Thursday, March 26, 2020

SciPlay: Fake Slots in a Casinoless World

I've averaged down on a few current positions (possibly too early and unwise), many of which carry debt, are exposed to customers leaving their houses and are thus down significantly.  But I also wanted to look for a company that might be thriving during this crisis, debt free and can take advantage of people having too much free time.  One such company is SciPlay (SCPL), which a reader asked me to look at in the comments section on my post on Accel Entertainment (I still own despite all bars and restaurants being take out only in Illinois).  I feel like a click bait author associating this idea (which is admittedly a little scummy and not without hair) with the "stay at home trade" but SciPlay should accelerate their already healthy growth rate in this environment with casinos closed for at least the next several weeks, potentially much longer.

SciPlay is a social casino gaming company that was IPO'd off of Scientific Games (SGMS), a major slot machine manufacturer and casino supplier, in May 2019 to reduce SGMS's heavy debt load.  Scientific Games still controls SciPlay with an 82% ownership stake in the operating entity (this is one of those ugly Up-C structures).  Social casino games are free-to-play simulations of slot machines where there isn't explicit gambling occurring but players can purchase virtual tokens to move the game along faster similar to other freemium style mobile games.  I downloaded one of their games and didn't understand it, but SciPlay has 8 million monthly users, however only 6% of those actually pay up for virtual tokens but those users are quite valuable, paying on average ~$88/month (!!) for these in-app purchases.  SciPlay pays a 30% revenue share to Apple, Google, Facebook and the like to be on their platforms, a dispute with any would be an issue, but otherwise this is a decent enough decent business that spits off a fair amount of cash.

The proceeds from the IPO (priced at $16) were used to pay a one-time upfront $255MM licensing fee to Scientific Games for their intellectual property library which allows SciPlay to develop new games in the future based on popular slot machine themes like James Bond or the Godfather that Scientific Games has a license for the rights.  Scientific Games and other slot machine manufactures have years of experience creating and cultivating addictive gameplay -- the "Scientific" part of the name seems almost nefarious to me -- that gameplay design can be fairly easily translated to a mobile device.  SciPlay currently has 7 games, the most popular and the one that makes up 40-50% of their revenue is Jackpot Party Casino, its a few years old now but does receive regular updates, there is some fatigue risk to their revenue but so far they've shown the ability to extend the game's life.  The one risk that remains a bit untested is how online/mobile gambling being rolled out impacts the social casino games, SciPlay claims in states like New Jersey where mobile gaming is legal they see no significant change in their customers behavior.  The explanation given -- social casino is more of a mindless time wasting exercise or a way to learn about slot machines versus a true gaming experience, not sure I totally buy it, but I do see people on my commuter train (when I wasn't holed up in my basement) playing social casino games on the train in the morning.  Doubt that would be the same activity if its actual slot machine mobile gaming with an 8% rake, but then again, maybe the time wasting crowd aren't the 6% of users that are paying.

The share count and market capitalization of the company often appear wrong on free sites due to the Up-C structure where the public company only owns 18% of the operating partnership with Scientific Games owning the other 82% economic stake directly in the operating partnership. SciPlay finished 2019 up with $110MM in cash and no debt, the company did $122MM of adjusted EBITDA in 2019 or $94 million in net income before the non-controlling interest allocation.  This represented EBITDA growth of 30% over 2018, let's dial back the growth rate a touch (although I wouldn't be surprised if they matched or exceed that) and say they do $150MM in EBITDA in 2020.  Keeping the same revenue base and converting an extra 1% of users from 6% to 7% paying users through this casinoless time would do it.
Even in a no growth environment, SCPL is trading at 7.8x TTM adjusted EBITDA (sorry if the price is stale by the time you read this), prior to the coronavirus market volatility, peers (ZNGA and GLUU) were trading at 14x 2021 EBITDA estimates, there's a big gap there between where 2021 EBITDA could be for SCPL and where the stock is trading today.

I bought a small amount, feeling a little guilty about the business model, but I'm not an ESG investor.

