(Members can download a PDF of this update here)
Evolution reported 1Q25 and the stock tanked -18% on the results.
Revenue growth decelerated to just +4% y/y (constant currency +6% y/y), down from +12% y/y last quarter. While it is always hard to attribute a stock movement to a single variable, we think it is this large revenue contraction that is most likely cause of the sell-off.
They attribute this slow down to “conscious actions we have taken that will be beneficial for the business in the longer term”.
(1) The first is issues related to the Asia Cyber Attacks where they are implementing measures to stop criminal activity that is weighing on their Asian operation. This first appeared 3 quarters ago and is still on-going. Asia growth was a meager +2% y/y compared to +11% last Q.
(2) The second—and new issue—is “self-initiated” actions in Europe to ring-fence regulated markets. This is in addition to what they did in the UK prior.
As a reminder, the UK gaming commission was investigating Evolution for potential unlicensed gambling activity and so they implemented measures to make it harder for players to play Evolution games illegally. However, this weighed on their UK growth. It sounds like rather than waiting for similar actions to come against them elsewhere in Europe, they implemented similar security measures in all of their regulated European markets.
The net of this is that Europe growth was -1% y/y, a stark contraction from +9% y/y last quarter.
Interestingly, Martin Carlesund commented in the press release that “despite the effects from the ring-fencing and the cyber-attack countermeasures, the underlying potential in both Europe and Asia remains solid”. On the call he elaborated further, saying “what is important to remember is that the underlying demand remains strong and that through the ring fence measures [we] have created an even stronger foundation that we can grow from.” This commentary is key when thinking through whether their financial results reflect underlying weakness in end markets or their offering.
North America growth was solid at +15% y/y and they also noted LatAm is doing well with their Columbian studio catering to Spanish-speaking markets. However, all across the board growth was worse this quarter. North America decelerated 400bps y/y sequentially and LatAm fell 1,000bps.
They are still invested in plenty of new studios with a second studio launching in Romania and a third in New Jersey. They also note that the Brazil and Philippines studios are on track for this year and a second studio in Michigan is coming. The studio builds do express confidence that they will continue to grow.
These measures also increased cost which drove EBITDA to shrink -1% y/y to €342mn for a 66% EBITDA margin. They noted that their legal costs have gone up as they engage in more external legal advisory to operate their global operations, but they will get operating leverage from this item overtime. Additionally, since the Geogia strike, the cost of their studio mix has changed unfavorable in the short-term. Notably, they believe the second half of the year will be stronger and thus maintained their 66-68% EBITDA margin guidance.
2025 they are still referring to as their “strongest product roadmap ever” with 110 games planned to release for the year. The few new product launches to date (notably “Race Track” and “War”) were not enough to noticeably move results though. However, they are optimistic about several other games set to release later in the year (Marble Race, Fireball Roulette). Live revenues were similar to the companies total revenues of +4% y/y.
RNG revenues similarly contracted to +3% y/y from +7% after enjoying 2 quarters of elevated growth. They note that their slot brand NoLimit City is one of the most popular in the world right now though. The same factors that impacted their overall results impacted slots.
All around it was a pretty poor quarter, but the key will be to understand to the extent these mediocre financials were really the result of their own initiative versus a reflection of end market or competitive weakness. Evolution seems to think that the growth contraction was largely self-inflicted, with new studio investments to grow capacity showing their confidence in that belief. They noted nothing was new on the competitive front.
Martin closed out the press release with the following:
We will move on to our updated thoughts on the business and then valuation, but first are our notes from the call below.
1Q25 Call Notes
Studios
- New studio in Romania, which partly makes up for the capacity that was lost in Georgia.
- New state-of-the-art studios in Brazil and in Philippines opening later in the year
- Second studio in Michigan, while also expanding at full speed in Malta, Colombia, Argentina, New Jersey, and Philadelphia.
- “Testament to our stance that we will always prioritize growth and to take market shares over margin.”
Georgia Strike Passing
- The situation for Evolution continues to be stable, and they operate without disruptions.
- Engaged an accounting firm which concluded that the salaries and work environments were not problematic.
Tariffs
- Obviously monitoring the news flow related to the potential changes to global tariffs. At this point in time and from what is known today, they do not expect a material impact on their results.
Capital Allocation
- €2.80 per share dividend going to shareholder vote
- 2.1mn shares repurchased for a total cost of €154mn
- Reiterated intention to repurchase €500mn of shares in 2025
Ring-Fenced Europe Activity
- Impacted 2 months of the quarter
- When asked about the difference in channelization of European countries to get a sense of underlying growth: “I won’t comment on the growth in particular countries. In general, we have seen a blended rate of 9%. And I wouldn’t say that any of the countries stick out in any extreme way.”
- No more markets to ring-fence: “There won’t be more markets. We’re sort of done what we’re supposed to do or proactively did, and it’s all more or less happened in the beginning of February. So as I said before, 2 months out of 3.”
- “I personally met almost all major regulators in Europe during this period. And it’s close to 100% proactive measure.”
