Can Kindred Group bounce back after a difficult H1?

The first half of 2019 has been one to forget for Kindred, at least as far as the share price is concerned. If the stock market loved it in 2017, then it fell out of love during 2018 and turned to downright hate in 2019. From a high of SEK131.9 in February 2018, the stock has fallen to just SEK49.4 at the time of writing, with the slopes of the chart going from green run to black run to ski jump during that period. But this hasn’t been a tale of a company imploding in on itself, with revenues going from £319.9m in H1 2017 to £450.6m in H1 2019. It’s more of a company finding conditions going against it and the wider market re-rating it as a result.

Kindred’s bottom line is starting to look very squeezed with EBITDA going from £59.9m in H1 2017 to £61m in H1 2019. While some of this is marketing inflation and operational cost rises as the business scales and expands, this is largely due to a rise in betting taxes. Betting duties in H1 2017 were £47.6m. In H1 2019, they were up 111% to £100.5m and rising. In comparison, marketing costs including revenue share were up from £88.4m to £131.6m, a 49% rise. What should be more alarming is this is not yet a business bearing the full brunt of tax liabilities either, even if it is paying some weighty ones in France.

There is still 41% of the business that is not “locally taxed” as Kindred describes it. Bearing in mind a large chunk of that is the Netherlands with a 29% tax rate, if the business was suddenly 100% regulated under the current operating model, then EBITDA would be reduced to a very small number indeed. This is not a problem unique to Kindred, of course, but it faces a specific set of problems that are. Kindred’s multi-country approach has been one to applaud through most of the decade, with the operator establishing top-tier positions in Sweden, France, Belgium and the Netherlands, while pushing into the UK through acquisitions. But as has often been the case in the short and dynamic history of online gambling, a strength can quickly become a weakness and an over-exposure to markets undergoing substantial change simultaneously is less than ideal.

Transformational years

Kindred is a business transforming, but not yet one transformed. The lack of M&A in the past two years is a big part of that. But shifting market dynamics have not always moved in its favour either. The business has become less geared to the Nordics and slightly less geared towards casino, but has not necessarily ended up in a better place as a result. What we’ve seen is more a business expanding through acquisition into one of the toughest markets in the world, while facing increasing slowdown and regulatory pushback in some major grey markets. The most obvious example of this shifting landscape in the first half of 2019 is the Nordics, which has dropped from 36% of the total business to 29% in H1 2019, with revenues of £129.3m compared to £137m in H1 2017.

Norway’s issues with payments blocking was the first blow, but then came Sweden. The opening of the regulated market in Sweden was supposed to be a big positive, not just for Kindred but for the online gambling sector as a whole. But in the early stages it appears to have been a positive solely for the ex-monopolies Svenksa Spel and ATG, which have mopped up all the early market growth and some of the grey market share for good measure.

Kindred didn’t break out revenues for the second quarter, although we believe they were up sequentially but did note that early investment was having a big impact on the bottom line.

Kindred CEO Henrik Tjärnström noted concerns over channelisation in Sweden

“The new licensing regulation in Sweden has resulted in significant short-term margin pressure driven by higher betting duties but also higher marketing as we are investing for the longer term,” Kindred commented in its H1 results statement. “In the Swedish market, we saw a significant improvement quarter-on-quarter, but EBITDA contribution was still down £9.2m when compared to the second quarter last year.” That naturally has investors feeling nervous about the remainder of the year. But Kindred isn’t showing any signs of backing off from Sweden in the short term.

Bonus costs should ease off in the second half and Kindred is not letting up in marketing intensity, although the nature and content of its marketing is shifting to a more responsible gambling-led approach. But the big-name sponsorships keep coming and Unibet signed an agreement with Hockeyallsvenskan to be the main sponsor of the league from 1 July 2019 worth SEK25m over two years. The concern though is whether revenues can come back to where they were and then begin growing again, with Kindred noting that the market could be down as much as 20% year-on-year in Q2.

Kindred CEO Henrik Tjärnström noted concerns over the channelisation in Sweden and, reading into additional comments, it’s possible some VIP activity is moving to the new black market. But he appears to remain confident in his long-term outlook for Sweden, with the expectation to gain back share from the ex-monopolies through their better product offering and to benefit from the margin pressure on smaller operators which are likely to be forced out of the market. But he’s also realistic when he says that it will take a few quarters or even years before the business is back to the same level of profitability, and with pending changes in some of its other core markets, that could be a problem.

