Nektan — Update 19 April 2016

Nektan — Update 19 April 2016

Nektan

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Nektan

Funding the move forward

Interims/trading update

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19 April 2016

Price

70p

Market cap

£17m

Net debt (£m) at end December 2015

5.6

Shares in issue

24.1m

Free float

43.6%

Code

NKTN

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(5.6)

(34.6)

(58.2)

Rel (local)

(7.6)

(40.1)

(54.6)

52-week high/low

175.0p

70.0p

Business description

Nektan is a leading international B2B mobile gaming content developer and platform provider. It operates both regulated real money and freemium games. Its Respin JV provides US casinos with mobile-based, in-venue technology and products.

Next event

Trading update

July 2016

Analysts

Eric Opara

+44 (0)20 36812524

Jane Anscombe

+44 (0)20 3077 5740

Nektan is a research client of Edison Investment Research Limited

Nektan’s Q3 trading update shows revenues increasing rapidly, albeit from a much lower base than we hoped last year. We are reintroducing FY16 forecasts (EBITDA loss of £5.6m versus our October 2015 target of £0.2m profit) and will add FY17 in July. With Q316 revenue 115% higher than Q216 and following a cost efficiency programme, we believe that a positive EBITDA run rate is within sight. Nektan’s unconsolidated US JV Respin is also picking up steam and now has 54 signed contracts with casino operators. Nektan successfully completed a £2.93m fund-raising at the end of March to support its continuing growth.

Year end

Revenue (£m)

EBITDA*
(£m)

PBT**
(£m)

EPS**
(p)

DPS
(p)

P/E
(x)

Yield
(%)

06/14

1.9

(3.5)

(3.7)

(22.3)

0.0

N/A

N/A

06/15

0.5

(5.1)

(6.9)

(33.4)

0.0

N/A

N/A

06/16e

6.2

(5.6)

(9.7)

(41.6)

0.0

N/A

N/A

Note: *EBITDA is before Nektan’s share of the (non-consolidated) Respin JV. **Normalised, excluding amortisation, exceptional items and share-based payments.

Resetting our expected growth trajectory

Nektan reported interim revenues of £1.6m on 31 March, up from £0.5m for the whole of FY15, illustrating that its B2B partnerships and house brands are starting to bear fruit. However, the ramp-up in sales was slower than we expected, largely due to slow progress from a significant media partner (£6.7m shortfall), and we have cut our forecasts: we now expect FY16 revenues of £6.2m and an EBITDA loss of £5.6m, down from £15.0m and £0.2m profit respectively. However, the Q316 trading update (18 April) shows the group now moving in very much the right direction, with Q316 net gaming revenue (NGR) of £2.30m, up from £1.07m in Q216 and £0.56m in Q116, and 11 new partners added in the period.

Moving towards an EBITDA positive run rate

Following an extensive review, Nektan has adopted a leaner cost structure consistent with its early stage of development and management has cut the fixed cost base from £0.5m to £0.3m a month. Developer and marketing costs have been largely protected to ensure that the company’s growth potential is not inhibited. We expect Nektan to achieve an EBITDA-positive run rate in this financial year and will reintroduce FY17 estimates in July with the full-year trading update. The recent £2.93m fund-raise (convertible loan notes and equity) has put in place additional working capital and the directors continue to assess the group’s financing options.

Valuation: Greater clarity after July update

Nektan’s recent share price fall is a reflection of its slower than anticipated revenue progression but we believe the growing momentum in its European business, together with the progress of its US JV Respin, point to a business with enduring potential, albeit in a competitive vertical. The next trading update should be a positive catalyst if it confirms progress towards an EBITDA-positive position and, with the reintroduction of FY17 estimates, provides greater clarity on valuation.

Commercial momentum

European business operational update

Nektan has continued to see good success with its partner acquisition endeavours. ‘Live’ partners increased from 20 in October 2015 to 30 at the end of January and 11 new partners were signed in Q316. This suggests the company’s business development activity remains healthy. There is a natural lag between partnerships being signed and revenues beginning to ramp up, allowing time for software development work and for effective marketing plans to be implemented. As a result, we expect the strong early-year NGR momentum to continue as more partner sites receive a commercial launch.

While real commercial progress has been made, the company is tracking behind the forecasts in our last published Update report dated 23 October 2015 mainly due to slower than expected acceleration of one large contract, as reported with the interim results on 31 March. The partner has not been disclosed by management but we believe it is a large UK media group which has been reorganising some of its online gaming activities; we continue to believe the partnership offers substantial medium term potential for Nektan. Among its other partnerships, Nektan finds that it is achieving the most success from partners with existing RMG experience and those with smartphone traffic acquisition expertise. As a result, it is directing it efforts towards partnering with more organisations that fit this profile.

Localised offerings: presently, players in continental Europe have only had access to English language versions of Nektan’s games billed in sterling. Nektan expects to launch local language and currency versions of many of its games in the coming weeks, beginning with Sweden. We expect this to have a strong positive effect on its European player conversion rates.

