Evolution AB | Has the dust settled?
A closer look at what's happening under the hood.
Evolution AB (hereafter ‘Evolution’) has been a highly discussed company within the investment community: some love the stock, while others avoid it entirely. Regardless of personal sentiment, looking objectively at the numbers suggests an appealing opportunity may have emerged.
Evolution operates in the online gambling sector, specifically dominating the live casino segment. With the broader market expected to grow at roughly 10% annually in the coming years, Evolution, as the undisputed market leader, should, on the surface, be able to grow at a similar rate simply by benefiting from this secular tailwind. Furthermore, with operating leverage deeply embedded in its business model, profits could increase at an even faster rate.
Yet, the company is currently trading at just around 12.5x earnings. This needs a closer look: is Evolution a classic value trap, or an investor’s opportunity of a lifetime?
The Business Model
Simply put, Evolution creates and develops live casino games and broadcasts them via live streams to online casinos. Instead of dealing directly with the end consumer, the company operates a B2B model where it receives a commission (typically between 10% and 20%) of the online casino’s revenue generated from these games.
This structure makes Evolution’s business model incredibly scalable. Once the break-even costs are covered, which primarily consist of the dealer’s salary, cloud broadcasting infrastructure, and basic studio overhead, every additional player who joins the virtual table and generates commission translates to almost pure profit. It is this phenomenal operating leverage that allows Evolution to consistently generate staggering net income margins of around 50%, a metric that most companies can only dream of.
North America Expansion
Being aware of a huge untapped market, Evolution set its sights on the U.S. and in 2018, opened its first purpose-built U.S. studio in New Jersey. Fast forward to today, and North America stands as one of the company’s fastest-growing geographic segments.
However, the U.S. market comes with a unique structural quirk. Due to strict state-by-state gambling regulations, cross-border gambling is largely prohibited. This means Evolution is legally required to build a physical broadcasting studio in every single state where it wishes to operate. They now have dedicated studios in states like Pennsylvania, Michigan, and Connecticut.
As a double-edged sword, this localized requirement makes them much less flexible in their operations in Europe because they can’t just stream from one central mega-studio to the whole country. Putting in state-specific infrastructure takes a lot of money, time, and trouble with the government. This creates a huge economic moat that keeps smaller competitors away.
Regulations are tough but can also strengthen moats.
EU Ring-Fencing & Asian Hijackers
Despite its success, Evolution’s path is not without challenges.
In Europe, the company is facing the ongoing trend of “ring-fencing.” Ring-fencing means ensuring that the players can only reach Evolution’s content from licensed operators within their respective markets. This process has now been going on for a year, and as the numbers below show you, it hasn’t ended yet.
There is still no way to know when the trend of ring-fencing regulations will end and growth will start up again. Not only does ring-fencing hurt the company’s European sales, but it also hurts its margins badly because fewer players pay the fixed costs.
Meanwhile, in Asia, Evolution has been battling a frustrating technological issue: stream hijackers. Unlicensed, rogue operators have been scraping and restreaming Evolution’s live casino video feeds to their own black-market players, bypassing Evolution’s commission structure entirely.
Management has been very vocal about wanting to fix this. On recent earnings calls, CEO Martin Carlesund talked about how the company is using aggressive, localized technology to stop these unauthorized scrapers. Carrelsund said that putting these strict blocking measures in place hurt Asian revenue growth for a short time, but that it had to be done. Protecting their intellectual property ensures that Evolution’s moat remains intact.
Asia’s revenue (and likely profitability even more) took a serious hit, but also here the most painful period seems to be behind us. Asia revenues have now grown for a second quarter in a row (QoQ). Carlesund noted;
“We are in a better place right now than a year ago. However, as the challenge has been somewhat of a cat-and-mouse game, we remain cautious.”
The Competitive Landscape
Evolution is the undisputed king of live casino, but the lucrative nature of the market has attracted serious competition. While (way) smaller in scale, these rivals are fighting hard for operator shelf space. Here are Evolution’s three main competitors:
Playtech: Evolution’s oldest and most formidable global rival. Playtech has a massive presence in Europe and Latin America. Unlike Evolution’s pure-play live casino focus, Playtech offers full turnkey solutions (sports betting, slots, platform management). They operate state-of-the-art studios in Riga (just like Evolution) and are aggressively developing game-show-style titles to challenge Evolution’s leadership.
Pragmatic Play: Originally dominating the digital slots market, Pragmatic Play has aggressively entered the live dealer space. They are arguably the fastest-growing competitor today. By utilizing aggressive pricing and cross-selling strategies to operators who already use their slots, they have built a strong global footprint, rapidly expanding their live portfolio to mimic Evolution’s core offerings.
Authentic Gaming (Light & Wonder): Acquired by gaming giant Light & Wonder, Authentic Gaming carved out a unique niche by streaming live roulette directly from the floors of famous brick-and-mortar casinos (like the Bellagio) rather than closed studios. With the financial firepower of Light & Wonder behind them, they are steadily expanding their footprint in both the U.S. and Europe.
Because many players have to choose between watching a movie and a gaming show, management has also talked about Instagram and Netflix as serious competitors. We won’t call them key competitors, though, because they’re not in the same business.
Back-of-the-Envelope Valuation
With a clear understanding of the highly scalable B2B business model, the growth catalysts in the U.S., and the evolving competitive and regulatory landscapes, the ultimate question remains: what price are we paying for this underlying business?
Let’s take a brief look at how Evolution is currently valued by the broader market…
The Story
We expect Evolution’s ring-fencing measures and Asia-related hacking issues to impact revenue over the next few years. Thereafter, these issues should largely be resolved, allowing the company to grow at least in line with the overall market. While Europe and Asia should continue to provide steady growth, the main growth drivers are likely to be North and South America. Beyond year six, we expect revenue growth to gradually moderate.
Evolution’s net margin is likely to decline slightly, as operating local studios in the U.S. is more capital intensive, and the company will need to invest more heavily in cybersecurity to prevent similar hijacking incidents from occurring again.
The exit multiple will likely sit around 15. Evolution isn’t included in ESG ETFs as it is operating in the gambling sector, and many investors don’t invest in Evolution because of the same reason. However, for a company of Evolution’s ROIC, growth, and capital allocation decisions, we believe a P/E of 15 is more than justified.
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The Dutch Investors
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