Share values for The Stars Group (NASDAQ: TSG) — the company behind PokerStars — plunged this week following the release of the company’s Q2 financial report on Monday.
The stock had closed just shy of $16 last week, but quickly dropped to $13.32 and, despite recovering somewhat midday, was down to $12.98 at the closing bell. Since then, it has continued to trade between $13 and $14.
The drop in price is likely related to two factors:
The Stars Group’s falling earnings come despite rapid growth in net revenues, which were up 55% year-on-year thanks to last year’s acquisition of Sky Betting and Gaming (SBG).
That was an extremely costly acquisition, however, and as much value as it has added to the company, investors were likely expecting more. In the months following the announcement of the acquisition, TSG stock traded as high as $37.80, but it lost more than half of its value in the latter half of the year after the deal was completed and the first numbers started to come in.
The gaming and sports betting industry in general has been going through a rough patch this past year. GVC, for instance, has seen its shares drop by half over the past year, while William Hill and 888 Holdings are down 40% and 35% respectively. “Disrupted” markets – that is, formerly grey markets that are now cracking down on offshore operators – are to blame in part, while stricter regulatory enforcement in regulated European jurisdictions has resulted in stiff financial penalties for many operators.
Moreover, The Stars Group’s traditional core business – online poker – has been on the decline for nearly a decade, with total combined cash-game traffic for the industry dropping steadily at a rate between 10% and 20% per year.
That has slowed this year, but thanks to emerging operators and markets; for established companies focused largely on Europe, poker is shrinking as fast as ever.
The Stars Group has attempted to paint a rosier picture of the state of poker by making adjustments to maintain positive revenue growth despite declining traffic. Since PokerStars was acquired by Amaya (as The Stars Group was known at the time) in 2014, there have been multiple rounds of rake increases and scaling back of the player rewards program, as well as fewer promotions and less aggressive tournament guarantees.
All of these things serve to increase the site’s net revenue per hand dealt, and as recently as Q4 last year, The Stars Group was able to maintain slightly positive net revenue growth for poker.
However, there are only so many such adjustments that can be made to bolster revenue without compounding the losses in traffic by driving players away or depleting their balances too quickly.
Despite one additional change to its Stars Rewards program, including a 55% reduction in rewards to scheduled tournament players, poker revenues for the first half of 2019 are down 11.1% year-on-year, and will likely continue to fall.
In that context, then, it’s unsurprising that The Stars Group is attempting to pivot to new verticals – largely sports betting – while also betting heavily on the newly legal markets opening in the US since the Supreme Court’s PASPA decision making that possible. The acquisition of Sky Betting and Gaming is part of that, as is this year’s deal with Fox Sports to establish a new Fox Bet brand.
These changes don’t come cheaply, however, and the payoff is uncertain. That’s how we see earnings per share down 20% despite a 55% increase in net revenue, and it’s not hard to see why that would spook some investors.
The company could be join the Pennsylvania online poker market as soon as next month, however.
The Sky Betting and Gaming acquisition cost The Stars Group $4.7 billion, which some have pointed out is more than the company’s current market capitalization, which sits at $3.8 billion based on today’s share value.
It’s also taking some time for the company to carry out the planned integration of the new operation with its existing BetStars brand, which will be important for cross-selling. “Sky Bet by Stars” launched for Italian players earlier this year, and Germany is slated to follow in coming months, but there’s no word yet about the UK, for instance, which is a very large and important market for sports betting.
Meanwhile, on the US front, Fox Bet is an ambitious project with large potential upside, but which won’t realize that upside for several years at least. The Stars Group says it expects Fox Bet to turn a net loss of $40 million on the year due to the expenses it’s incurring in acquiring licenses, developing the platform, marketing the new brand, etc.
That works out to about 14 cents per share, or around 8% of this year’s expected earnings per share for The Stars Group as a whole: A big expenditure for a global company to make on a single brand which will focus on a single vertical and in a single market.
Even in its own presentation, The Stars Group said it is only aiming for Fox Bet to break even in 2022, and we would naturally expect the company to be presenting investors with the most optimistic scenario it considers realistic. Given how many unknowns there are just in terms of future legislation in the US, it’s entirely possible that this new endeavor could remain in the red for many more years than that.
Overall, it’s a very aggressive strategy for The Stars Group, but that has always been the company’s approach. The movements in its share value over recent years appear to be a matter of investors getting excited by the initial announcement of its big gambles, only to panic when the short-term cost of those initiatives becomes apparent.
The truth is that it’s far too early to know whether and to what extent these gambles will pay off. The big questions of the next few years will be:
Only once we have answers to those questions will we have an accurate idea of how profitable The Stars Group is likely to be going forward, and what the company is worth. And it will likely be several years before we have those answers.