- Understanding the negative impact:
- “So we are not really affecting the channelization in the country. The channelization in the country is dependent on the parameters that the [ regulators are up ]. So if you put a high tax, 35%, 38% tax or if you put limitations to what the players can do or deposit rules or other things that actually is an abstraction for the player and against the player as well, then the channelization will go down, equal to an annual regulation of whatever that might be. So if you push the market too hard, the market will find its way to its products in another way. So the regulators, when they push it [indiscernible] down and the channelization goes down, it’s because players are not comfortable playing on the regulated side. Then the regulators, in some cases, now moved to a repressive measurement. So they want to restrict it even further. They want to [ invest money ] in the customs in the [ new parts ] supporting. And that’s where we are now. So the players, they need to want to play on the regulated side. We can’t do much about that. So that’s why, even though it’s a click away that it’s a bit slow to get back to the license side.”
Asia Cyber Attacks
- “It’s very hard to quantify the Asian growth. We have now 3 quarters in a row where we are essentially flat. If you go back 3 quarters before that or even a little bit longer, you will see q/q growth. But of course, we should have a q/q growth.”
- 3 quarter of impact from Asia and when asked when the q/q growth pick up could happen, Martin responded “I don’t have any more insight on that right now”
LatAm Growth
- “It’s as simple as Latin America, except Brazil, is doing very well. We’re growing very nicely there. And then we have Brazil, which is the regulation just came into force, and that has made that market decline and grow from a lower level. That, I would say, have taken a little bit slower start than expected, but we have not changed any of our outlook. It looks very promising, and there’s [ 230 million people ] living in Brazil. So the future looks good.”
UK Gaming Commission
- Taken all actions they requested already
- Cooperating and expect it to move forward but don’t know when it ends or the final outcome yet.
Business Update.
Evolution’s revenue growth has declined from growing +31% y/y in 1Q23 to a meager +4% y/y in 1Q25. While most investors assumed their very high growth days were over given their larger base of revenue, it was surprising to see just how quickly the deceleration had taken place.
Now key to any Evolution thesis today is whether the recent revenue growth softness is indeed self-inflicted and transitory, or a signal of a broader and more pernicious weakness in their business model or their end markets.
On the one hand, there are real reasons for the growth slow down between the Georgia strike, the Asia Cyber attacks, and the European ring-fence initiatives. However, it does seem to be many sequential quarters of explanations for poor growth numbers. It is the 3rd quarter Asia has been adversely impacted and management is sparse on details of how they are fixing the issue (and exactly how prevalent the issue is). When asked when the situation would reverse and Asia could return to q/q growth, Martin responded “I don’t have any more insight on that right now”.
This is likely frustrating investors because many feel that Asia is a bit of a black box to understand, and not only do they not fully understand the cyber attack issue, but they also don’t know when it will reverse. In defense of management, answering they “don’t know” is a very honest answer, but of course is unlikely to instill much investor confidence. However, Martin did note that they should eventually show q/q growth in Asia.
The impact of the Georgia strikes on top line are over, but it continues to weigh on their expenses as they have had to shift activity to higher costing studios. This is relatively small minor impact though.
The biggest development of this quarter was the ring-fencing initiatives in Europe, which actually drove a contraction in y/y European revenue growth. After the UK Gaming Commission investigated Evolution for potentially helping facilitate (inadvertently) illicit gaming activity, they decided to be proactive with other European regulators. Essentially, they are now implementing technical checks to ensure their games are being accessed legally in regulated markets instead of putting the onus on operators as was the case prior.
The implication of the contraction in European’s revenue is that these actions have resulted in some illegal gambling activity being blocked. It is certainly good that Evolution was proactive about this instead of waiting for regulators to investigate them, but now there is a greater risk of “unfair” competition between Evolution and the smaller suppliers.
One of the biggest risks we noted in our original Evolution report wasn’t unregulated markets but poorly regulated markets. In Germany there are limits on how much a player can deposit in a month and in the UK there are limits on bet sizes. This is bad regulation because it doesn’t take into account how wealthy the individual is and largely results in activity moving to illegal markets.
Gambling is characterized by “whales”, which are very affluent, big spenders. If they are used to betting €20k Euros in a session and regulators limit that to just €1k a month, as they did in Germany, that player is likely to just play illegally elsewhere. (Most gamblers are not simply going to stop).
The unfair competition aspect is that Evolution is going to have to follow all regulations, but many smaller, unscrupulous suppliers can service the black market that exist within a regulated market because of the distortions these regulations cause. This whale now stops playing legally because of the deposit limits and moves to an illegal operator. Evolution loses their commission on this player and a smaller supplier operating illegally takes it.
This is what Martin was referring to below when he talked about the channelization going down because of onerous regulation. (Channelization is the portion of players that are playing legally). High taxes are another push for players to play illegally because operators needs to adjust the odds of winning more unfavorably to offset the taxes, meaning players get better payouts playing illegally.
They make clear on the call that this isn’t something they can do anything about. While Evolution might have the best games and competitive position, if a market is poorly regulated, competitors will get a clear leg up on them because they can offer games to operators who do not have to abide by regulations or taxes. This is the “unfair” competition that is bubbling up.
