Great Acquisition, page-146

Aristocrat Leisure has hooked Big Fish, a US social casino app developer, which is expected to boost recurring revenue. The acquisition confirms a stronger focus on digital gaming.
-Aristocrat's exposure to digital gaming significantly increases
-Difficult to predict when social casino apps will stop growing
-Digital opportunities prevail, capital management potential despite structural decline in slot expenditure
Â
By Eva Brocklehurst
Digital gaming is expected to become the largest contributor to Aristocrat Leisure's ((ALL)) revenue after incorporating the latest acquisitions. This highlights a change in focus and a boost to recurring revenue as a percentage of the total.
Digital game developer Big Fish, a subsidiary of Churchill Downs and headquartered in Seattle, will be acquired for US$990m, funded by debt, and the deal is expected to be accretive in the first full year of ownership.
Brokers observe the Big Fish business has struggled of late but achieved 4-year compound annual operating earnings growth (EBITDA) of 15% and revenue growth of 12%. Deutsche Bank estimates the acquisition will be accretive by 5.6% on a full year basis and complement Product Madness with its digital-first content creation, while the social gaming business will expand Plarium's addressable market.
While Aristocrat Leisure's track record in acquisitions has been successful, the move recently into digital gaming raises some questions for Morgan Stanley. Big Fish is more of a strategic fit than Plarium was, given social casinos are complimentary to Product Madness and revenue and cost synergies may be achieved.
It increases the company's proportion of recurring revenue and makes Aristocratic Leisure the second largest social casino publisher. Still, earnings can be volatile, as Morgan Stanley points out, Big Fish revenue for the 12 months to September 2017 was down -5%.
Credit Suisse observes the industry is still fairly new and it's difficult to predict when apps will stop growing. The broker models 12% like-for-like compound digital operating earnings growth to FY20, as the company exchanges its knowledge base between Product Madness, Plarium and Big Fish.
The broker believes Aristocrat can inject content into Big Fish social casino apps such that it can stimulate revenue. The more users, the more robust the company's statistical modelling becomes in assessing user behaviour. Therefore, the business is likely to be able to grow in a market that is currently expanding at an estimated 10%.
Credit Suisse acknowledges the Big Fish track record is patchy. The company was enjoying strong momentum from the app Gummy Drops, which abruptly peaked late in 2016, yet was spending as if future sales would be much higher.
Marketing expenditure was not halted quickly enough and operating earnings dropped. However, the broker notes marketing dollars have now been re-directed away from casual games such as Gummy Drops to higher-margin social casino games.
Outlook
Meanwhile, FY17 earnings growth was largely driven by a strong performance in the Americas, digital and international. Underlying earnings per share increase by 36%. Digital earnings were up 34.5%, international up 40% and the Americas up 23%. In FY18 the company expects to maintain share in Australasia, although international earnings are expected to moderate. Plarium is expected to make a small contribution.
Morgan Stanley forecasts 18% profit growth in FY18, excluding the impact from Big Fish, because of further market share gains in operating leverage in North America, given the release of a highly-anticipated Dragon Link game. This is partly offset by Plarium which is now expected to be earnings neutral. The company still remains a cyclical business and Morgan Stanley considers the current share price fair.
UBS found few surprises in the results and remains a buyer of the stock, given the significant business restructuring that has occurred. The broker incorporates the acquisition of Big Fish into forecasts and assumes minor levels of near-term growth. The acquisition reinforces a perceived preference for growing exposure to digital and recurring revenue.
Digital is now 38% of group pro forma revenue after completion of the acquisition and recurring revenue is now 65%. The fixed cost nature of the company's major expenditure, R&D, implies significant leverage during periods of revenue growth and UBS suggests this is under-appreciated by the market.
Ord Minnett reduces net profit estimates by -4.8% for FY18 and -3.2% for FY19. The broker downgrades to Accumulate from Buy following the run-up in the share price in September, and despite the sharp fall that occurred post the result. Further digital growth and capital management opportunities are available, in the broker's opinion, despite a structural decline in slot expenditure.
FNArena's database shows five Buy ratings and two Hold. The consensus target is $25.40, suggesting 13.2% upside to the last share price. Targets range from $23.30 (Macquarie, yet to comment on the acquisition) to $29.75 (Deutsche Bank).