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The content here is for informational purposes only and should not be taken as legal, business or tax advice, or be used to evaluate any investment of security, and is not directed at any investor or potential investor in any AlphaSwap Podcasts.
Transcript of the Podcast
Khing:
Hello, and welcome everyone. I'm Khing Oei, and this is the AlphaSwap Podcast. Every week, we'll be discussing a top investment idea from the platform and have an in-depth conversation with a user who posted the idea. You can learn more and join our community at alphaswap.io. This week, we're talking to Dennis Chan. Hey, Dennis. How are you? Can you start by giving us a quick introduction about yourself?
Dennis:
Hi, Khing. I'm great. So, hi guys. I'm Dennis. I recently graduated from the National University of Singapore. I was majoring in systems engineering. And before that, I did my internship at two small-sized Asian equity-focused hedge funds and a multi-family office, and also a firm that does private equity ... sorry, private placements. And I also have a charter and alternative investments.
Dennis:
So here's a little bit of my background and how I go into stocks. I got interested in investing when I was serving in the Singaporean army. And that's how I picked up on investing. I picked up on reading on a lot of different types of investment books, and I also talked to some of my friends who are already into the investment sector.
Khing:
Great. And what is your investment philosophy in that regard?
Dennis:
So, I think that my investment philosophy is different from the majority of investors out there, because I focus mainly on the micro cap and small cap space. So I came to this conclusion because when I first started reading about investing, there are a lot of conventional wisdoms out there that upon my own further inspection didn't really make much sense. So these are a few of the conventional wisdom surrounding ... there are a few of the commercial wisdom surrounding stock picking such as how large cap stocks are often considered to be less risky as compared to small caps. And that diversification is key.
Dennis:
So, how I look at it is that you have to understand the stocks, thereby to the greatest extent that you can understand it. And so it made no sense to me that a big company like Amazon with so many different moving parts would be easier to understand, and therefore be considered as a safer investment than a small company with much lesser moving parts. So secondly, onto the point about diversification, I understand that it's a pretty popular way to preserve wealth. But let's say that you are a returning investor and you invest in 30 different stocks, or even ETF.
Dennis:
So, how many of these stocks do you actually understand? I would say that it's probably not a lot. And also, the more stocks that you invest in, the more market risk you are facing. So to me, at least, market risk is not something that can be easily understood by just anyone. Understanding market risk is much harder as compared to understanding the idiosyncratic risk of an individual stock. So I guess that my approach can be summed up to this famous phrase, this famous quote from Warren Buffett, which is that, "Risk comes from not knowing what you're doing." So I seek to understand each of my investments to the greatest extent that I can.
Dennis:
And also, there's another important caveat to my investment philosophy, which is think from first principles. So with first principles, I start looking at things that has worked in the past, at least empirically, and whether there are any other real life anecdotal evidences that fit into these empirical truths.
Khing:
Okay. Gotcha. Thanks for clarifying that. So, what's a trade today? What's a stock? What's a thesis? And is there any context you can give on this?
Dennis:
Yeah, sure. So the stock that we're talking about today is GAN LTD. So GAN has been ... I've written it up several times on the AlphaSwap platform. So GAS is a enterprise SaaS company, software as a service company for online casino gaming. So they are primarily focused on enabling the US casino industry's ongoing digital transformation, which is accelerating due to the repeal of the federal ban on sports betting in May 2018.
Dennis:
So when I first took notice of this stock, it was trading on the AIM Exchange in London at around 70 cents British pounds. So if you adjust for some of the corporate action and the currency exchange rate, it would be around 3.7 USD when I first invested in the stock. So as of now, it's been doing pretty well and it's like a five bagger.
Khing:
Gotcha. So, what does the company do?
Dennis:
Right. The company has two segments, which focuses on different services provided to both online casinos and land-based casinos. So it is very important to understand the different dynamics that these two services have between them in order to understand how good of a strategic position this company has.
Dennis:
So stimulated gaming is one of the segments. And basically what they do is like an online casino for land-based casino owners to engage with their customers. So it's basically like a fake casino where you put in real money, but you don't get anything out of it. So the purpose of doing this is for entertainment owning. So it works like this.
