In this guide, we explore the ins and outs of the gambling industry with the aim to learn how to invest in casino stocks.
Our ultimate guide on casino stocks starts by building an understanding on the market structure and how they make money. Next, we identify the key drivers / current themes and examine developments in three key markets: US, UK and China (Macau). Finally, we conclude by looking at our investable universe as well as the key valuation metrics used to appraise gambling stocks.
(We’re in no way endorsing gambling. Gamble responsibly if you do.)
Gambling, or gaming as they kindly want to be known as, is in every one of us. Like us writing this guide, for example. A game of chance (and skill perhaps?), it’s estimated that ~26% of the world’s population gamble, or 1.6 billion people worldwide.
The landscape of gambling has changed drastically the past few years, with new regulation and increasing take-up rates in online & mobile gambling. With the reopening of casinos post COVID-19, it remains to be seen if it can recapture its visitors quicker than expected.
What do they do?
Casino stocks are companies that are involve primarily in the offering of betting, gaming and lottery services. In addition, some leading names in the industry also operate as a one-stop shop, with services including hotels, retail stores, restaurants and other amenities. We stop short at analysing these and will focus solely on gambling in this guide.
According to The Business Research Company, the global gambling market reached a value of ~$449.3 billion in 2018. More importantly, it grew annually at 4.1% vs 2.9% of the global GDP growth since 2014!
Globally, the gambling market is segmented in to casino, lotteries, betting and others. Lotteries was the largest segment in 2018 with a market share of ~46% or $207.3 billion. On the other hand, sports betting segment is expected to be the fastest growing segment going forward with a ~6.9% growth.
Casinos generate a significant amount of their revenue from table games and slots. The key expenses for a gambling business is its staff wages, marketing and capital expenditure. The latter includes investing in new gambling software and its foray into the online / mobile segment.
On distribution channels, the sectors is split into offline (land-based), online and virtual reality (VR) gambling, a newcomer. Driven by convenience, costs and regulations, online & mobile remains the most conducive growth channel for the industry.
Asia-Pacific remains the largest market for gambling, accounting for ~32% of the global market in 2018. It is widely expected that APAC’s contribution will likely to grow further driven by the higher penetration of smartphones and hence, online gambling.
How do they make money?
The house always win, as they say. Operators and bookmakers make money by offering you a game of chance. With the exception of Blackjack, Poker and Baccarat, the game of chance, or at least that’s what the casino try to market it, is not quite what it seems. In a nutshell, operators makes money through games that they have an “edge” to win in the long term.
Consider this betting strategy in a fair game that has two distinct outcome: doubling your bet after every loss and quit once you’ve won a round. Originated from the 18th century, this is known as the martingale betting system.
Mathematically, martingale allows the gambler to almost surely win if the goal is to win $1 (you can then multiply that by any amount you like). However, this must also means that the gambler has infinite wealth as the bet will increase exponentially. This is not realistic. Furthermore, most casinos impose a limit on bet sizing, further benefitting the house.
Interestingly, here are a few other ways that casinos do to improve the house edge and to get you to spend more.
- There’s isn’t a clock in sight
- Free rounds of alcohol
- Free accommodation
- Strategically placed bathrooms
- Casino floors are designed in a maze-like layout
It’s worth to remember that no matter how lucky you feel, eventually the casino will get luckier. By design, of course!
Learning how to invest in casino stocks can be quite confusing at first. Here are a few commonly used industry jargon that could help clear the air.
Wagers / bets
This is the cash placed as bets by customers. For sport betting houses, it's likely to see seasonality in betting whenever major sports events take place. For example, Flutter Entertainment (FLTR.L) generated 13% more Group revenue in 2018, driven by the FIFA World Cup.
This is the total bets made less the total payout to customers. Consequently, we can also calculate the gross win margin. This measures the gross win as a percentage of the total bets.
Gross win = Total bets – Total payout
Gross win margin = Gross win / Total bets
In fact, we notice an interesting sequential relationship with this concept. As gross win margin increases, ie customers winning more, we see a sequential increase in gross wins. A plausible explanation is that customers are recycling their winnings into new and larger bets. Intuitively, when was the last you heard that a gambler stopped because he/she was winning too much?
