Primary Analysis: 888 Price Whispers Imply 10% Yield on FRNs, 10.5%-11% Yield on Fixed Rate SSNs to Compensate for Limited Near-Term Cash Generation Potential, UK Regulatory Risk; High Net Leverage of 4.3x; Notes Supported by Strong Position in Operating Markets, Implied Equity Cushion of 4.7x

Relevant Items:
Offering Memorandum
Financial Model on Aggredium (888 Only)

888 Holdings is raising debt to fund the acquisition of William Hill International, or WHI, which was first announced in September last year. The acquisition will be funded via £1.017 billion-equivalent issuance, £759 million of euro- and sterling-denominated term loans, £163 million raised through an equity placing in April, and £288 million of cash. The deal implies an enterprise value for WHI of between £1.95 billion and £2.05 billion and reflects a multiple of about 8.2x.

Price whispers for the margin on the floating rate notes are between 525 bps to 550 bps with an OID in the low 90s, implying a yield of about 10%, while pricing for the fixed rate notes has been talked between 6% and 7% with an OID implying a 10.5% to 11% yield.
 
WHI acquisition by 888 creates the third-largest publicly traded gaming player: The enlarged group will be the world’s third-largest publicly listed online gaming company by revenue, with market leading positions in its betting and gaming product verticals in the U.K. and Continental Europe operating across 23 licensed jurisdictions, based on size of combined revenue. Leading players in the U.K. and Spain online market include Flutter and Entain, while Bet365 holds a leading position in Spain. The combined group on a pro forma basis generated $2.7 billion in revenue for the 12 months ended Feb. 28, 2022, generating $412.2 million in adjusted EBITDA equivalent to a 15.3% margin.

High pro forma leverage, though valuation implies equity cushion: The acquisition is primarily debt funded (apart from a small amount of £163 million of equity), which will raise the leverage to 4.3x on a pro forma basis from 2.4x before. This is higher than the closest peers Flutter (2.9x) and Entain (2.4x). We do note however that based on past gaming transactions the implied valuation of 9x for the combined group implies an equity cushion of about 4.7x.

Combined margins below peers: An EBITDA margin of 20.6% pro forma the transaction remains below the 24% average from Reorg’s selected peer group of comparable players. The slightly lower margins can be partly attributed to the lower margin retail business of William Hill International as well as relatively higher marketing costs compared to peers.

Cash generation limited through interest burden and capex in near-term: A significant increase in interest costs on the debt structure as well as a sizable jump in capex due to WHI’s retail network could lead to a much reduced level of cash generation. Using the pro forma combined EBITDA of about $412.2 million assuming no synergies, and no normalization of WHI’s retail performance, we estimate levered free cash flow including lease liabilities for the combined group of about $20.5 million on a working capital neutral basis. This assumes cash interest costs of about $138.4 million (assuming an equal size between the fixed and floating issuance, 5.5% on the floating rate notes and term loans and 6.5% on the fixed rate notes), capex of around $150.7 million (£110 million), $48.6 million in taxes and $53.9 million of lease repayments. Refer to ‘Business Model and Financial Overview’ for more details.

Low geographic diversification, U.K. Gambling Act review may affect future profitability: The combined group is relatively less diversified compared to peers and would have 67% of its revenue coming from the U.K. (U.K. online 43%, U.K. retail 14%). It is anticipated that the U.K. government will issue its white paper as it reviews the Gambling Act in the second or third quarter of 2022 and any proposals to amend the Gambling Act could follow. The group says it is well positioned to be resilient to any spending limits that may be proposed by the white paper with 67% of its customers spending under £500 per quarter, and 22% achieving winnings in the first quarter of both 2021 and 2022. In the first quarter of 2021, only 5% of customers spent more than £1,500, which dropped to 3% of the customers in the first quarter of 2022. However, any significant revisions of the act could be detrimental to the group’s topline and profitability.