Dennis:
The gambler would have to buy virtual dollars from the online casinos, but with real money and they can't take cash out from the virtual dollars. So this is not that different from spending real money to buy a bunch of credits on popular video games. And it might seem strange to a lot of people. Why would anyone put in money when there is obviously no returns? So I think it's crucial to understand the gambler's mentality in this scenario. So they purchase big dollars so that they can practice online with the belief that they will become a better gambling in the future when they go back to the casinos.
Dennis:
And the other segment is on real money gaming. So this consists of both eye gaming and sports betting. So this is where a client from the stimulated gaming segment can easily convert to real money gaming with the help of GAN's platform, as long as the state that they are operating in legalizes sports betting and online gaming. So as we all know, the pandemic has wreaked havoc around the casino industry in the US rates. So as it continues to ravage around the country, states like Michigan are already turning to new venues of taxation, especially since the states that have legalized online gambling and sports betting have done pretty well over the past few years.
Dennis:
So I think that you would not be crazy to assume that more states would go towards the same route in the near term. So the market for this is actually really huge. And the management of GAN believes that the current market size is only around 5.7% of what it could be, when all of the states or at least most of the states legalize gambling. So yeah, that's the thesis.
Khing:
Gotcha. And why is the market mis-pricing their stock, and what are the catalysts needed for it to unlock this value?
Dennis:
Right. I think that there are a few reasons why the market is mis-pricing the stock right now, mainly because of a few temporary problems. If you look at the income statement of the company, at least for the recent quarter, you will realize that it's not posting a profit. And the reason for that is because there is a one-time IPO expense that drove its operating income down to the negative territory.
Dennis:
And also, recently, FanDuel dropped out of the sports betting site. So this is obviously an [Ewing 00:08:29] hammer for this company. So FanDuel, which is obviously a pretty famous fantasy sports provider, and also a bookmaker, decided to deploy their own proprietary digital wallet for its sports betting business, which means that GAN will no longer receive sports gaming revenue from FanDuel after August 31st of 2020.
Dennis:
So to me, it seems like the market is overreacting to this piece of news, because GAN only derived around $3 million from FanDuel's sports gaming operations in FY 2019. To me, it doesn't really matter because a big chunk of FanDuel will still require GAN's services. So as of 2022, sports betting revenue is actually only roughly 5.1% of GAN's total revenue. So this means that FanDuel's sports gaming departure is not likely to be as big of a problem as previously thought, because growth in the other segment of the companies are going to catch up to this, and going to draw in more revenue as compared to what they've lost from FanDuel.
Dennis:
And also, the management didn't change their revenue guidance for FY 2020. So I see that as a good sign that they will be able to deliver as promised. And I mean, adding onto that, the CEO also stated that FanDuel is not actually leaving the GAN platform, it's just more like they are just leaving the sports betting site. So yeah. And I guess, another catalyst that is coming to fruition is that GAN recently landed a tier one client, which will increase their gross operating revenue by 300 to $400 million.
Dennis:
So assuming that their take rate is around 6%, take rate means, what is the percentage of fee that they get from handling so much wager? So assuming that is around 6%, this would add around 18 to $24 million to their top line. And most of it is going to trickle down to the bottom line, because the company has a gross margin of 65%.
Khing:
Makes sense, makes sense. And while we're on that note, can you give us some key metrics of the company? Margins, growth rates, free cashflow yield, a few relevant metrics.
Dennis:
Yes. So as I've already mentioned previously, has a very high gross margin of more than 65%. And I believe that is expected to continue to grow, especially in the North American market. So as for the other metric, because GAN is only, and though its operating cash flow is positive, I don't think that free cashflow yield is that important at this juncture.
Dennis:
Profitably metrics are also not that important, because while we are dealing with a company that is at about breakeven point, what truly matters right now is, and whether they are able to ... what's the word for it, gain market share and outpace their competitors, which it seems to be doing that.