Net gaming revenue
As the name suggest, NGR represents the gross win minus any free bets or bonus that were given. In an equation, this is
Net gaming revenue = Gross win – (Free bets or bonuses given)
Cost per acquisition
Cost per acquisition shows how much it cost to acquire a new player. This is generally measured by the number of new users signing up on a new marketing campaign. Akin to A/B testing, this is more applicable to operators to measure their marketing effectiveness. Nonetheless, it provides a data point for investors to understand its marketing strategy.
Average revenue per user
As its name suggest, it represents how much an average player brings to the casino, generally calculated on a monthly basis.
Other segment specific KPI
In general, the concept above can be applied to various other segment in the casino & gaming industry. For example, wagers/bets is equivalent to slot handle in the slot machine segment.
|Industry||Table games||Slot machines|
|Wagers / Bets||Table drop / Drop / Non-rolling chip drop||Slot handle|
|Gross win||Gross table games win||Slow win / Slot gross win|
|Gross win margin||Gross table games margin||Slot hold percentage|
Key drivers and current themes of the industry
In addition to macro drivers such as GDP growth, number of tourists and investment in infrastructure/connectivity, we highlight the key drivers and themes that can make or break the industry.
Regulation is the single largest driver of the casino & gaming industry. Its changes can close or open new opportunities overnight. For instance, the repeal of Professional and Amateur Sports Protection Act (PASPA) in 2018 has opened the door for the US sports betting market to flourish. See more in the section on US.
Another key area of gambling regulation is taxation. This applies to both the operators and customers. Interestingly, taxes via online and land-based casino can differ. As a result, this can lead to various impacts on prices of betting and gaming products for consumers.
Finally, gambling’s history reputation hasn’t been one to brag about. In recent decades, money laundering has been closely associated with the gambling industry. In fact, the failure to monitor problem gamblers and stop money laundering has prompted the UK’s gambling regulator, Gambling Commission, to impose a record fine of ~£20 million on its operators. This is one of the “black box” of the gambling industry – a known unknown. Consequently, this is a tail-risk event we should always consider when investing in the casino & gaming industry.
Growth opportunities in the online / mobile channel
Online / mobile channel remains one of the most interesting area of growth for the casino & gaming subsector. With COVID-19 serving as a catalyst to hasten the shift to online gambling, the fight for superior user experiences and products will be key for operators to gain market share in this channel.
Interestingly, the global online gambling arena remains in its infancy, partly driven by both regulations and trust issues. In spite of this, some countries continue to deliver an explosive growth via online in recent years. For example, the UK remain the most developed online gambling market with just under 40% of gambling revenue deriving from the online channel. Importantly, the UK online channel has been growing at ~27% per annum from 2015-2018!
While land-based gaming such as casinos are far from facing an existential crisis, the online sales channel will be the key battleground in years to come.
The rise in online gaming has piqued the interest of traditional conglomerates to diversify. As a result, leading to increased appetite for consolidation.
Evidently, the increasing demand for online gaming is showing positive correlation to technological development cost of the industry. As such, consolidation could offer a way to synergies and leverage these cost.
In addition, the popularity in online segment has spurred the growth of many online-only players across various markets. In the market today, larger operators are acquiring these players as a means to gain a head-start in its online proposition, while offering a diversification benefit.
Furthermore, consolidation is also being driven by regulation. The complexity of its means there’re little uniformity geographically. Consolidation provides an alternative to reduce exposure to a single regulatory regime.
According to the Gambling Commission, the UK gambling sector generates ~£15 billion in gross gambling yield (also known as gross win) in 2019. This represents ~4% of the global gambling industry. Globally, UK is the most developed online gambling market. It derives almost 1/3 of the industry’s gross win from the online channel.
Remarkably, despite the gradual shift towards the online channel, there are still ~9000 betting retail shops in the UK. A possible explanation could be that baby-boomers are less tech-savvy and prefer the traditional betting houses. In our view, the marginal cost of retaining betting houses will soon outweigh its benefits in the near term, driven by scalability and technological advances.
