jackpot or not

I couldn't sleep on night so decided to write an article to myself on Jumbo to get my head around the opportunity. The share price is up slightly since I wroth this but not much. So here it is -

Jumbo have had a roller coaster ride over the last couple of years when it comes to their share price, but how stable is the business and is this a great investment opportunity.

Not too long ago Jumbo (JIN) was a favorite on a well known facebook investment site, but since announcing its overseas expansions a lot of investors have lost interest as they are waiting for JIN to get runs on the board and there is the worry of state licenses not being renewed by Tatts.

As a value investor, I have also had trouble getting my head around JIN and the opportunity it presents. On a pure valuation basis it looks cheap to me as the company is sitting on $16.9m in cash and a market cap of $74m. If you take off the cash you get a market cap of $58m and as Jin are making profits of around $7m per year (taking out overseas expansion costs) this puts them on a PE of 8. Therefore they look cheap just for the Aussie business and their overseas achievements to date have not being priced in at all. Earnings are going to be flat for the next couple of years and the opportunity as an investor is to estimate what the market is likely to price in going forward.

So I feel that with JIN the only way to look at this business is to ask the question –

WHERE WILL JIN BE IN 5 YEARS?

AUSSIE BUSINESS

Their Australian business in my view is stable and you would think little risk in relation to their partnership with TATTS . Tatts need JIN in order to grow their internet business and they are still getting the sale of tickets, just through another channel. Mike Ververka, JIN’s CEO has told me that they are very careful not to compete with TATTS when marketing on the internet and he feels very confident that the relationship will be in tact for many years. Further to this if a contract was not renewed in one state JIN could just go and source their tickets from other states as there are no legislated boundaries, when it comes to lotto tickets. I have a feeling state governments wouldn’t be too happy with this revenue loss, which would cause a problem for Tatts. In my opinion it won’t happen and it is an opportunity more than a risk as JIN is likely to be re-rated every time Tatts and Jin have the time to sit down and renew their 5 year agreements.

Jin continues to grow their subscriber base, which is now sitting at 1.64million accounts.

I expect Jin to continue to grow earnings and net profits to at least $10m over the next 5 years, when you take out overseas expansion costs. This is a guess but a conservative one as internet use will increase dramatically over the next 5 years.
But I may be wrong as it is strange that Tatts just don’t give them new 5 year terms and this is where the big risk with JIN is and possibly if it turns out not to be a risk where we can get a great business very cheaply.




GERMANY

JIN have licenses to sell lottery tickets in all German states now. According to Mike V (JIN CEO) there are 4-5 main companies and 12 applying in total. Where JIN have a huge advantage over most of these new entrants is that they have a state of the art internet site, which they have developed in Australia over many years. Mike believes their main competitor and the possible market leader of internet lottery sales in Germany to be a company called Lotto 24. They have an experienced management team and have had a 9 month head start on JIN in getting into the lottery market over there. They also have a much larger marketing budget and therefore don’t expect to be making money for 5 years. The interesting thing is that they have a market value similar to Jumbo, but don’t have a profitable business in Australia, or a footing in the USA or Mexico. If this doesn’t make JIN look undervalued, I am not sure what will.

Mike has stated that there is not likely to be just one or two internet providers in Germany, but more than likely 3-4 and the risk is not whether they make money there, but more likely how long it takes whether it be 4 years or 5 years.

So the German internet lottery market is expected to grow to $2 billion in 5 years. Lets conservatively say that JIN is able to get just 10% of this market at the expected 15% margin (in Australia they achieve 20%) and you get revenue of $30m. Lets assume NPAT of 20% and you get $6m.

MEXICO

JIN have cancelled there agreement in Mexico so this can not be in any way anymore to usefully value JIN. It is noted that JIN still have a presence there and we will watch this space.

USA

JIN have been it the USA for 4 years now networking and getting established in anticipation of a change in government legislation allowing states to individually sell lottery tickets on the internet.

JIN have cleverly set up a joint venture with Retail Gaming Solutions in New York called Lotto Points Plus. They have signed up more than 800 convenience stores and over 159 Tops Friendly Markets, a leading grocery chain, to market tickets via reward systems over the internet. This will give JIN a leg up in increasing its chances of getting approved first when the legislation goes through, as they have shown that they can work with local businesses and are less of a threat to them, which will make the changes easier to sell politically.

I am not going to put a value on the USA as it is just too hard to tell when the legislation will go through, but it could be huge and they are making all the right moves over there in my opinion.



MY 5 YEAR VALUATION –

EXPECTED NPAT STRIPPING OUT EXPANSION COSTS.

NPAT AUSTRALIA - $10M
NPAT GERMANY - $6M
NPAT TOTAL – $16M

USA – not priced in at this stage too early

Assume conservative PE of 10 = market cap of $160m plus cash.

Current market cap of $57m plus cash (unit price $1.30)

If this was achieved it would be an almost 300% return. If they get a couple of wins in the US and do better in Germany and Mexco than the conservative estimates above the company could be worth multiples of the valuation above in my opinion.


CONCLUSION

Based on the above very conservative assumptions JIN looks like a good investment case for the next 5 years. Other companies like EML, which have great investment models and great potential have higher valuations than Jin and are not making money. EML has a market cap of $100m.

Jin could be sold down more in the short term, but its share price could also rally based on a new contract being signed by Tatts, success in Germany, a state win in the US and increased profits in Australia due to bigger jackpots in the second half of this year.

Mike Ververka owns 20% of the company and he is not selling shares, this is a great sign in itself.

Its great when the market falls out of love with a great company and I feel that Jin has enormous potential and none of it is being priced into the share price at this time. As the market usually looks ahead the five year forecasts are most likely to be priced in a lot sooner.

It may be an idea to wait and see what happens in Australia and how JIN goes in Germany before going into this one in a big way. At the moment it could be worth making a small investment but there are other companies that may have more certain upside in the near future.

The above is not investment advice but purely my assumptions and best guesses.