Likelihood of future acquisitions to drive growth: The group is highly acquisitive and acquisitions have remained core to its growth strategy. There is a risk that the group may debt fund future acquisitions, which may carry execution risks. In 2019, 888 acquired the Costa Bingo brands from former B2B partner Jet Management, the BetBright sport platform and, in 2018, 53% of the All American Poker Network, a U.S. sports betting platform, for a total consideration of $60.6 million. Further, in response to new regulatory regimes and technological advances, the gambling market has continued to consolidate in the company’s key jurisdictions including the U.K., Spain and Italy.

Growth in key online markets: The global online betting and gaming market benefits from structural tailwinds driven by digital migration from land based gambling, as well as the broader growth in e-commerce adoption across markets. The market wide benefit from digital migration varies by jurisdiction, with those markets that are already at higher levels of online penetration, such as the U.K., expected to experience more limited annual growth, with the expected compound annual growth rate of the UK online market for 2019-2026 being 5.2%. The overall EMEA online gambling market is expected to grow at a compound annual growth rate of 12.4% between 2020-2026 according to Regulus Partners.
 
Investors considering 888’s debt package highlighted the regulatory risk that the company faces as a key concern. The U.K.’s white paper review of the Gambling Act of 2005, which has been delayed multiple times and is expected to lead to regulatory changes related to advertising, affordability checks and other features of the gaming sector, is expected to be released soon, investors noted. However, the company has preemptively tightened its affordability checks in advance of the introduction of new regulation, which means the regulatory impact may be limited, one investor said. Tighter affordability checks have impacted part of the company’s U.K. online business, and management conceded there is more impact to come, however this is only a small part of the overall business, the investor noted.

Meanwhile, political turmoil and questions about U.K. Prime Minister Boris Johnson’s leadership mean that the government may lose focus on the white paper, resulting in further potential delays, another investor argued.

The company does still operate in several unregulated markets, including Canada, where it faces some regulatory risk, one buysider said. Management said the company aims to have just 10% of its revenue generated in unregulated markets but did not provide a timeline for this, he added.

The deal has been intermittently pre-marketed to a group of investors since April, with market volatility occasionally interrupting the process. As a result, market conditions have changed drastically since some investors first considered the credit. Since April, the issuer changed the structure of the deal to tap U.S. markets, reflecting greater challenges in Europe, however equity market declines since then have also reduced the equity buffer on the transaction, another investor noted. But with the deal underwritten late last year, the banks were keen to get the debt off their books as soon as possible, he said.

On the positive side, the combination of 888 and William Hill’s non-US business, which the new debt is financing, increases diversification. However, the combined group is fairly levered, with pro forma net leverage at 4.3x, has a lower margin compared to its peers largely because of marketing costs, and cash generation will be limited because of the significant interest burden. The new debt structure also features a USD term loan B, which will need to be amortized at 1% per annum, another investor said. Capex for the combined group will also be significantly higher, at about 30% of EBITDA because of William Hill’s large retail network, investors said.

The company has provided current trading information for January and February, but one buysider complained that more recent information may be needed. Meanwhile, EBITDA addbacks are significant, including adjustments related to William Hill’s retail network normalization and for expected cost synergies, the buysider noted.

As a comparable credit, investors suggested Intralot, Gamma (bond issuer of Lottomatica, whose sponsor Apollo was one of the bidders for William Hill), and potentially Playtech.
 
888 Holdings is raising debt to fund the acquisition of William Hill International, or WHI, which was first announced in September last year. WHI’s implied enterprise value of between £1.95 billion and £2.05 billion reflects a multiple of about 8.2x WHI’s normalized adjusted EBITDA for the 12 months to February 2022 of £238 million.

Pro forma for the acquisition, net leverage for the combined group will rise to 4.3x from 2.4x. Leverage is based on LTM acquisition-adjusted EBITDA of £405.3 million, which includes 888’s EBITDA of £109 million, £187 million of WHI’s EBITDA and £110 million of further pro forma and synergy-related adjustments. Per the group’s OM, the board has set a goal of achieving a pro forma net leverage ratio at or below 3x in the medium term.