Management change: Nektan has made changes to its senior management team in recent months. CFO David Sparks left the business at the start of December, while CEO David Gosen resigned to pursue other opportunities in mid-January. Executive chairman Gary Shaw has assumed the position of interim CEO, while Jim Wilkinson has moved from being an independent non-executive director to assume the role of non-executive chairman of the company. We believe that the management changes will strengthen the company’s cost focus as it continues to move towards profitability.

Respin update

Nektan’s interim and Q316 trading statements gave updates on the progress of its equity-accounted US JV Respin. It continues to make excellent progress and now has 54 signed and pending contracts with tribal and commercial casino operators (up from nine in 2014). It has launched its new Rapid Games in-venue mobile gaming product and has become the first company to receive approval from Apple for in-venue mobile gaming for its Evolve platform. On 7 April Respin won the iGaming North America 2016 ‘Best Innovation in North America’ award ahead of a number of major players in the market.

Nektan has previously stated that Respin will fund the roll-out of its Xstraspin and Respin cabinets through finance leases. We believe that much of the development heavy lifting at Respin is now complete. However, Nektan’s interim results did state that Respin may require further capital contributions. Should this be the case, Nektan may need further funding to finance its contribution.

Revised estimates

Exhibit 1 shows our revised FY16 estimates and compares them to our previous forecasts, as published in our 23 October 2015 update note.

Exhibit 1: Recent results and estimates

Year ended June (£000s)

H115

H215

FY15

FY16e

FY16e Old

Real money gaming (RMG)

115

270

385

6,132

13,000

Freemium gaming

0

0

0

0

1,500

Content licensing/rev share

21

8

29

20

500

Software development/other

114

0

114

27

0

Revenue

250

278

528

6,179

15,000

COS

(87)

(216)

(303)

(2,130)

(3,000)

Gross profit

163

62

225

4,050

12,000

Net revenue margin

65.2%

22.3%

42.6%

65.5%

80.0%

Marketing/partner costs

(310)

(414)

(724)

(4,526)

(7,300)

% of revenue

124%

149%

137%

73%

49%

Other operating costs

(2,213)

(2,875)

(5,088)

(5,123)

(4,500)

Other income

0

478

478

0

0

EBITDA

(2,360)

(2,749)

(5,109)

(5,600)

200

Depreciation/amortisation

(351)

(476)

(827)

(1,100)

(1,000)

Normalised operating profit

(2,711)

(3,225)

(5,936)

(6,700)

(800)

Share of Respin JV (Exhibit 2)

(203)

(482)

(685)

(1,657)

(930)

Net interest

(30)

(199)

(229)

(1,322)

(928)

Normalised PBT

(2,944)

(3,906)

(6,850)

(9,678)

(2,658)

Source: Nektan, Edison Investment Research

Revenues: Nektan’s RMG casino business has always been its core offering and, with revenues now starting to build some momentum, this continues to be the case. H116 revenue was £1.63m (£1.59m of NGR, £0.04m from content licensing/software development), up from £0.25m in H115. However, this was below our previous forecast largely due to the slower than expected acceleration of the large contract referred to above. Management estimated that this represented approximately £7m of the reported revenue shortfall. This effectively marks the difference between our October 2015 RMG revenue forecast of £13.0m for FY16 and our revised forecast of £6.2m.

The 18 April trading update reported that Q316 NGR was £2.30m, up from £1.07m in Q216 and £0.56m in Q116 (ie £3.93m for the nine-months). The number of first-time depositors (a useful lead indicator) is also growing, at 15,628 in Q316 up from 11,011 in Q216 and 6,472 in Q116, a very encouraging trend. Our new FY16 revenue forecast of £6.18m implies £2.25m in Q416, which allows for some seasonal softening going into the summer months as people pursue more outdoor-focused leisure activities.

Nektan has understandably focused much of its attention on driving its casino revenues. As a result, it has experienced delays in rolling out additional product lines such as bingo, which we now expect to contribute only nominal revenues in FY16 (£50k), before gaining traction in FY17. The same can be said of the company’s freemium gaming plans, which remain a part of the strategy but have now been pushed back into FY17.

Costs: Nektan’s management has made extensive progress in continuing to cut the cost base to reflect the slower than expected ramp-up in revenues. Management has clearly stated that moving the company to an EBITDA-positive position is a high priority near-term objective. To achieve this, it has reduced the fixed cost base by some 35% to a run rate of around £0.3m a month from April 2016, with the savings coming almost entirely from administrative functions.

Nektan recorded an impairment charge of £745,000 in H116, which related to a reassessment of the recoverability of two debtor balances. This is a non-cash item that is captured in the change in working capital on the balance sheet via a reduction in accounts receivable.

Financing

Nektan had a net debt position of £2.1m at end June 2015 and £5.6m at end December 2015. The £2.93m March 2016 fund-raise marked its third in this financial year (2015/16). The first saw it raise £2.75m in October 2015, £2.39m of which came from a convertible loan note issue (10% coupon), and the balance from a placing of 232,258 shares at a price of 155p. An additional £1.36m was raised support the expansion of the Respin opportunity through the placing of 937,929 new ordinary shares at a price of 145p in December.

