CFA Institute Research Challenge Hosted by CFA Society Greece Athens University of Economics and Business CFA Research Challenge 2017 Athens University of Economics and Business Consumer Discretionary Sector, Consumer Services Industry Accounting and Finance Department Athens Stock Exchange This report is published for educational purposes only by students competing in the CFA Research Challenge OPAP S.A. Reference Date: 31/1/2017 Ticker: OPAP:GA (Bloomberg) Executive Summary Recommendation: BUY Valuation Results Target Price: €10.73 We issue a BUY recommendation on OPAP S.A. with a target price of €10.73, Current Price: €8.2 implying a 30.8% upside potential from the current price. To calculate the above target price we have used the Discounted Free Cash Flows to the Firm model and Upside Potential: 30.8% have also performed Residual Income Valuation resulting to €10.30 target price, to further substantiate our recommendation. Peer Group Analysis provided that OPAP 40% is 25% discounted compared to peers implying a target price of €10.98. 30% Robust Business Model OPAP is the leading company in the Greek Gaming Market with a 72.7% market 20% share and controls the widest commercial network in Greece with 10,311 POS. The 10% game diversity is outstanding as OPAP holds 4 exclusive licenses to operate 14 0% different games. The regulatory framework prevents potential rivals from entering the gaming market and provides OPAP with a significant comparative advantage -10% under a fully protected environment. -20% VLTs to maximize growth potential -30% The Video Lottery Terminals (VLTs) project is expected to dramatically boost the robustness of the company with a 10% estimated 5Y GGR CAGR. The exclusive ATHEX Composite Index OPAP license provided by the Hellenic Gaming Commission, allows OPAP to launch 35,000 VLTs throughout the country by 2019. Market Data Impressive efficiency drives profitability Market Cap. €2,647M The expected high VLT driven revenue growth combined with asset depreciation and minimum CAPEX requirement rapidly increases the efficiency, as measured by Shares Outstand. 318,112,195 asset turnover, from 0.8x in (FY2016) to 1.7x in (FY2021), causing expected ROE 52wk price range €5.4 – €8.9 to surge from 13.80% in (FY2016) to 31% in (FY2021). Avg daily volume 564,131 Strong FCF generation which is paid out as dividends OPAP’s elevated amortization (over €100 million), is expected to push FCF Yield Free Float 62% from 5.75% (FY2016) to 15.1% (FY2021), exceeding reported net profit. Taking into account the over €1 billion in retained earnings, OPAP’s Dividend Yield is estimated to grow from 8.8% (FY2016) to 11.3% (FY2017), aligned with Important Terms management’s intention to distribute the generated FCFs as dividends. GGR: Gross Gaming Revenue Mild-impact Investment Risks The most important risk for OPAP is the highly unstable macroeconomic NGR: Net Gaming Revenue environment. In case of a stagnation in the Greek economy (assumption of a VLT: Video Lottery Terminal constant Caa3 Moody’s sovereign credit rating), the valuation derives a target price of €8.52. The results of the Monte Carlo Simulation performed on our FCFF model, strongly supported our BUY recommendation with a 87% probability and a minimum target price of €8.54 in a 90% confidence interval. 2015A 2016* 2017E 2018E 2019E 2020E 2021E GGR (€ thousand) 1.399.671 1.391.490 1.501.910 1.839.766 2.117.878 2.248.611 2.235.980 GGR Growth Rate (%) 1,6% -0,6% 7,9% 22,5% 15,1% 6,2% -0,6% EBITDA (€ thousand) 377.102 278.549 327.200 407.764 471.825 502.806 499.635 EBITDA Margin (%) 26,9% 20,0% 21,8% 22,2% 22,3% 22,4% 22,3% Net Income (€ thousand) 209.900 144.797 171.396 209.707 241.964 272.864 244.995 EPS Growth (%) 5.4% -31.0% 21.8% 21.7% 15.0% 12.5% -10.0% P/E 12,5 18,0 15,2 12,5 10,8 9,6 10,7 P/B 2,2 2,5 2,5 2,7 2,8 2,9 3,2 Debt to Equity (%) 12,2% 34,7% 35,4% 37,1% 29,5% 22,5% 24,7% Dividend Yield (%) 4,9% 15,7% 9,8% 11,2% 12,0% 12,5% 11,3% Source: Team Estimates *Pro-forma Athens University of Economics and Business 1 Accounting & Finance Department CFA Research Challenge 2017 1. Investment Summary We issue a BUY recommendation, with a target price of €10.73 implying a 30.8% upside potential from the current price of OPAP. Valuation Techniques Figure 1: GGR (€ billion) Our target price derives exclusively from a 10Y Discounted Free Cash Flows to the Firm Model. We have opted for an extended 10Y period to integrate the impact of a potential 33% market deregulation due to the expiring VLT license in 2027. Additionally, to further 2.25 2.12 2.24 substantiate the results, we have performed a 10Y Residual Income valuation, returning a 1.84 21% 1.40 1.39 1.50 target