Using an average of previous transaction multiples within the gaming industry and the combined group revenue split of 43% in U.K. online and rest 57% in retail and other segments, Reorg gets to an implied multiple for the combined group of about 9x, implying an equity cushion of about 4.7x.

Using the same methodology we get a multiple of about 8.87x for WHI, slightly higher than the 8.2x transaction multiple (WHI’s revenue split comprising 41% online and 59% retail and others).
 
Use of Proceeds, Redemption of William Hill Existing Debt

The acquisition will be funded via £1.017 billion equivalent issuance, £759 million of euro and sterling denominated term loans, £163 million raised through an equity placing in April, and £288 million of cash. The transaction includes a cash consideration of around £585 million, which is down £250 million from the previous amount of £835 million, and will also be used to redeem about £1.159 billion of existing debt at WHI, among other things. Further, we note there is an agreement to pay up to £100 million in deferred consideration in 2024, conditional upon the enlarged group achieving a minimum level of adjusted EBITDA for the 12-month period ending Dec. 31, 2023. EBITDA must be more than or equal to £428 million for the full £100 million to be payable. If payable, 888 may elect to satisfy all or any portion of the deferred consideration in cash or by the issuance of new ordinary shares.

The £1.159 billion of existing debt of WHI to be redeemed includes £349.1 million 4.875% 2023 notes, £350 million 4.75% 2026 notes, and £459.9 million of WHI facilities. The outstanding 2023 notes are expected to be redeemed in full after the completion of acquisition (only about €900,000 were redeemed upon exercise of a change of control put option by 2023 noteholders and rest of the 2023 notes are intended to be redeemed at a make whole premium). The existing 2026 notes are expected to be repurchased following a change of control offer, under which the issuer is required to offer to redeem or repurchase the bonds at 101%. The 2026 notes are currently trading at 100.6%.

As previously noted, the bonds are non-call for life, meaning if the bondholders do not exercise the change of control put option to extinguish the notes, the issuer can purchase them in the open market or redeem them at a make whole premium. The make whole for the 2026 notes at 109%, according to sources. Given the make whole redemption is expensive compared to the current price of the 2026 notes, 888 could also choose to let the bonds stay in the new combined structure until they mature. 888 said on the roadshow call that if the 2026s are not redeemed as part of change of control offer, the group will repay a portion of the sterling term loan A (delayed draw) and euro term loan A.

The group’s pro forma capital structure is below:
 

The group said it expects £164.2 million in cash and cash equivalents at the closing date with £150 million under its RCF, resulting in liquidity of about £314 million.

888 has also agreed to sell the entirety of its bingo business to the Broadway Gaming group which, subject to the satisfaction of certain conditions, is expected to complete in the second quarter of 2022. This is intended to allow the company to focus on its core platform, enabling greater resources to drive growth in its core markets and reducing compliance complexity arising from related accounts across B2B and B2C bingo and the company’s core platform.

The corporate structure is below:
   
Initial price whispers for the margin on the floating rate notes are between 525 bps to 550 bps with an OID in the low 90s, implying a yield of about 10%, while pricing for the fixed rate notes has been talked between 6% and 7% with an OID implying a 10.5% to 11% yield.

An average yield of about 9% for comparable issuances across the gaming sector is below current price whispers, although the makeup of the current market, as well as pricing for various other recent issuances, points to notable premiums being placed on issuers coming to market.

The premium may also reflect near-term regulation risk through the anticipated publication of a white paper on gambling regulation reform by the U.K. government and lack of clarity on future cash generation potential of the combined group, which would likely be adversely affected by significantly higher levels of interest and higher capex brought in by William Hill’s retail network.

However, a likely wide pricing of the notes could appear attractive as the medium-term outlook of the notes is supported by the growing nature of online gaming and a deleveraging target to at or below 3x in the medium term.
   
Historical financials for 888 and the combined group pro forma the transaction are below:
 
888 is one of the world’s largest online betting and gaming companies by revenue, with overall revenue of $947.6 million for the 12 months ended Feb. 28, 2022, and an adjusted EBITDA of $150 million, equivalent to a 10.5% margin.

