Will Aristocrat Win The US$1bn Jackpot?

Australia | Jul 01 2024

Last week’s investor briefings saw management at Aristocrat Leisure communicating some aggressive aspirational targets.

-Aristocrat Leisure’s investor day detailed market share opportunities
-The Interactive segment’s revenue target materially exceeds expectations
-Jarden concerned by the investment required within Interactive
-Capital management remains in focus

By Mark Woodruff

While Aristocrat Leisure’s largest division, Gaming, remains the near-term earnings driver, analysts received a welcome surprise when management set a FY29 US$1.0bn revenue target for the company’s Interactive business at the recent investor day.

FY24 guidance for profit growth was left unchanged and management stated it “remains committed to returning cash to shareholders through dividends and share buy-backs”.

The day highlighted ongoing market share gain opportunities for the medium-term across Aristocrat’s Gaming, Interactive, and Social Casino divisions.

The Gaming division generates revenue via traditional gaming machines located in pubs, clubs, and casinos. While Aristocrat sells poker machines, most revenues in this division flow from a daily cut of revenue earned by a rented machine.

As the term implies, Social Casino involves the provision of content to paying users who are not betting real money.

For those customers willing to play online real-money games, Aristocrat rebranded the former Anaxi and NeoGames businesses to form Aristocrat Interactive.

Comprising iLottery, Content, and Gaming Systems, this segment generated US$330m of revenues to the end of the first half of FY24 (on a pro forma 12-month basis), excluding the NeoPollard Interactive (NPi) joint venture.

Management highlighted Interactive’s potential to capture a significant market share in the burgeoning iLottery and iCasino sectors. Most growth is expected from the iLottery and Content segments, which currently account for 18% and 22%, respectively, of revenue generated by the Interactive division.

Ord Minnett believes the primary driver of further expansion for iLottery will be in the US market.

Over the past three years, the US has seen iLottery gross gaming revenue (GGR) grow by roughly 30% annually, driven by the opening of new markets and increased spending, explains this broker.

Aristocrat’s success in this area can be attributed to the technological advantages offered by NeoGames, according to the analyst, which operates the three most profitable iLottery states in the US.

As a result of the investor day, both Morgan Stanley and Macquarie raised their 12-month target prices for Aristocrat by around 6% and 9%, respectively.

In setting a FY29 US1.0bn target for the Interactive division, management has exceeded the consensus forecast for US$681m, highlighted Morgan Stanley.

Supporting this growth in Interactive (out to FY26) are new tenders in iLottery, the distribution of over 90 premium games per annum in Content, along with new geographies in North America.

On top of these initiatives, management is acquiring talent, building Gaming Systems with existing Aristocrat customers, and spending on research and development at 11-12% of revenue in the medium-term.

Morgan Stanley now believes Interactive’s earnings will expand at a five-year compound annual growth rate (CAGR) of around 50%, up from the 30% consensus was anticipating.

Given these higher growth expectations, and potential divestments within lower-growth digital assets, this broker increases its forecast price earnings multiple for Aristocrat Leisure, as well as raising Interactive’s earnings margin to 45%, which has the effect of raising the group margin to circa 47%.

Macquarie explains Interactive’s market share (currently 4.5%) will rise due to an increase in content and product availability via leveraging Aristocrat’s deep and broad portfolio.

This division is also expected to grow by simply entering new jurisdictions, as Aristocrat is currently only operating in three of the seven US iGaming markets, explains the analyst.

While maintaining a Buy rating and $47.20 target, Jarden was far less impressed than Macquarie and Morgan Stanley by management’s FY29 aspirations and would have preferred disclosure of targets for above-cost-of-capital earnings growth within a timely manner.

Disappointingly, suggests Jarden, the US$1bn revenue target compares with the more than -US$1.5bn of capital already invested through the acquisitions of NeoGames (-US$1.2bn) and Roxor Gaming (-US$115m), along with the design and development (D&D) spend to date. More costs will be incurred, but they have not yet been disclosed.

The ability of the NeoGames team (which is now essentially running Interactive) to execute will be critical, according to the analysts, given some headwinds currently.

There has been a slow opening of new US states, notes Jarden. Two years ago, Aristocrat expected 12-15 states by FY25, versus the seven currently open. Also, additional investment costs (including D&D) are necessary to realise targeted revenue, note the analysts.

Such factors may lead to a declining return on invested capital (ROIC) measure, cautions Jarden, albeit off a strong base.

Capital management

Management has previously noted the balance sheet is under-geared but will reassess once the outcome of a strategic review is clearer, explains Citi.

This broker estimates Aristocrat has the capacity for around $60m of capital management, while proceeds from the potential sale of digital assets (which could be in the range of $1.7-2.3bn) may also become available.

The company is still open to “strategic M&A to fill gaps in its business offering”, observes UBS.

In searching out M&A, management will focus on areas of core competencies, suggests Morgan Stanley, to accelerate market share gains and future growth.

Outlook

Macquarie highlights adjacencies also represent medium-term growth opportunities, with some land-based products in North America and regions like Europe and Latin America. In both cases, Aristocrat is only just emerging or has no presence.

As the gaming landscape continues to evolve, Ord Minnett believes Aristocrat is poised to ride the wave of change and emerge as a dominant player in the industry.

The average target price of six covering brokers monitored daily in the FNArena Database is $53.05, up from $51.83 prior to the investor day, suggesting just under 6% upside to the current share price.

Five of these brokers have a Buy (or equivalent) rating, while Ord Minnet remains at Hold. It should be noted Morgans hasn’t refreshed research since May 20.

Outside of daily monitoring, Jarden maintains its Buy rating and $47.20 target.

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