ARISTOCRAT FY24 Result —Sticking to its Strengths–top 10 holding

Result Details and Operational Review

The full-year result was strong driven by margin expansion across all verticals. Revenue was 5% higher and EPSA was 20% higher yoy. The revenue number was below my estimate, mainly due to acquisition timing, while the NPAT number was much higher. The second half's strength was due to operational leverage, impressive cost control and mix benefits. FX and the acquisition also assisted to a lesser degree. Everything was moving in the right direction.

ALL continues to be the clear leader in the market and outspends the competition on D&D and marketing. Gaming operations added 7,100 to the installed base, a record and a strong 2H. Outright sales were mixed being flat in NA, Asia grew but Australia was lower as competition (LNW) impacted. Overall outright sales were 3% lower. The outright sales market looks to be less of an issue, especially in the NA as casinos appear to be more willing to lease units to maximise ROI. Although ALL is 40% of the US market, management stated that they do not consider that as a bar to growth. They believe they win market share in areas they wish to compete, leading with better hardware and technology and seeing more license opportunities. As casinos further move to optimise returns on the floor, ALL expect to win market share.

Pixel became the leader in the social casino market for the first time. ALL has been working to optimise the UA spend and that was seen again, enhancing profits. There is a strategy to change the source of users from depending on UA spending to the in-house platform and DTC which will enhance margin over time. The social casino business is less reliant on UA than the exited casual gaming business.

The new Interactive businesses are making good progress. Neo games were included for 5 months and Roxor for the full year. The new division comprises three businesses. ilottery is a stand-alone business in the ilottery space and is growing through geography and new products. The business has exposure to 92% of the US population and now will increase games for penetration. The second business is the content business, which should grow strongly as it bundles and sells ALL products across online gaming operations as well as other operators. Management stated that the LFL 2H revenue run rate was 50%. The third part is Platforms which manages installed casino management systems. Platforms appear to be growing around 16% LFL. Management stood by their target of US$1b revenue for this division by 2029, it has FY24 revenues of $224m but with another 7 months of Neo to come in fy25 ($100m?). Management expects margins to improve with scale. There was a mention that Roxor and Neogames brought new technology that has been rolled out but that required new licensing which slowed progress but now the business is growing strongly.

Strategy

As previously flagged ALL has implemented a change in strategy. In brief, this is exiting the casual, action, strategy and role-playing gaming segment and with the acquisition of Neo games and Roxor concentrating on the real money and regulated gaming segments. I fully support the move. It takes a confident and mature management team to exit a growing and profitable business. The reason is that although the TAM here is huge, ALL lacks the competitive advantages it has in the segments that are more aligned with their skills in casino games and working in regulated environments. The sale price is reasonable but will lead to mid-single-digit dilution. The exit while things are going well crystallises value. Too many management teams wait until the deterioration sets in and an exit becomes value-destructive. Management states that the move will enhance both LT growth and margins. the Big Fish business is still being evaluated but is expected to be sold (except for the social casino part), it is much smaller and less profitable than the exited businesses. ALL is well placed as a leader with world-class content across the three remaining verticals. The main remaining part of Pixel will be the social casino business. Maximising the ability to sell ALL’s successful casino games on different platforms and geographies is the strategy going forward.

Capital allocation

ALL capital allocation strategy is clear and has been consistently applied in the past. Organic growth through investment in capex (about 30% of revenues), including design and development (D&D) as well as UA (User Acquisition) spending followed by merger and acquisition opportunities and then share buybacks. All have been utilised. After the sale of part of the Pixel business, ALL will be close to debt-free. Share buybacks or M&A to get All to their 1-2X ND/ebitda target would be accretive.

Valuation

My expectations with many of my holdings that are leaders and that I already hold a good size investment is that opportunities to add at very good valuations will be rare. Sometimes the wait can be years. Maybe that is the case here. The strategic moves by management I think are sound, they imply a higher PE as the company becomes stronger. The current low debt also implies a higher PE. My growth estimates, I feel, would be a little below what management is expecting.

My base case is 10% eps growth over the next five years and a 20X exit PE. At $64.41 gives a 5% return, ok but too low to add. There is potentially higher eps as they leverage up or get better scale benefits than I am anticipating. The historical trading pattern has been quite volatile for this kind of stock, but IMO the company is becoming a stronger competitor. 20X for a global market leader is a bit low, often I use 25x exit PE in my international company's valuations. Using 25X gives a 10% return.

To derive a required 10% return on my base case assumptions requires a SP of $52. I would classify that as a strong buy and may be tempted to add around $56.

What could go wrong? LNW, who are ex-ALL and have copied their games (IMO)-fair game, they all do it, could be more successful outside of Australia. ALL could fail to execute through poor capex decisions or macro could turn ugly.

In conclusion happy to add on a pullback with ALL.

Note the C19 slump with casinos closed, otherwise consistent growth.

To remind everyone, I am an investor, not a speculator, my philosophy is to buy quality growth companies at reasonable valuations and to hold them. Most of my wealth is in my share portfolio.