The company owns and operates a range of brands providing betting and gaming products across its B2C product areas of Casino, Sports, Poker and Bingo. The group also provides B2B services to third-party partners by making its B2C gaming platforms available and provides back-office capabilities to third parties, who in turn market the resulting online gaming services under their own brands and share a proportion of the revenue generated with the group.

William Hill is the number one Casino brand in the U.K. in terms of awareness, the number two betting brand in the U.K. in terms of awareness and is a top-three brand by revenue share, in both retail and online sports betting, generating £1.241 billion in revenue for 2021. The business offers betting and gaming products and services through its land-based operations and online distribution channels, including mobile. Approximately half of the group’s 2021 revenue was attributable to its U.K. online betting operations.

William Hill Online is a leading online betting and gaming provider to customers in the U.K., Southern Europe and the Nordics, and it has also recently launched in Latin America. It generated £280 per active player in the year ended Dec. 28, 2021.

Following its acquisition of William Hill, 888 said it expects the enlarged group to be the world’s third largest publicly listed online gaming company by revenue, with market leading positions in its betting and gaming product verticals in the U.K. and Continental Europe across 23 licensed jurisdictions, based on size of combined revenue. The combined group on a pro forma basis generated $2.7 billion in revenue for the 12 months ended Feb. 28 2022. On a normalized basis, excluding the effects of enforced retail closures on William Hill as a result of Covid-19 and assuming 888 had owned and integrated William Hill for the duration of the 12 months ended Feb. 28, 2022, the pro forma normalized revenue would have been $2.8 billion. The derivation of pro forma normalized revenue is shown below:
 
Pro forma normalized adjusted EBITDA over the period would have been $481.3 million or, including an adjustment in relation to William Hill Retail’s retail contribution based on the performance of the business of the second half of 2021 and in the first 2 months of 2022, $555.4 million, including £54 million of cost synergies expected by 2023. This implies a pro forma normalized adjusted EBITDA margin including cost synergies of 19.8%, significantly higher than 888’s LTM adjusted EBITDA margin of 15.8%.

The acquisition is in line with 888’s intention to drive its international expansion through growth in locally regulated markets, with complementary brands to create sustainable leadership positions and improve the group’s ability to drive market share gains. Specifically, the U.K. is the world’s largest regulated online market and 888 believe both it and William Hill were among the fastest growing brands in the U.K. online gambling market in 2021. The enlarged group also benefits from strong and growing positions in the locally regulated markets of Spain (where it is expected to have a top three market share) and Italy.

The acquisition is also expected to improve business sustainability, with a greater mix of revenue coming from locally regulated and/or taxed markets and will leave 888 well-positioned in other countries that are expected to regulate online gaming in the future.

By combining 888’s approximately 2.2 million active customers with William Hill’s approximately three million active customers, the enlarged group will have more than five million annual active customers and 1.6 million monthly active users. Average revenue per user for 888 stands at £141 per user compared with £71 per user for William Hill and the combined group is seeking to drive average revenue per user growth by capitalizing on the best parts of both businesses.

Cost synergies are also expected by management and pretax are estimated at approximately £100 million per year in 2025, which the group expects to lead to improved profit margins and free cash flow generation.

Management said it believes that the increased scale of the business, including realization of anticipated synergies, will provide economies of scale across third-party costs, including marketing by leveraging marketing technology and practices across a suite of brands. Scale also drives operating leverage through servicing additional revenue via the combined technology and operations, which in turn is expected to improve the EBITDA margin of the enlarged group.

The group expects the phasing of these pre-tax synergies to be as follows: approximately £5 million in 2022, £54 million by 2023, £70 million in 2024, and £100 million in 2025, of which £15 million are expected in capital expenditure synergies in the aggregate. To achieve these synergies, the group expects to incur one-time cash costs of approximately £79 million, spread across the next three years.