price of €10.30 combined with 25.6% upside potential. Gross Gaming Revenue (GGR) to reach 10% CAGR Our recommendation is highly based on the huge potential of the new investment project of OPAP regarding Video Lottery Machines (VLTs). It is anticipated to create a 10% 5Y GGR CAGR despite the gradually declining gross margin from 33% (FY2015) to 21% (FY2021). The sharp increase reflects the potential of OPAP to constrain the illegal slot GGR Gross Margin machine market which is estimated around €1 billion (in GGR). VLT revenues are Source: Company Data, Team Estimates expected to contribute 39% to the aggregate GGR by 2021 and raise EPS with a 11.5% 5Y Figure 2: Strong Cash Flows CAGR. (€ million) Robust Profitability and Outstanding Cash Flow Generation 500 OPAP operates under a straight forward business model with strong receivable and liability 400 turnover ratios. Taking into account the elevated - over €100 million – annual amortization of the exclusive licenses, OPAP’s FCF exceeds reported net profit, with 2017 being the 300 only exception due to the elevated €90 million CapEx. With robust profitability levels and 200 a rapidly growing asset turnover driven by the increased efficiency of the VLTs’ 100 deployment, OPAP’s ROE is expected to surge from 13.78% (FY2016) to an impressive 31.00% (FY2021). The robust, cash-intensive business model is the foundation of OPAP’s 0 dividend policy. Management is committed to distributing the entire free cash flow to the shareholders and we have considered a generous dividend policy with payouts exceeding 100% for the next 5 years. Net Profit Dividend FCFF Source: Team Estimates VLTs to generate added value OPAP’s new investment project regarding VLTs is expected to boost residual income from €23.1 million (FY2017) to €154 million (FY2021) taking into account that there will be no Figure 3: Added value significant increase in Invested Capital. OPAP has followed the least capital intensive 25% solution for this project in order to minimize additional capital investments and upfront 20% payments to vendors. Consequently, ROIC will reach an impressive 23.5% (FY2021) 15% exceeding by far the minimum expected return as defined by 9.45% (FY2021) WACC. 10% OPAP’s growth potential is greater than peers’ 5% Having conducted the peer group analysis, we have reached an implied price equal to €10.98. OPAP’s fair value is estimated by using the PEG ratio as it embodies the expected growth of OPAP in the next 3 years, implying a 34% upside potential from the current ROIC WACC price. Even though OPAP seems overvalued for 2017, the increasing ROE from 17% Source: Team Estimates (FY2017) to 26.5% (FY2019) together with the estimated 3-year EPS CAGR of 13.2% further support our expectations for 34% upside potential. Figure 4: Investment Risks Investment Risks Macroeconomic Risk The most significant risk for OPAP in terms of likelihood and impact is the volatility in the Regulatory Framework Greek macroeconomic environment. To examine the sensitivity of the implied target price VLTs’ Investment to this risk, we have assumed that Greece’s sovereign credit rating will remain constant at Online Competition Caa3 (Moody’s) and we reached a target price of €8.52. Furthermore, we have performed a Relationship with the agents Monte Carlo Simulation on our DCF model to stress several assumptions simultaneously Illegal Betting Markets such as the credit rating of Greece, the Wagers/VLT/day, the cannibalization rate, the Illegal Actions market share loss due to potential market deregulation and the perpetual growth rate from IT and Cyber Security 2027 onwards. The results support our €10.73 DCF target price and return a standard GGR Contribution deviation of €1.12. The price can fluctuate between €8.54 and €12.22 in 90% confidence Source: Team Estimates interval with the minimum observation in our 10,000 iterations being €6.72. Athens University of Economics and Business 2 Accounting & Finance Department CFA Research Challenge 2017 2. Business Description Figure 5: Shareholders’ Structure History-Overview OPAP (Greek Organization of Football Prognostics) is the indisputable leader in the Greek 33% Gaming Market since 1958, controlling a leading 72.7% market share. In 2001 the company was listed on the Athens Stock Exchange and in 2013 became fully private as the Greek 62% State transferred the last 33% of OPAP to Emma Delta. The robust business model has 5% enabled OPAP to sustain profitability despite the recession in the Greek economy. Emma Delta Baupost Free Float Games’ Portfolio Analysis Source: Company Data OPAP owns a fully diversified portfolio of 14 unique betting games offered throughout Greece and Cyprus.