Intralot - Playing the odds - Positioning
All,
Please find our updated analysis of Intralot here.
So do we play the odds? Intralot of course published their H121 results upon which the 24s came flying to a 10% YTM. We have been talking about this trade since that day, but have been held back by some capacity issues and now the bonds are already 5 points lower. Still, we see the odds materially skewed to the downside. In our opinion the market practically fully expects Intralot to retain its Malta license - a mistake we’ve made before. The license will be hotly contested and even a win of the renewal will have its challenges. We should hear of the license retention next - probably early November. Then of Q3 in late November / early December. Q3 could have further strong US growth, but the lag in the ROW business should become ever more apparent and we expect questions around the ROW balance sheet / coupon to surface.
Restructuring:
- The restructuring involving the 21s was not designed by the company to rid itself of all excess debt and to start afresh into a bright future. It was a compromise with the 21s, where the company tried to give away as little as possible (or rather a lot more than the 24s would have liked to see).
- By consequence the ROW part of the business is still over leveraged and on our projections will be either struggling to pay its coupon next year, or will lose its license in Malta. The latter would leave the 24s with a negative CF business.
Malta:
- The license renewal of Intralot’s largest remaining contract outside the Inc. is up for renewal this Friday (weekend). Intralot cannot afford to lose this license, also, because it represents the last major almost-fully-owned lottery management license the company has. So its not only important from a financial perspective, but its retention is key to future sales in other jurisdictions.
- If Intralot succeed: The ROW business has to spend over €40m CapEx on top of its usual expenses next year. Money it is unlikely to have if it also intends to pay the coupon. CapEx will generally be rising for Intralot as further renewals are coming up.
- If Intralot fail: The CapEx will be lower, but the sub-scale of the ROW business will be readily apparent (if it isn’t already).
- We expect Intralot to bid aggressively for Malta so as to retain the contract. However, that likely results in lower profits going forward.
Value Drivers for the 24s:
- Growth: The Inc. is growing fast, but it’s only owned 66% now. With its high multiple however it is likely to prop up valuations.
- Growth: ROW has certainly been lagging behind wrt. post covid rebound, but management also conceded on the last call that the budgeted EBITDA would not be achieved - as per our thesis since the budget came out in Feb. It has a hole of €20m in it.
- Asset sales: This is a finite source of inflow before future earnings are being eaten away.
- The Inc could see a strong bid, which would drive value for the 24s. But with the new constellation of ownership, we think we have time before such a bid emerges - if it does. Intralot are intending to hang on to the asset and the asset needs the Greek programming cost centre (not in its figures). So a bid could actually come in lower.
- ROW could sell 16% of Inc to finance the CapEx in Malta and retain control of Inc. We think this is likely to happen, although it is unlikely to be a great value driver since the raised cash will not be used to pay down the bonds, but will leave the business towards Malta very much straight away. ROW would then look the way it does now, but hold and receive dividends from only 50% of Inc.
Timing:
- We should be hearing of the decision in Malta in November. Binary.
- Q3 results should be out in late November or early December. Strong Growth in US, little growth in Europe.
- Q4 should come out only in May. Likely disappointing - Intralot always is in Q4. Needs to address Cap Structure.
Positioning:
- We are doing the rare manoeuvre of selling our existing long position in the 24s of 5% of NAV and instead selling the same amount again short at 83c/€. We are not yet looking at Intralot as a YTM credit. The company will be bidding for a renewal of its Malta license - the largest remaining outside the US - tomorrow and we should hear of the success or failure in a month's time. Failure would leave Intralot ROW decidedly sub-scale and cash burning. Success would require it to spend more money on CapEx in the next 6 months than it can part with. Either way, we think there are hurdles ahead that will make investors think again about recovery value instead of YTM and accordingly we see the bonds with good potential of going back down to where they so recently came from.
- Upside to the bonds could come from furhter growth in the US (likely), a high bid for the US asset (unlikely in the very short term) or high growth in the ROW assets (unlikely). However, over the coming weeks and months we do not see sufficient upside (from Inc.) to drive the bonds beyond 10% yield i.e. beyond where they recently popped.
So its 7 points upside and 20 points downside the way we see it.
Happy to discuss,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003