Assuming no synergies are realized from the acquisition and without including William Hill retail normalization adjustments of $69.1 million, we estimate levered free cash flow including lease liabilities for the combined group amounts to $20.5 million on a working capital neutral basis. This assumes cash interest costs of about $138 million (assuming an equal size between the fixed and floating issuance, 5.5% on the floating rate notes and term loans and 6.5% on the fixed rate notes), capex of about £110 million or $150.7 million and $48.7 million in taxes, calculated as the sum of the group’s reported LTM cash taxes.

With regard to the capex assumption, capex is expected to be “slightly” higher during 2022, compared to the £22 million for 888 and about £83 million for WHI in the LTM to February 2022, so we have increased the level of capex by £5 million across the combined groups.

A pro forma free cash flow calculation is below:
 

888 Historical Performance

The group’s cost base primarily consists of cost of sales, marketing expenses and operating expenses. Cost of sales consists primarily of gaming duties, payment service providers’ commissions, chargebacks, commission and royalties payable to third parties and amounted to $840.1 million or 31% of sales for the enlarged group on a pro forma basis.

The group is subject to corporate income taxes and gaming duties in jurisdictions in which betting and gaming is regulated. Taxes and gaming duties are subject to change and present some risk to the group’s operations. For example, in 2021, 888 saw tax increases in Germany and Denmark. As a result, gaming duties increased by 21% to $184 million in 2021 from $151.8 million in 2020 driven by strong revenue growth in regulated and taxed markets, including the U.K. and Italy, and the new tax regime in Germany commencing the second half 2021.

Operating expenses relate to staff costs primarily and corporate professional expenses and have remained largely stable for 888 between $215 million and $220 million since 2019. On a pro forma basis for the enlarged group operating expenses total $1.148 billion, equivalent to 42.5% sales.

Marketing expenses have improved year over year for the two months to Feb. 28, 2022, decreasing by $7.1 million to $50.3 million reflecting the data-driven optimization of digital marketing to market conditions, with increased activity in 2021 driving higher marketing spend in that period. Pro forma marketing spend for the enlarged group totalled $595.1 million on a pro forma basis.

The company said that it believes it will be able to continue to grow its customer base, through traditional marketing, advertising and promotional activities, informal marketing campaigns, and cross-promoting between games. Increased marketing investment in new or regulating markets is in line with the group’s strategy to build brands and use its data-driven marketing expertise to drive increased customer activity and deliver market share gains. Notably however, in some geographies the advertisement of gambling is limited or prohibited by law.

The enlarged group operates in a market that is highly competitive due in part to low barriers to entry. However, as regulatory tightening is contributing to raising these barriers, scale is increasingly important as technological complexity and the costs of marketing grow.

The global online betting and gaming market benefits from structural tailwinds driven by digital migration from land based gambling, as well as the broader growth in e-commerce adoption across markets. The market wide benefit from digital migration varies by jurisdiction, with those markets that are already at higher levels of online penetration, such as the UK, expected to experience more limited annual growth, with the expected compound annual growth rate of the UK online market for 2019-2026 being 5.2%. The overall EMEA online gambling market is expected to grow at a compound annual growth rate of 12.4% between 2020-2026, according to Regulus Partners.

Consequently, since Jan. 1, 2019, the William Hill retail estate has been remodeled through the permanent closure of approximately 832 licensed betting offices (LBOs), resulting in a more sustainable and cash generative footprint.

In response to new regulatory regimes and technological advances, the gambling market has continued to consolidate in the company’s key jurisdictions including the UK, Spain and Italy. In the U.K., the leading six groups combined to capture 78% of the total UK online gaming market in 2020. Similarly, the top eight group operators in the Italian market accounted for 78% of the domestically licensed market.

Notably it is anticipated that the U.K. government will issue its white paper as it reviews the Gambling Act in the second or third quarter of 2022 and any proposals to amend the Gambling Act could follow. 888 is well positioned to be resilient to any spending limits that may be proposed by the white paper with 67% of its customers spending under £500 per quarter, and 22% achieving winnings in the first quarter of both 2021 and 2022. In the first quarter of 2021, only 5% of customers spent more than £1,500, which dropped to 3% of the customers in the first quarter of 2022. Furthermore the scale of the business will allow the enlarged group to retain optionality regarding its product offering to mitigate any challenges that may arise from the Gambling Act review.