The other aspect of this is how well a country can find and shut down illegal gaming operations. It generally is very hard to do, and new operators pop up very quickly. Players still prefer to play legally because who wants to send money to an unknown online-only website and continue to find new ones when the current one inevitably gets shut down? It is a large inconvenience, and illegal sites are less likely to have good user experiences anyway—plus they will not have all of the great Evolution games players love. It never feels great though to be at the whims of a regulatory body that can—even if well-intended—often implement arbitrary rules with material adverse side effects with no quick way to reverse course.
Zooming out though, it seems very likely more is spent gambling in the future than today as the world generally becomes more affluent overtime, the global population grows, and access increases. And it also seems highly likely that more people gamble online in the future than today. And of the online gaming operators, Evolution is clearly the #1 supplier of games with no competitor coming close. So if you believe that the market is going to grow, internet gaming penetration will grow too, and Evolution is the leader in the category, how do they not continue to be much bigger in the future than today?
Sure, regulation can be pesky, but if any regulatory pushes too far it will likely reverse eventually because it robs them of tax revenue and ends up hurting the very players they intend to help. Asia may be a bit of a black box, but you don’t actually need much (or any?) Asia growth for Evolution as a whole to grow. While that wouldn’t be our base case, it is worth noting.
Of course, what assumptions an investor needs to assume all comes down to valuation, which we will hit on in the next section. But it should be reiterated, that competitively Evolution has not been threatened. They are not losing revenues because someone has better games or player experience than them. Instead, it is because other suppliers are skirting regulations and taxes, while they can’t.
The willingness for competitors to serve these illegal markets is giving them a “competitive advantage” versus Evolution because they do not have to follow betting size restrictions, deposit limits, or collect taxes. Regulatory incompliance will of course never be a “vector of competition” that Evolution will try to win with, but it is still weighing on their market share. However, it does seem likely that these self-inflicted measures to restrict illegal activity will be short lived (only 2 months of it were in this quarter’s results though), and they will return to growth thereafter.
Longer term it could become a bit of an advantage as the most legitimate operators, which do the most advertising, will only want to work with compliant suppliers. Some suppliers may make the decision to forgo the legal market all together in order to take advantage of the illegal markets where they have a better chance of garnering gambling activity. (Suppliers generally cannot serve both because of the certifications to be a legal supplier will not be granted if they are seen to also be operating illegally.)
They noted in the press release that “demand for online casino games continues to grow” and expect Asia to return to q/q growth. On Europe, Evolution noted that “What is important to remember is that the underlying demand remains strong”. They also have high expectations from their “state of the art” studios in Brazil and Philippines, neither of which have opened. Brazil has only just legalized online gambling, and it could take a bit of time to gain traction. There also is upside in more U.S. states potentially legalizing in the future. While much has gone against Evolution recently, there is a lot of optionality for positive surprises.
However, at their current valuation, an investor likely doesn’t need to assume much to get a double digit return. To see exactly what growth assumptions an investor needs to make at the current valuation, we will turn to our reverse DCF.
Valuation.
At a $70 ADR stock price, Evolution is valued at an EV of $12.9bn. With ~€1.1bn in LTM net profit (backing out the earn out liability reduction), they generated about €5.25 in per share earnings over the past 12 months. This converts to about $6 in TTM EPS for a multiple of 12x. Even with very low revenue growth of 5% and EBITDA margin headwinds, they should do around at least that this year. With of course much upside if they do return to stronger growth in the back half.
This of course is just looking at a single year’s earnings and things could be much stronger over the next several years. To get a better sense of the long-term return profile, we will turn to our reverse DCF.
We lowered our growth assumptions to show what returns would look like under more conservative scenarios. We ran a low growth scenario at 5%, a moderate growth scenario at 10%, and a “high” growth scenario at 13%. We put high in quotes because high growth a few quarters ago would have been closer to a high teens rate. While that is certainly not out of the realm of possibility, we thought we should focus on the return profiles with more tapered growth.
We then assumed 3 different EBIT margin scenarios: 50%, 60% and 65%. The 60% EBIT margins scenario translates roughly to 68% EBITDA margins, the high end of their guidance. Although when they revealed that guidance, they noted there was room for margins to go back to their prior levels.
The results of the reverse DCF are below. We can see that the market is probably assuming somewhere closer to 3% growth for Evolution. So the question isn’t necessarily whether Evolution will return to strong double digit growth in the future, but whether you are confident they will not continue to contract. Even achieving a very low growth rate can give an investor a double digit return.
Of course things could get worse though. What if the Asia slow down isn’t just due to cyber attacks, but also the byproduct of broader competitive market shifts? What if more regulation pushes players to play illegally in the EU? What if their legal and operational costs continue to rise, pressuring margin?
It is on each investor to make their own judgement on whether they think the potential returns are worth the risks they may perceive. We named our research firm Speedwell after the ship that helped ferry passengers to the Mayflower. The idea is that we want to help you get into the position to take the journey, but ultimately, we are not going to go with you. Each investor must ultimately make their own decisions
We will let Martin have the last word:
*At the time of this writing, one or more contributors to this report has a position in Evolution. Furthermore, accounts one or more contributors advise on may also have a position in Evolution. This may change without notice.