The most recent fund-raise consisted of a subscription for up to £2.56m of new convertible loan notes and up to 2,560,000 warrants, which was supported by new and existing shareholders together with a number of directors. A further £0.34m has been raised via a subscription of 441,333 new ordinary shares. This brings the total amount raised to £2.93m. The March 2016 subscriptions were unanimously approved by shareholders at an Extraordinary General Meeting held on 29 March 2016 and the new shares began trading on Monday 4 April. Should all of the loan notes and warrants be converted into shares, it would lead to potential 13.5m additional shares, an overall potential dilution of 32.3%.

At the time of the interim results, management stated that it expected the fund-raise to enable it to manage its working capital requirements during key periods over the next 12 months (including gaming taxes, convertible loan note interest and scheduled investments into Respin), provided the group continues to perform in line with expectations. Prudently, however, management is continuing to assess the group’s financing options including “seeking new investors, debt finance or other financial support from key stakeholders; seeking a strategic partner; or seeking to realise value from its trading assets”.

Exhibit 2: Financial summary

£'000s

2013

2014

2015

2016e

June

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

1,061

1,865

528

6,179

Cost of Sales

(572)

(132)

(303)

(2,130)

Gross profit

489

1,733

225

4,050

EBITDA

 

 

(1,994)

(3,474)

(5,109)

(5,600)

Operating Profit (before amort. and except.)

(2,500)

(3,717)

(5,936)

(6,700)

Amortisation of acquired intangibles

0

(1,751)

0

0

FX and exceptional items

(14)

(3)

(1,266)

(798)

Share based payments

0

(255)

(7)

0

Operating Profit

(2,514)

(5,726)

(7,209)

(7,498)

Share of net profit from Respin JV

0

0

(685)

(1,657)

Net Interest

(9)

(5)

(229)

(1,322)

Profit Before Tax (norm)

 

 

(2,509)

(3,722)

(6,850)

(9,678)

Profit Before Tax (FRS 3)

 

 

(2,523)

(5,731)

(8,123)

(10,476)

Tax

111

310

(19)

0

Profit After Tax (norm)

(2,398)

(3,409)

(6,865)

(9,678)

Profit After Tax (FRS 3)

(2,412)

(5,421)

(8,142)

(10,476)

Average Number of Shares Outstanding (m)

5.2

15.3

20.6

23.3

EPS - normalised (p)

 

 

(46.3)

(22.3)

(33.4)

(41.6)

EPS - (IFRS) (p)

 

 

(46.6)

(35.4)

(39.6)

(45.0)

Dividend per share (p)

0.00

0.00

0.00

0.00

Net Revenue Margin (%)

46.1

92.9

42.6

65.5

EBITDA Margin (%)

-187.9

-186.3

-967.6

-90.6

Operating Margin (before GW and except.) (%)

-235.6

-199.3

-1124.2

-108.4

BALANCE SHEET

Fixed Assets

 

 

3,196

2,158

4,325

6,364

Intangible Assets

2,857

1,843

3,146

2,800

Tangible Assets

310

315

115

500

Investments

29

0

1,064

3,064

Current Assets

 

 

2,836

1,734

4,869

4,203

Stocks

0

0

0

0

Debtors

2,203

857

1,473

3,203

Cash

633

877

3,396

1,000

Other

0

0

0

0

Current Liabilities

 

 

(1,621)

(811)

(2,025)

(2,400)

Creditors

(1,621)

(811)

(1,007)

(1,500)

Short term borrowings

0

0

(1,018)

(900)

Long Term Liabilities

 

 

(455)

(44)

(4,531)

(11,100)

Long term borrowings

0

0

(4,507)

(11,100)

Other long term liabilities

(455)

(44)

(24)

0

Non-controlling interest

0

0

0

0

Net Assets

 

 

3,956

3,037

2,638

(2,933)

CASH FLOW

Operating Cash Flow

 

 

(3,619)

(1,869)

(6,666)

(6,698)

Net Interest

(9)

(5)

(91)

(830)

Tax

0

0

0

0

Capex (incl JV funding)

(7)

(1,149)

(3,981)

(3,370)

Acquisitions (net of cash acquired)

(2,526)

(977)

0

0

Financing

13,881

4,244

7,732

2,026

Dividends

0

0

0

0

Net Cash Flow

7,720

244

(3,006)

(8,872)

Opening net debt/(cash)

 

 

7,087

(633)

(877)

2,129

HP finance leases initiated

0

0

0

0

Other

0

0

0

1

Closing net debt/(cash)

 

 

(633)

(877)

2,129

11,000

Source: Company accounts, Edison Investment Research. Note: Historic numbers comprise the continuing operations of the Nektan group.

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Research: Financials

OTC Markets Group — Update 19 April 2016

OTC Markets Group

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