888 also benefits from structurally low capex needs, with LTM capex for 888 of $7.5 million and this dynamic is expected to persist following the completion of the acquisition. However, the group is highly acquisitive and acquisitions have remained core to its growth strategy. For example, in 2019, 888 acquired the Costa Bingo brands from former B2B partner Jet Management, the BetBright sport platform and, in 2018, 53% of the All American Poker Network, a U.S. sports betting platform, for a total consideration of $60.6 million. Further, in March 2022, the group also announced a strategic investment to launch the 888 brand across selected regulated markets in Africa. Therefore, capex is expected to be “slightly” higher during 2022, compared to the £22 million for 888 and about £83 million for WHI in the LTM to Feb. 28, while returning closer to levels seen in the past, management said. Further, management expects to see capex related synergies of about £15 million.

With regard to working capital, 888 benefits from no inventory requirement, however it has experienced historical swings in payables and receivables. Trade receivables are driven by the group’s relationships with payment service providers who are third-party companies that facilitate deposits and withdrawals of funds to and from customers’ virtual wallets with 888. For the 12 months ended Feb. 28, 2022, changes in trade and other receivables led to outflows of $26.8 million.

Trade and other payables primarily comprises trade payables and accrued expenses. Changes in payables led to outflows of $45.9 million for the 12 months ended Feb. 28, 2022, compared to inflows of $44.1 million and 15.6 million in 2020 and 2019 respectively. The group attributes the inflows experienced over the most recent 12 months to a significant increase in trading activity.

Free cash flow on a levered basis after lease expenses has been historically strongly positive, with the group generating $60.6 million, $182.5 million and $117.3 million in 2019, 2020 and 2021 respectively as it benefits from relatively stable EBITDA margins and limited capex need. However, for the 12 months ended Feb. 28, 2022, on a levered free cash flow basis after leases the group has burned $5.2 million in cash, largely as a result of $81.9 million of outflows from working capital during the period, driven by a ramp-up in business activity.
 
The selected peer group consists of direct competitors and peers across the gaming and gambling sector such as Flutter Entertainment, Entain, Lottomatica, Codere and Cirsa as well as others such as Playtech.

With 888 being an online betting and gaming company with over 67% of its revenue from the U.K. (combined with WHI), Flutter is a key competitor who held about 30% of the online market share in 2020 compared to 888 and WHI’s combined 12%. Flutter also has a leading position in the Italian online market with a 22% share combined with Sisal. Flutter held the second highest share of the Spanish market at 16%. Flutter’s adjusted EBITDA margin of 16.6% for the 12 months to December was lower than 888’s pro forma margin including the WHI transaction of 20.6%, although in line with the non-pro forma 15.8% as of Feb. 28 for 888 standalone. The adjusted EBITDA margin across the peer group averaged about 24%.

Entain is also a prevalent player in the U.K. online market with a 17% market share, while holding a secondary position in Italy (14%) and a modest 8% in Spain. Lottomatica had a 13% market share in Italy.

The EMEA online gambling market is expected to grow at a CAGR of about 12.4% between 2020 to 2026, according to Regulus Partners, with one of the key drivers being the availability, cost and adoption rates of enabling technology and services such as broadband, smartphones, mobile data and digital payments solutions.
 
Capex across the peer group averages at about 5%, in line with 888 and WHI’s combined estimated capex of £110 million reflecting 6% of LTM pro forma February sales.

888’s net leverage pro forma the transaction of 4.3x remains moderately lower than marginally better rated (B1) Lottomatica’s 4.9x (including Holdco PIK) and significantly lower than similarly rated Cirsa’s 6.9x (including Holdco PIK). Further, 888 is expected to reduce its leverage to a medium-term target of 3x or lower with suspended payments of dividend unitil achieved.
 
-- Garan Dhillon; Nikhil Varsani; Beatrice Mavroleon