. And what may work in its favour is its experience in some of Europe’s more restrictive regulated markets.

Expanding Europe to the US?

Certainly their travails in Belgium or France or the torturous roll-out of regulation in the Netherlands will have taught it a lot about flexibility and staying on the right side of some wildly shifting regulatory moods. “It’s almost like 30+ new countries coming live. But the difference from Europe is it’s coming in a shorter space of time and we believe we have the scale and the ability to handle that situation,” Tjärnström noted. For Kindred this means building teams on the ground in the US with a mix of local and European experience and treating each new state like a brand-new market.

It’s a viable strategy, although it will depend a lot on the favourability of regulations and some luck in finding and striking the right partnerships in each state as it opens up. But there is no lack of confidence here. Even if all goes to plan and Kindred manages to execute perfectly on its US plan, the very best it can hope for in 2019 and even 2020 is a small uptick in revenues and a break­even contribution to bottom line. What it doesn’t solve is the nearer-term growth issues the business, and indeed the rest of the egaming industry, faces. And while it’s easy to get swept up in the optimism and potential of the US market, there are a number of headwinds to contend with in the European market, which all acted to slow down growth in its core business in the final half of the year.

Fourth-quarter results showed 5% year-on-year revenue growth to £250m, which Tjärnström was keen to state was a good performance against a prior year when sports betting margin was at a very high level. Sports betting margin was remarkably stable against what the industry has described as exceptional results in the prior year. Kindred’s margin after free bets was 9.4%, compared to 10.5% in Q4 17, which was a much softer fall than anticipated due to European soccer and ice hockey results. As a result, sports betting posted 3% year-on-year growth with 9% decline in the Nordics, outweighed by 10% growth in Western Europe.

Gaming performance was soft, although the two are not unrelated due to cross-sell issues, with 7% year-on-year increase to £125.2m in the quarter. Once again a strong performance from Western Europe, up 17% year-on-year made up for 2% decline in the Nordics although 36% growth from the much smaller Central, Eastern and Southern region was a positive sign. But generally Q4 with 5% group revenue growth after a Q3 of 19% year-on-year growth looks less eye catching than the 36% growth seen in 2017 and the 33% growth seen in H1 2018. Kindred said daily revenue through the first six weeks of 2019 was 17% higher than in the previous first quarter, but it remains to be seen how that holds up through what is sure to be a difficult opening period to the year for many firms.

EBITDA was also down 21% in the fourth quarter to £59m on the back of a hike in marketing spend and betting duties in the period as Kindred felt the cost of scaling up in regulated markets and pre-regulation Sweden. The overall picture then is one of tightening margins and slowing revenue growth. Tjärnström said he expected to still continue to grow faster than the wider market, but it’s possible that wider market could slow considerably
through the course of the year. The Nordics in particular looks a tough market right now, with single-digit decline all year slowing to -5% in Q4 and its core market of Sweden throwing some curveballs as it shifts to regulated for the first time.

Swedish smoke signals

Kindred noted it had invested heavily in marketing in the early weeks of the Swedish market with all customers given an additional bonus as permitted by the regulations, leading to a spectacular looking 97% rise in active customers and a 166% rise in new depositing customers over the last 90 days. But this is not as yet translating to revenue. There is likely to be a short-term hit in the Swedish market as competitive pressures rise with the addition of the ex-monopoly operators into the gaming market in particular, and no rationalisation yet in terms of smaller operators getting squeezed and some unregulated operators still active in the market.

Tjärnström noted they were seeing “very strong underlying activity” and that the regulatory environment would benefit them in the longer term. “We have five strong brands and we believe we are the market leader behind the incumbents, and we expect things to become much tougher for the smaller operators and that will be to the advantage of the larger operators over time. We are seeing some very positive indicators early on in the process.” He added that the mandatory deposit limit and national self-exclusion was bang in line with its view of creating a sustainable business. “I’m absolutely not ruling out growth in Sweden in Q1 but it’s important to build for the long-term.”
But if Sweden is another market that may give some short-term pain for longer-term gain, it is to Western Europe where the business will have to turn for immediate growth. Western Europe took the largest share of revenues to-date in Q4 with 59% of group revenues and Kindred is confident of gaining share in the UK saying they were seeing good results from 32Red and would continue to invest there in 2019. Its other core Western European markets are France, Belgium and the Netherlands, although the latter presents some issues in the year ahead.

The Netherlands has once more raised the issue of blacklisting operators active prior to the new law coming into effect. “I’m not saying it won’t happen in the Netherlands, but we have no indication it will happen to Kindred there,” Tjärnström said. But an ever-more cautious approach in that market may be a net result, and with the UK also looking difficult it begins to get harder to see the obvious easy growth in the year ahead. But there is, of course, one other glaringly obvious part of the puzzle that could still make the difference and that is M&A.

Caution to the wind?

“We expect more M&A in the future,” Tjärnström said, adding the important thing was “to buy the right assets. No doubt there will be more, and I would be extremely surprised if there isn’t”, he said. What is less clear is where Kindred turns for acquisitions or how big it is thinking. “M&A is part of our DNA, and we have done some smaller and some slightly larger, such as 32Red. That is clearly in scope and even bigger than that if we find the right opportunity,” Tjärnström added. Acquiring in some of its core markets would seem the most logical proposition, but good targets look in fairly short supply or overpriced in the Nordic market at least. And it was illuminating to hear Tjärnström look much further afield for future prospects.

“We’re also looking at opportunities in markets where we deem re-regulation is happening and will give favourable operating conditions. We see clear opportunities longer term from regions like South America, Africa, India and Asia. Those could come either organically or through M&A as well,” he said. Could Kindred make a game changing acquisition outside of the European markets it’s mostly depended on for the past two decades? In the current environment we certainly wouldn’t rule it out. But it would be a bold move from a firm that has benefited so well from gradual expansion to adjacent markets.

One thing that feels more likely is Kindred will make some kind of acquisition in 2019. Tjärnström noted the business had gone from 2012 to 2015 without a deal, but this is its longest period since then and these are very different times where the markets demand scale and growth seems very hard to come by outside of M&A in the short-term. This is not a business to act rashly and it will wait for the right opportunity, but there is a sense of expectation building and both the markets and the rest of the industry will be watching very closely to see which way Kindred jumps next. Perhaps it might be in a direction nobody expects.