NeoGames Soars on Michigan Contract Extension, Analyst Says Overhang Removed

Posted on: December 18, 2020, 02:37h. 

Last updated on: December 18, 2020, 03:08h.

Todd Shriber @etfgodfather Read More
Expertise: Financial, Gaming Business, Mergers and Acquisitions.

On a rough day for US equity markets, one featuring a slew of mediocre showings from gaming stocks, NeoGames (NASDAQ:NGMS) stood out, surging 12.46 percent on favorable contract news.

NeoGames Michigan
A Michigan Lottery office in Detroit. NeoGames contract renewal with the state sent the stock soaring. (Image: CNN)

The Michigan Lottery added four years to a pact with NeoGames in which the Israeli company will continue providing iLottery services in the state, news that was enough to spark a rally that occurred on above-average volume.

The new accord goes into effect in July 2026 and, according to one analyst, removes a crucial overhang for NeoGames stock, because Michigan is the newly public company’s biggest customer. The company’s current contract with the state was slated to expire in July 2022. Data confirms just how important the Midwest state is to NeoGames’ growth trajectory.

Since 2015, iLottery gross gaming revenue (GGR) generated by instant game sales in Michigan has grown at a compound annual growth rate of almost 64 percent. The total rose from $19 million to $219 million over the past five years,” said Stifel analyst Steven Wieczynski in a note to clients.

The Wolverine State footprint is relevant to NeoGames investors not only because of the state’s large population, but also because it’s an evolving, fast-growing gaming market.

Risk Mitigated

With online gaming stocks soaring this year, some members of the investment community are scrutinizing risks associated with these names, which in many cases, boils down to much dependence on a specific market or region.

That was the case with NeoGames, as some analysts and investors fretted about the company’s reliance on Michigan prior to its November initial public offering. Those market participants expressed concern regarding what could happen to the stock if the Michigan Lottery deal wasn’t renewed because of the agreement’s status as a major revenue driver for the company.

“Given the fact the Michigan contract accounted for more than half of NGMS’ revenue stream over the last year, we fully understood the concerns coming from the investment community,” said Wieczynski.

The analyst points out that when state lottery deals come up for renewal, the incumbent company wins 90 percent of the time, because switching costs often outweigh the benefits of a state changing vendors.

Don’t Underestimate iLottery

While internet casinos and online sports betting are grabbing most of the positive press, investors shouldn’t overlook iLottery. That industry is rapidly growing, and NeoGames possesses dominant market share.

With an array states seeking revenue-raising ideas in the wake of the coronavirus pandemic, iLottery could be a sensible fix, because many states already have established, traditional lotteries, easing regulatory hurdles associated with the online equivalent.

“We believe the iLottery growth story remains somewhat unknown in investor circles, given the lack of public equity exposure. But ultimately, we believe there should be an overwhelming appetite for a name like this, given the recent euphoria around sports betting/iGaming,” said Wieczynski.

The analyst forecasts NeoGames growing earnings before interest, taxes, depreciation and amortization (EBITDA) around 30 percent annually over the next three years.