Operators need to continue to diversify, acquire tech-driven synergies and grow its online sales channel. As mentioned above, we’re seeing a wave of consolidation sweeping through the marketplace today. The recent merger between Flutter Entertainment’s (FLTR.L) and The Stars Group in May 2020 is a case in point. Consequently, it created the world largest gaming company. The technology arms race trend will continue to persist in the sector and so will the consolidation, in our view.
US is the largest gambling nation in the world. With a gross win of ~$120 billion, it has a market share of ~25% globally. Despite seeing a massive increase from its online and mobile channel over the years, casino remains the single largest contributor to the US gambling industry.
Uniquely, the US gambling market is regulated at both the state and federal. This means that regulations can vary from one state to another across the US. The repeal of Professional and Amateur Sports Protection Act (PASPA) in 2018 has open the door to a wealth of opportunities in the US sports betting market.
With arguably the largest sports fan base in the world, US boast sports organisation like the NBA, NHL, MLB, NFL and many more. While the prospect of this market remains uncertain, the UK’s sports betting market may offer a glimpse to what the market may look like.
UK has ~55 million adults and the latest data point suggest a gross win of $3.3 billion. US’s adult population is approximately 260 million, which by a simplistic deduction implies a $15.6 billion (260/55*$3.3b) market. However, we have not taken into account that US has a significantly larger sports fan base than the UK. In short, our rough estimation may likely just be a lower bound, which is already >10% of the 2018 total revenue!
As the effects of PASPA begins its ascent, a few trends we think are here to stay. Due to the historical limitations, mainstream operators are less developed in the US online gambling market. For this reason, online gaming is one of the most sought-after expertise in the industry today. PASPA will only propel this further.
Going forward, with tourism under-pressure, on-going riots and a threat of a second-wave pandemic, US gambling operators will need to act fast to gain an upper hand in the booming online & sports betting segment.
Macau / China
A Special Administrative Region of People’s Republic of China, Macau is the most densely populated region in the world with a mere population of ~630k. A region with heavy Portuguese influence, Macau is known for its gambling tourism, earning the nickname “The Las Vegas of the East” or Cotai Strip. Interestingly, Macau reported a gaming revenue of ~$36.5 billion, approximately ~6x greater than the Las Vegas Strip.
Macau’s growth can be attributed to its accessibility and developed infrastructure. In fact, Macau’s continued strong growth coincides with the opening of Hong Kong-Zhuhai-Macau Bridge (HZMB) and Guangzhou-Shenzhen-Hong Kong Express Rail Link (XRL) in 2018. With further projects in the pipeline to improve connectivity across the region, these should continue to drive further upside.
Key valuation metrics
In addition to traditional metrics such as P/E, P/B and dividend yield, we found the following metrics helpful when analysing the casino & gaming industry.
Free cash flow to equity
Free cash flow to equity (FCFE) is the amount of cash a business generates that is available to be potentially distributed to shareholders. In simple terms, this is free cash flow after paying operating and investing expenditures. This measure better informs investors on its dividend paying ability and capacity.
We use EV/EBITDA as it more accurately capture the underlying gaming business as opposed to non-cash items that may give a different picture.
Debt-to-equity and current ratio
In general, gaming operators (especially casino) carry quite an amount of debt on its books. Monitoring both debt-to-equity and current ratio not only allows us to analyse its liquidity position, but also its growth and expansion plans.
Casino stocks investable universe
Here's a list of our gambling / gaming stock investable universe.
The gambling industry remains behind its curve when it comes to online propositions, especially when it’s dominated by conglomerates who derives most of its revenue from land-based casinos. There’s no question that this trend will start to move towards online, rather, it’s a question of the speed of the transition.
The PASPA repeal is perhaps the most interesting theme in the sector currently. The enormous US sports fan base will not only attract foreign operators with sports betting and online expertise, but also have spill over impacts. For example, higher viewership, advertising and commercials fees and so on.
Gambling stocks considered a taboo by some in the market. Similar to tobacco, gambling is a sin stock. Considered unethical, the only way the casino & gaming industry thrive is by getting people to gamble more.
Consequently, the rise of Environmental, Social and Governance (ESG) investing may have adverse impact in these stocks. Nevertheless, investing in gambling stocks is an interesting corner of the market we ought to learn.