Companies making large multi-billion-dollar acquisitions often use the word transformational to describe the transaction. More often than not, they are anything but.
On April 21, Stars Group Inc. (TSX:TSGI)(NASDAQ:TSG) announced that it would pay US$4.7 billion to acquire Sky Betting & Gaming, a U.K.-based online sportsbook with US$869 million in annual revenue.
âThe acquisition of Sky Betting & Gaming is a landmark moment in The Stars Groupâs history,â stated Rafi Ashkenazi, Stars Group CEO. âSBG operates one of the worldâs fastest-growing sportsbooks and is one of the United Kingdomâs leading gaming providers.â
Landmark … transformational … whatâs the difference?
Stars Group obviously feels the addition of a meaningful online platform for sports betting significantly diversifies the companyâs revenue streams, while also making it the worldâs largest publicly traded online gaming company.
Yes, itâs a big deal, both figuratively and literally, but is it enough to get you to buy its stock?
The upside of this deal
As mentioned earlier, Sky is a fast-growing online gaming company in the competitive U.K. market. In 2014, Sky had 6% market share. Today, itâs got 12%, putting it in a tie with bet365 and just behind PaddyPower Betfair.
In a market thatâs grown by 19% annually over the past three years to US$7.1 billion, the doubling of its market share is a significant financial boost. Not surprisingly, Skyâs revenue and adjusted EBITDA increased by 46% and 51%, respectively, over the same period.
Equally important is the fact it generates 82% of its revenue from mobile users with just 18% from desktop betters. Younger users tend to place their bets using a smartphone. Sky has more customers ages 18-34 than any of its peers, which sets up for a lengthy relationship.
But probably the biggest selling feature of the Sky acquisition is diversification. Without Sky, Stars Group generates 54% of its revenue from poker, 22% from sports, 21% from casino games, and 3% from Oddschecker.com. With Sky, poker revenue drops to 37% of overall revenue, making its business far less reliant on one product.
The downside of this deal
The company is paying $3.6 billion in cash, another $900 million for Skyâs debt, and issuing approximately 37.9 million shares of its stock for a total outlay of $5.6 billion — a multiple of 15.3 times adjusted EBITDA.
Sky shareholders will own approximately 15% of Stars Group, which will see long-term debt almost triple from $2.4 billion at the end of December to $6.9 billion by the third quarter when the deal is expected to close.
Stars Group paid $116 million in interest on its debt in 2017. With an additional $4.5 billion in debt added to the pile, its annual interest expense increases to approximately $331 million, or slightly more than Skyâs adjusted EBITDA in 2017.
With interest rates moving higher, itâs a potential risk.
Should you be buying?
Once the deal is complete, the combined company will have annual revenue of US$2.2 billion and US$881 million in adjusted EBITDA.
While I have some reservations about the price it paid for Sky, it definitely makes Stars Group a stronger business. Given how much free cash flow it generates â US$482 million in 2017 â the quick repayment of the added debt shouldnât be a problem.
Trading at 4.8 times sales, TSGI stock is a buy, in my opinion.