Dennis:
So if we look at the EV to revenue ... sorry, last 12 months ... sorry, EV to last 12 months' revenue, GAN is actually trading at a pretty high valuation of 16.7 times. And the EV to next 12 months' revenue would be around 12 times. But I don't think that this is that big of an issue, as long as they are able to execute on what they set out to do.
Khing:
Cool. That leads into my next question, which is about valuation. Can you give us a bit of context on the valuation and what would unlock it?
Dennis:
Right. So the way that I see valuation is [inaudible 00:12:29]. So you stretch it too much and it gets harder and harder to stretch it further. Of course, there are stocks like Amazon, which are almost always priced to perfection. So with respect to GAN, it may seem pretty overvalued on the surface. But given the fact that the current market size is only 5.7% of what it could be at maturity, and the opportunity for GAN is more than $500 million, I think that valuation is pretty justified.
Dennis:
And there are also a few other things that are not factored into the guidance or the valuation that GAN is trading at right now. So Michigan, which has just legalized their online gaming array, is not factored into the revenue guidance, which means that the near term revenue may be ... And GAN also mentioned that they handle more than 30% of all gaming revenue in the US in FY 2019.
Dennis:
And to me, that means that they have really capitalized on basically one third of the market. And all these symbolize to me that GAN is going to be a winner in the longterm, in both the short and longterm.
Khing:
Okay. And what do you think are the risks of this trade? And any mitigants to those risks?
Dennis:
Right. So for now, I believe that the main risk would be the execution of the management team. And frankly, like what I've said before, the valuation is pretty high right now. So there's also some uncertainty regarding the resumption of sports leagues and college sports. So with regards to that, I've laid a clue to how this will play out, but as of now, the NBA playoffs has been running pretty smoothly. So I think it should be fine in that regard.
Dennis:
And even if it doesn't work out as planned, if you look at the revenue breakdown for GAN, you would see that the online sports betting site is actually not that big of a proportion of total revenue at around 5.1% of Q2 revenue. So it may not be that big of a deal, even if the whole sports' industry falls over. So another risk is that, since the reopening in Q2, the number of active players ... sorry, the number of active player days has decreased sharply.
Dennis:
So even though that is the case, on the other hand, you have the average revenue per daily active user increasing dramatically in response to that as well. So this signals to me that those gamblers who have found online gambling to be entertainment will continue to do so, and even increase their bets over time. So ... yeah.
Khing:
Gotcha. Okay. That's very clear. Thanks very much, Dennis. And I guess to end this podcast, it'd be great to get any important investment lesson that you want to share with our listeners.
Dennis:
Right. So there are many lessons that I've learned over my six years of investing, but I guess the most important one would be about stop-loss and conviction. I think that a lot of investors out there are afraid of cutting losses when a stock tanks, because it means that their conviction is wrong, or at least their thesis is wrong. I don't think that's the right way to think about things.
Dennis:
So we live in an uncertain world where there is no definite answer. So even if you're 80% certain that your thesis is right, you still have to think of a way to handle the times when you're wrong, even though that's only like 20%, which is why I think that a gaming or a gambling analogy makes sense in this case. When you have to play multiple rounds and you have a success rate of 80% and you have a asymmetric reward, it becomes easier for you to, on the average, in the long run, do well.
Dennis:
So having a stop-loss in this case is very important because in the event that there is a market sell off, like during the early days of COVID, or if one of your thesis flops really, really badly, at least you have some money left to invest for another day. So I guess to me, capital preservation is much more important than proving that my thesis is right. So I always have a stop-loss, yeah.
Khing:
Gotcha. Dennis, thanks very much for sharing your investment idea with us and your great insights. Really appreciate it. Anyone who wants to learn more about his idea can obviously read the full thesis on alphaswap.io. And there are also a lot of other ideas on the platform. If you haven't registered yet, it takes about 20 seconds. Please do so. Anyone who's interested in also being featured on this podcast, please send us an email at info@alphaswap.io. Thanks very much.
Dennis:
All right. Thank you. See you.
Khing:
Thank you. See you.
