Where next for consolidation within the egaming affiliate sector?

If market consolidation patterns across various industries are similar, then the egaming affiliate vertical is only just heating up.

RB Capital has been involved in some of the most significant transactions in the sector and we’re engaged by buyers and sellers on a regular basis. Demand is on the increase, as is the supply of businesses looking to cash-in on this frenzied activity.

Notwithstanding – or perhaps because of – the above, the path is fraught with risks on both sides of the table and we see some potentially turbulent times ahead for conglomerates which are over-leveraged in certain markets. We’ll delve into these a little later in our analysis.

Having worked on both the buy- and sell-side we’re party to the motivations and challenges of buyers and sellers and have seen some interesting trends forming on both sides. We’ve also noticed that the affiliate businesses are becoming more sophisticated, which tends to require a more structured and measured approach to the sales process and importantly, the preparation required on the sell-side to ensure the maximum value is achieved for both parties.

Buy-side ecosystem

With the emergence of several key players in the sector, the die has been cast as to who the ‘big four’ firms are. Catena and XL Media are the most established to date; they are publicly listed entities with the support of the markets behind them – more so on the Nasdaq side, but that’s another topic altogether. However, in Q1 of this year RakeTech announced a €70m capital raise obtained through a private investment fund. Less than two weeks later, GIG’s affiliate arm Innovation Labs raised SEK400m (£36m), via a secured bond issue, to fuel further acquisition.

What is interesting to note is that of the above four mentioned firms, two are pure affiliates while the others are diversifying their portfolio offering by providing other parts of their business with a traffic source. Operators such as Cherry, GIG and Stride Gaming have all made acquisitions leading to ownership of a sustainable traffic supply. It seems to be a strategy that is working well for operators adopting a multi-brand approach, with all three firms reporting significant gains in Q1 2017. Importantly it de-risks recurrent revenue in the medium term through a multi-channel strategy.

Indeed, there is a definite trend pointing to operators recognising the importance of having their own traffic source. Over the past 12 months, RB Capital has seen the panel of potential buyers widened, with more operators at the table. However, with aggressive bidding and a well-trodden path of extracting value from these acquisitions, it will make it difficult for some operators to continue to scale without strategic acquisition of a tier one to two player.

There are several other firms which are arguably better capitalised, although less public facing; some choosing to stay under the radar due to funding strategy, portfolio offering, or occasionally exposure to darker markets. Others are rapidly growing organically through a number of disruptive methods; ASO being one such example. We are also seeing an emergence of a number of privately funded tier two players with the momentum potential to displace the incumbents.

As to deal-flow; while the list of active buyers is extensive, we will generally only approach a select few who we know will be interested in the asset in question and a strategic match for a future partnership. Strategy and discretion is key when selling a business. With the wrong sell strategy, an asset can easily become known to all; which quickly leads to the notion of a fire-sale.

Sell-side landscape

The scale of this sector will only be realised when the bulk of consolidation has taken place. We certainly don’t envisage any slowdown over the next two to three years and in that time, new players will continue to enter the market catering for expanding niches. While it will be more challenging for these entrants to achieve scale, medium-sized players will be well positioned to acquire, ingest and augment their own growth.

We are starting to see more sophisticated businesses that are not only well structured and staffed, but some of which are also technically ahead of the curve, with many falling into the Ad-tech genre. Such businesses control valuable IP and can demonstrate resilience within regulated markets while having defensible valuations, with those with the potential to scale being the most valuable from our perspective.

Nevertheless, there are still many large affiliates that rely significantly on Google’s algorithms, either passively through the production of quality content or actively through pursuing link building strategies or paid search. While such strategies are mostly short-term due to third-party dependence, they encourage momentum and will continue to attract buyer interest as they are essential for conglomerates and – save for PPC affiliates – some of the most profitable business within the affiliate sector, with profit margins in excess of 90%.

The appeal of such businesses is clear, however there is always a risk of overreliance on a single acquisition channel. If – as we have seen recently – such entities were penalised or search algorithms tweaked due to regulatory changes, these businesses will be adversely affected. The recent introduction of paid search on app stores enables operators to advertise and affects affiliates’ organic ranking; hence requiring a rethink in strategy.

There are a multitude of other factors that need to be considered in terms of risk management and mitigation. For example, most buyers we encounter are more interested in businesses with a high proportion of their revenues derived from revenue share rather than CPA (Cost Per Acquisition) deals, due to the recurring tail of revenue that the former affords.

Buy-side risk

It is thus our view that some buyers’ M&A are focused on the types of businesses that we’ve mentioned above, where acquisitions of seemingly identical entities to their own are the strongly preferred option as they are easily weaved into their own structure and very little additional resource is required to run the business.

Clearly there is some merit in this approach (time and ease of integration being the most obvious) though over-reliance on one acquisition channel and in some cases, one market could lead to revenue diversification issues. Considering the high multiples and attractive earn-outs paid for these entities, careful consideration of each acquisition is necessary.

One current example is in unregulated, non-English speaking markets. It’s reasonably well understood that Google has a lower tolerance for clean link profiles in such territories; indeed, we would speculate that this is mainly due to the relative lack of paid search in these markets and the English (read natural language) algorithm is more sophisticated. As and when governments open regulatory proceedings, Google will almost certainly allow PPC and the big money terms will be dominated by operators with the largest budgets, squeezing affiliates off the first page thereby eroding traffic and subsequent revenues.

With the introduction of paid search, Google may add suitable weighting to their ranking algorithm to fall in-line with other regulated markets such as the United Kingdom – this could be the largest cause for concern as if such measures were implemented, affiliates with more precarious link profiles may risk being penalised.

Sell-side advice

We are regularly approached for advice by affiliates looking to sell their business, often the catalyst in their decision to sell is a series of approaches from would-be buyers.

Statistically you are more likely to sell your business to someone you already have a relationship with, so we always endorse having such conversations. However this needs to be capped to a specific level; with caution on revealing any aspects that might inadvertently send the wrong signals. Top-line financials and NDPs are fine, anything else should be played close to your chest until you have properly prepared the business and are ready to engage multiple buyers.

Indeed a good portion of RB Capital’s time is spent de-risking elements of a seller’s business that may directly or indirectly affect the overall valuation. Remember, while there’s a temptation to sell to a friendly acquirer, you’ll never fully determine the true market value of your asset unless you take the business through a competitive sales process.

That said, the sales process is highly delicate and a balance of strategy and operation; it’s an intensive process where if led incorrectly a seller can easily lose sight of fundamental aspects of their day to day operations, which in turn affect revenues and lead to a decrease in valuation.

For those who aren’t in a rush – planning is key. The most common cause for aborted deals is when a buyer applies due diligence that uncovers risks leading to a devaluation of the business or in the worst case, beyond a threshold that the seller deems acceptable. Most factors surfaced at the DD stage may have some form of resolution at a cost of valuation or earn-out; hence pre-emptive strategies are essential.

A trusted brokerage with significant experience in affiliation and M&A will ensure you and your business are well prepared for the sale process. And in our experience, at the end of a successful transaction, when you will be celebrating the success of the sale, any brokerage fee incurred will be covered (in our experience many times over) by the additional value that has been achieved for your business.

Julian Buhajiar is co-founder at RB Capital and investor, CEO and board director to multiple ventures in egaming, fintech and media markets. 

Ben Robinson is co-founder at RB Capital. He has 15 years commercial experience and is co-founder, director and investor in numerous ventures within gaming and fintech.