Other thoughts:
  • Scientific Games controls SciPlay, and Scientific Games is essentially controlled by Ron Perelman, I don't have any real thoughts about him but he's a semi-controversial investor to some.
  • Scientific Games might be forced to sell additional shares in SciPlay to keep it afloat through the crisis as SGMS is highly levered and I'm assuming if the casinos are closed, they're not buying new VGTs.
  • David Einhorn had a quick blurb in his Q2 2019 letter about owning SGMS partially because of its stake in SPCL, backing out the SPCL position and you can create the core SGMS very cheaply.  I like the idea in concept, but would rather just own the no debt growth company in this environment versus something that will rely on the kindness of creditors.  There is an argument that SGMS's stake in SPCL is unencumbered and could provide a floor to SGMS stock, I don't know if its possible for SGMS to go bankrupt and spin their SPCL shares to pre-bankruptcy shareholders, but if they could SGMS's stake in SPCL is worth about $9.25 of each SGMS share.
  • SciPlay wants to branch out into non-casino games like puzzles, also they're 90+% U.S. based revenue, fair amount of runway internationally if they can navigate regulatory environments.
  • Repeating the risks here: 1) impact of legalized mobile gaming; 2) SGMS overhang; 3) no-to-low barriers of entry for mobile games; 4) reliant on Apple, Google and Facebook to remain in their good graces and on their platforms; 5) revenue concentration with Jackpot Party Casino.
Disclosure: I own shares of SCPL


  1. Don't think there is much overlap at all between the paying users of this app and casino gamblers. They have much more in common with other freemium game whales than other gamblers. Psychology is very different, a gambler would see no reason to pay money for a game that has no chance of paying them out. The app users don't see it is as losing money as much as an expense, so they wouldn't want to "lose" real money to play. So it doesn't surprise me at all that they haven't experienced losses in NJ.

    So there are probably still some short term gains from people being home and bored (but probably not much from substitution for casino play). Long term, I don't see legalized mobile gaming as a threat.

    As you say probably the biggest threat is AAPL/FB/GOOG having enough of them. Or alternatively, the government (or casino lobby) deciding that it is in fact a substitute for legalized mobile play that is hurting government tax revenues (and casino revenues) and trying to squash it.

    1. Thanks the comment and color on casual vs mobile gaming - hope the tone came across right, admittedly stretching a bit to say its a pure substitution for casino play. Maybe they pick up a few or those that are already players are on it more because they're trapped at home.

  2. Hi there, thanks for sharing the analysis. I thought I would give something back ;)

    The company looked attractive at first glance, but there is few things you might want to consider.

    1. The 82% share in the net income might not be true, as there is another shady clause about Scientific Games getting 85% of realised or assumed tax benefits, which I think is highly subjective and that may explain why in Q3 and Q4 we as shareholders got only 12% of the net income rather than 18% (I don't count Q1 and Q2 as IPO happend in the middle of Q2)

    2. It seems SciPlay is not the owner of the software, they only have a license (which is given by Scientific Games), which means you don't really own the bussiness, just a share in profits.

    3. There is a class action looking for compensatory damages of at least $146m due to possible misinformation during the IPO (my guess is that the suit is not likely to succeed but who knows and you got to include it in your risk assessment)

    4. And the last but not the least is the growth - looks like the revenue grew just because of them being able to achieve a better conversion from active users to paying users and higher revenue per paying user rather than by growing the active user base unfortunately. Interestingely when I looked how their applications installs grew, that looked fine, but it seems they were losing more or less the same amount (this stat is unavailable unfortunately sa can't say for certain)

    Bottom line for me. I bought a small package, I will keep it until the earnings in May but unless they show a real growth in the active user base or will nicely surpise with something else I will sell it (I still think they will positively surprise with earnings though - but not by much)

    1. Thanks for the comment:

      1) I thought I mentioned it, but maybe I didn't, yes there is a Tax Receivables Agreement ("TRA") here, I've written about them in the past. Dislike them, but not sure if it's really "shady" but it does put different shareholders on different economic terms which isn't great.

      2) I believe its a perpetual license, so I'm not sure if it matters?

      3) That's fair, its a busted IPO, lawyers likely to circle those

      4) They do need to come out with new games, new categories, etc., but guessing their conversion rate is increasing through this period

      But thanks, all good thoughts

  3. Cheers for the comments to my points. The TRA looked shady to me probably because it is the first time I have seen one of those. As for the license it is perpetual but from how the whole thing is set up it feels like SGMS can take it away if the really want it but I guess it then falls under your "SGMS overhang" point.

    Just read the earnings call, have to say it is very upbeat. The way it sounds the business is going to accelerate significantly and most likely some of the acquired users will stay with them for longer. And I really liked the part about CPI going down in the perfect time when there is more users coming in, it is a double whammy to their user base growth which was a concern for me. So far so good... or the already made 20% profit on investment made me too optimistic ;)

    1. Needless to say I am gonna stick with them a bit longer now