Olympic Entertainment Group (OEG) operates casinos in the Baltic region (Estonia, Latvia and Lithuania), Poland, Slovakia, Belarus and Italy. I invested in the company roughly two years ago. The following table provides an overview of the company’s current operating measures and valuation:
1) Excluding operating lease liabilities of EUR 26 m
2) Including dividends paid to shareholders
64% of the company’s shares are held by Armin Karu, founder of OEG and chairman of the board and Jaan Korpusov, member of the board. The company was founded in 1993 in Estonia, entered Lithuania in 2001 and Latvia in 2002.
Currently, the company has almost no debt on its balance sheet. Recently, management concluded a loan agreement with Swedbank over EUR 25 m for financing construction of the Hilton Tallinn Park hotel. The annual interest rate of the loan will be 6 months Euribor + 0.8%. The credit line expires in 2018 with an extension option of 3 years at the same terms.
With an estimated revenue in 2015 of roughly EUR 160 m, I expect the company to generate a 24% EBITDA margin and a 16% profit margin. Over the last four years the company grew book value at a CAGR of 24% (including dividend payments). Despite an accelerated investment activity free cash flow is expected to remain positive demonstrating the company’s strong internal financing capabilities.
Fast expansion into new and existing markets leading to high capital requirements
Management is currently allocating capital to the following investments:
First, the construction of the Hilton Tallinn Park Hotel. The opening is scheduled for the first half of 2016 and total cost are estimated to be roughly EUR 35 m. The onsite casino with 1,600 sqm will be managed by OEG while the hotel itself will be operated by Hilton Group. This is the only property owned by OEG. There is a nice picture of the area and the construction status as of April 2015 which I found here.
Second, in January 2015, OEG announced that it will enter the Maltese market. The company’s so far largest casino with 2,700 sqm is expected to open at the end of 2015. The casino will be part of the Malta InterContinental Hotel which is operated by the largest Maltese tourism group Eden Leisure Group. It will also be Malta’s largest casino. Management expects to invest EUR 7 m in this project.
Third, add-on acquisitions in existing markets. Most notably the company has been further increasing its market presence in Latvia. Here the company has executed an impressive roll-up strategy over the years by acquiring smaller and inefficient competitors at low multiples. Just two years ago the company started its operations in Italy and has added further casinos in 2015. Some days ago, OEG announced the acquisition of a Lithuanian sports betting operator. This follows the formation of an already existing sports bars network in Estonia.
Latvia stands out in terms of growth and profitability
The following is a presentation of the company’s geographical operations for the first nine months of 2015:
Roughly 90% of EBITDA comes from the Baltic region. After the completion of the hotel/casino in Tallinn, the company’s operations in Estonia should contribute increasing revenue and margins going forward.
Latvia is by far the most important market in terms of revenue and profitability. In contrast to Lithuania where the company applied for a license in 2001 to grow mostly organically, OEG entered the market in Latvia via an acquisition in 2002 and continuously grew the business conducting a roll up strategy. After the acquisition of Altea in 2013 and the integration and rebranding of the casinos in 2014, the group’s revenue growth in the country is currently accelerating due to the low revenue base of Altea. As taxes are based on assets and not on revenue as it is the case in most other jurisdictions, the incremental revenue growth is highly profitable leading to excellent margins. Revenue expansion is also supported by the overall market development which has been growing at a high single digit rate over the last years. In July 2015, the company announced the acquisition of another 20 casinos in Latvia. Again these casinos generate less revenue per unit (slot machine/game table) compared to OEG existing Latvian operations. Hence, after the integration phase in 2016, further strong EBITDA contribution from this acquisition can be expected.
Poland and Slovakia seem to be rather problematic. In Poland the company closed a casino last year. Italy is still in the build up phase. According to management, average win per slot in Italy is notably higher than in OEG’s other markets, leading to compelling economics.
Risks inherent with an investment in OEG
As outlined in my original write up, there are three major risks – (1) regulation, (2) substitution of land based casinos by online gaming and (3) misallocation of capital by management due to fast expansion.
(1) From my perspective, legislation change poses the biggest threat to an investment in OEG. The company has made some bad experiences in the past. For instance, in 2009 OEG had to shut down its operations in Ukraine after the adoption of a law that banned the casino business. While this example presents an extreme case, a change to the tax legislation might be a more likely outcome in the countries OEG is currently operating. Taxes are an important regulatory lever in the gambling industry, significantly affecting its development and profitability. For instance, a change to the tax regime in Latvia could have a substantial effect on the company’s profitability.
(2) OEG has been entering the online betting market relatively late. This was mostly due to the missing regulatory framework in most markets leading to mostly grey/illegal online betting. Obviously, OEG being a regulated land-based casino operator could not participate in any unregulated activity in the online space. Over the last years this issue has been resolved with OEG receiving licenses for the Baltic markets. Under its brand Olybet.com, OEG combines both online betting services and high street betting services through its bookmaker cafes.
Regulators are currently trying to reduce the activity of unlicensed betting operators by blocking their sites. However, this seems to be a difficult task. A more efficient enforcement of regulation is beneficial to OEG as the number of licensed operators is relatively small and the requirements to receive a license are relatively high. Nevertheless, in spite of increasing at a fast pace, the online betting market is still a fraction of the total gaming market in the Baltic region. I believe that the company is now well positioned to participate in the growth of internet gaming in its core markets. Apart from that the typical online customer might not be identical with land based casino visitor, as OEG focuses on casinos in the upper segment.
(3) In my original investment case, I also outlined how severely OEG was hit by the financial crisis and that it had to consolidate its business after a period of strong growth. Since 2013 management has returned to the growth path and has accelerated investment activity. The strategy to increase market share in the existing markets – especially Latvia – makes absolutely sense to me. The investment in the construction of the hotel in Tallinn has a touch of empire building at first glance. However, it is noteworthy that this is a redevelopment project of a soviet style hotel to a first class hotel meeting international standards. As far as I know the original hotel has been owned by OEG since the company’s foundation and hosted the company’s first casino. Hence, while the hotel business is not part of the company’s core competency, I believe that this project will add substantial value to shareholders. Entering the new markets Italy and Malta is part of the company’s long term strategy to become an international gaming group. So it really depends on management’s capabilities how the addition of new markets will work out. I know that the management team has gathered a lot of experience over the years and I assume that they have now reached a level where they have a profound knowledge of what is needed for a market to be attractive and how to execute well.
I believe that the company is currently not regarded as a long term compounder by market participants. However, from my perspective the chances are high that OEG will continue grow book value at 15%+ over the next years. Provided that the profitability in Latvia does not deteriorate to a large degree the opening of the hotel/casino in Tallinn and Malta and further growth in Italy should have a positive effect on earnings already in 2016. Hence, the earnings multiples being already attractive will go down subject to no rise in the share price (which was basically the case over the last two years). After three years (from 2013 to 2015) of substantial investment activity I expect capex to come down in the future as well. Hence, free cash flow should increase over the next years to EUR 20 m to EUR 25 m per annum based on a maintenance capex of EUR 13 m (leaving some room for smaller acquisitions) leading to a conservative estimate of free cash flow yield of roughly 8%.
From today on I will increase my existing allocation to this investment (2.4% of the portfolio) to a 4% position with a price limit of EUR 1.9 per share.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!