Taking a differing path

Kindred has always taken a different path to most of the industry, but as the market dynamics shift, its route out looks oddly conformist. The markets Kindred seems focused on for the next step change in growth are arguably the UK and the US and bring with them considerable challenges and no shortage of tier-one competitors. Where previously it was happy to be one of a small number of firms in markets others shied away from such as Belgium, the Netherlands, France and Eastern Europe, now it appears to be fighting its battles on the same field as everyone else.

Kindred’s acquisition of 32Red and Stan James took the UK from a minor market with big ambitions to one of its single largest markets, with 32Red generating £73.2m in 2017. But it did so at a time when the sky was about to fall in on the UK, and the end result has been a tough period repositioning the 32Red business and trying to grow the Unibet brand in sports against wider sector slowdown. Tjärnström said the UK business is growing fast in H1 and there is clearly a lot of headroom for them in terms of market share gains. But the current UK market conditions and the fierce competition for new players, not least in sports, would suggest it’s unlikely to be an easy route out of its current stall in growth.

The UK business is growing fast in H1, according to Kindred Group’s CEO

And equally its US expansion plans certainly require Kindred to keep some of its marketing investment in reserve, with licence fees in Pennsylvania alone representing the marketing budget of a small European nation. It’s unclear yet whether Kindred’s plans to take on the US sports betting market are an act of hubris or heroism, but it feels likely to be one or the other with Kindred starting broadly from scratch with no database, brand or obvious technology advantage (it’s operating on the same Kambi platform as much of its competition). Kindred also faces no small challenge from its European peers who are throwing money at the market in an attempt to build early momentum prior to a wider rollout of sports betting in the next couple of years.

The Stars Group recently announced plans to invest $40m into Fox Bet, GVC said it would invest meaningfully from the new NFL season and Flutter and William Hill are both already deeply committed to the market with strong brands and an existing revenue base. Kindred’s conceit is it can use its experience of building a revenue base in deeply localised European markets to build a business in the US that essentially resembles a series of disparate nations in terms of the state-by-state rollout. It certainly sounds logic, but you’d rate them an underdog to come through with a significant market share when all the shouting is done.

Short-term solutions?

So where does Kindred go for growth? The Central, Eastern and Southern region was the strongest performer, up 20% year-on-year, albeit to a relatively low £19.2m total, with growth strongest in casino – and it’s likely the investment in Vlad Casino is part of this, along with growth in Italy. But it’s hard to make a case for strong growth with a non-local brand in many of the remaining markets in the region, and it’s notable Kindred pulled out of a potential launch in Spain with management presumably concluding the investment could be better spent elsewhere in the world.

Germany is an interesting potential growth market, with Tjärnström noting the business was growing in Germany in the period, albeit from a “very low level”. And you sense the product offering is well suited to the German market with Kindred’s experience of hyper localisation, and its ability to scale-up spend to attack a market where it sees potential means it should definitely not be ruled out as a potential player in a newly regulated market. Unlike some of its competition, it won’t be hindered by its existing business and possible losses of gaming or a reduction in in-play availability too. That said, Germany is not an easy place to make market share gains in 2019 either, with GVC and Tipico formidable opponents, not to mention the likes of bet365 or The Stars Group and a host of gaming-focused operators.

Neither is the Netherlands, which is arguably Kindred’s most important market and probably its largest sports betting market, which currently offers the group a significant competitive advantage. But it is a market that faces huge regulatory changes and a massive increase in operating costs in the near future, as well as considerable operating uncertainty in the near term. It’s also a market where regulatory pressure is causing revenues to slow down in the near term and where regulators have slapped a €470,000 fine on the company, potentially giving Kindred a six-month handicap when the market launches. And you sense regulation will be no panacea with Holland Casino entering the market and a 29% tax rate. But it’s one of many tough questions Kindred needs to answer over the next 12 months.

This is not to suggest there is any crisis to be dealt with, and it’s important not to overreact to a flat first half against tough comparatives in H1 2018. But organic growth in regulated markets is tough going and it is arguable that what Kindred needs to put itself back on the front foot is a major acquisition, possibly in UK sports. The issue with M&A-driven growth is that assets are in short supply in the current market and a major merger with someone such as 888 or William Hill brings with it a whole new level of complexity. And if there was a simple solution, you suspect this skilled and experienced management team would have found it by now. Instead you sense the second half of the year will be even more important than the first.