(Debtwire) Loewen Play rebounds pre-COVID-19 but minimum arcade-distance regulation set to erode earnings

22 May 2020 | 09:24 BST

Loewen Play is modestly levered, generates solid free cashflow while earnings started rebounding in 4Q19. But the German gaming group's earnings face being blown off course again post lockdown by regulatory headwinds, leaving three buysiders and a deep-dive analyst cautious despite the EUR 350m 5.375% senior secured 2022s yielding 14% at 82-mid.

FY19 adjusted EBITDA slipped to EUR 93.6m from EUR 111.4m at FY18 and is languishing well below the EUR 123.2m LTM 3Q17 earnings marketed at bond launch.

However, fourth-quarter performance was strong with adjusted EBITDA of EUR 29.6m up 75.1% YoY while January and February were in-line with the November and December performance. But given the COVID-19 lockdown, earnings in March, April and May will fall significantly. 

All gaming arcades closed in mid-March due to the lockdown and will remain closed until end-May. Despite taking cost-cutting measures, the company expects a monthly negative EBITDA of EUR 3m-EUR 4m for each full month the arcades are closed.

Once they reopen, Loewen Play will face both social distancing measures as well as regulatory risks, such as minimum distance rules for arcade proximity to other arcades and also places of congregation, with minimum distances varying from 100 metres to 500 metres under various state laws. The German State Treaty on Gaming Regulation is imposing the requirement of minimum distance between arcades and prohibition of multiple concessions for new arcades. There is also regulation on the minimum distance between arcades to places of congregation such as social buildings or schools. The Interstate Treaty had allowed for a transitional grandfathering period till 30 June 2017 with state arcade laws allowing for a further transitional period till 30 June 2021.

When pushed on the earnings call, management noted that around 70-80 out of 428 of Loewen Play's arcade sites are within 100 metres of schools and competitor arcades. This means around 15%-20% of sites are at risk of having to close should regulation kick in.

“One of the regulations that hasn’t changed is the minimum distance rules, in respect to either schools or competitors.  The minimum distance differs by state, but currently impacts on 72 arcade sites, 17% of the overall arcade estate, or 10% of their amusement with prize (AWP) machines,” independent deep-dive research firm Sarria noted. “Some or all of these sites will need to be closed down. "

Another concern is that Loewen Play currently operates around 50% of its machines without unlocking devices. Loewen Play can still operate AWPs without unlocking cards but this will stop from February 2021 when the transition period of the Gaming Ordinance will end. "This will hit gross gaming revenue from February onwards,” Sarria cautioned.

The new machines with unlocking devices generate lower yields, which will be a drag on earnings, one of the buysiders noted.

“All their arcades should be open by the end of May but how many people will come to play these games?” the buysider said. “In the US, there will be queues of people to play again but the psychology could be different in Germany. The devil is in the detail on the treaty and I’m not sure buying these bonds is a slam dunk. They trade at this yield for a reason.

The strong 4Q19 results showed that the picture was improving pre-COVID-19 with the positive trend continuing this year, but fitting the remaining half of its machines with unlocking mechanism will weigh on results, while there is still not enough clarity on how many machines Loewen Play will be able to operate, a second buysider noted.

"80 is the new par for this name as there is uncertainty on the regulation and COVID situation. A second wave in September is a question mark and the bond may not go back to par anytime soon,” he added.

Liquidity play

Loewen Play's liquidity position is still reasonable with EUR 77m of unrestricted cash at mid-May plus extra cash in machines and tube fillings. The company had drawn its EUR 40m revolving credit facility in full after the COVID-19 outbreak.

Positively, net leverage is comfortable at just 3.7x pre-IRFS 16 FY19 EBITDA of EUR 93.6m and Loewen Play is highly cash-generative at current earnings. The company has guided to EUR 18.5m German capex and EUR 1.8m Netherlands capex, pays EUR 19m interest and around EUR 11m cash taxes, which would mean EUR 43m of free cashflow at FY19 EBITDA of EUR 93.6m. Loewen Play's cash position increased to EUR 70.8m in FY19 from EUR 41.8m in FY18.

With its bonds maturing in 2022 the group will have to prove it can stem its earnings decline in order to refinance. Its online offering is currently puny at just 1% of total revenues for the first two months of 2020.

Loewen Play hopes to improve its online offering following the onset of the new German Interstate Treaty, which will allow online gambling through virtual gaming machines and virtual casino games in Germany after 30 June 2021. The current grey market offering for online casino in Germany is in the range of EUR 1.5bn–EUR 2bn per year.

Expansion in Denmark and Spain could also boost its online presence. The Danish online casino market grew at a compound annual growth rate of 6% per year between 2012 to 2019. Loewen Play also plans to start its own Spanish Online Casino in late 2H20 and hopes to enter the Dutch online market by July 2021.

“They speak about the opportunity of the deregulation of the online market in Germany, but they have little or no experience in this market,” Sarria noted. “This space is highly competitive and the lack of a strong brand name, especially outside Germany, will require Loewen Play to spend heavily on marketing.”

"Their products have a place and will recover but online is very competitive and the Loewen Play brand is unknown outside of Germany. This single market exposure means large regulatory risk and the risk-reward is not great although Germany has been one of the first to lift restrictions at least," a third buysider said. "I like gaming names that have an online foothold and avoid everyone else with bingo halls setup for example."

Loewen ploy

Loewen Play is 65.6% owned by Ardian, 31.9% by Cofima and 2.5% owned by management according to its December 2017 bond prospectus. Cofima has been an investor since 2001 while Ardian acquired the business in 2008.

The shareholders have extracted substantial amounts of dividends via the past two bond issues of 2014 and 2017, with EUR 150.6m of the 2014 initial marketed issuance proceeds earmarked to fund the repayment of shareholder loans and registered bonds, while EUR 198.2m of the 2017 issuance proceeds funded a dividend.

Management reduced its shareholding in recent years. It had an 11.5% stake according to the 2014 bond prospectus but this had reduced to 2.49% by the time of the December 2017 bond.

The chunky dividends make shareholder support unlikely in any restructuring, while the reduction in management's stake at the last bond deal will not provide any comfort to bondholders either, Sarria noted.

Loewen Play’s EUR 350m 5.375% senior secured 2022s rose three points following the earnings call to 82-mid yielding 14%, according to Markit. The bonds are callable at 102.688 with the schedule stepping down to 101.344 from mid-December 2020 and par from mid-December 2021.

“The online story is a little too optimistic. They need to do something with the bond maturity and what will Ardian do? They have no money in it now, but will they just keep it? In normal times this is a cash cow and if legislation goes their way this will be fine, but they need to refinance before 2022 and while you could be repaid at par there is too much uncertainty,” the second buysider said. “There could be upside in one year but a lot of downside. At 60 it was a good buy but 80 is the new par for this name.”

Loewen Play declined to comment. It will host its 1Q20 earnings call on 25 June.

by Adam Samoon