Small cap reporting recap

Thursday, September 5th, 2019

The Clime Small Cap Sub-Portfolio results were more or less consistent with our forecasts with no big surprises. Nevertheless the market reacted very strongly in some cases. We will provide updates for each holding in coming weeks. But we’ll start with Jumbo Interactive (JIN) in this report and Hansen Technologies (HSN) next week. Oddly, both were sold off quite aggressively on their results.

We expected JIN to beat previous guidance, which it did by 11%. The main surprise for us was management’s new 3-year target of $1bn in lottery ticket Total Transaction Volume (TTV). This was much higher than our forecasts and implies the online share of ticket sales, which stands at 23.5%, continues growing at the accelerated rate witnessed in FY19.

TTV for FY19 was $320m, which was entirely lottery ticket sales. The $1bn 2022 TTV target is split approximately by $600m in lottery ticket sales and $400m in ticket sales processed through JIN’s new lottery platform for third party lotteries, ‘Powered by Jumbo’ . Note that although TTV is set to triple, revenue margins on lottery ticket sales  (20%) are higher than that of Powered by Jumbo (3 – 5%). The mix points to revenue compounding at around 30% over the next 3 years. 

Due to JIN’s largely fixed cost-base this incremental revenue should lead to much higher earnings growth – we forecast 46% annually over the same period.

Modelling in the growth targets, we upgraded our FY20 valuation from $21.00 to $24.89.

Despite the result beat and outlook, the stock was sold off by 15%! We took advantage of the pull-back and increased our position in the Model Portfolio at $17.11. The stock price now better reflects fundamentals at $21.89 (at the time of writing). 

For those familiar with JIN’s story, an issue we get queried on from time to time is JIN’s relationship with Tabcorp (TAH) and potential risks around its reseller licence coming up for renewal in 2022. The first thing to understand is that lotteries is a highly regulated industry and TAH itself is licenced to operate lotteries by State governments. A point of contention is the reseller commissions TAH pays JIN on each ticket sold. The commission rate is approximately 8%. There has been some debate about whether TAH will adversely adjust the commission rate under a new agreement in the future.

The nuance is that commissions are regulated. The States don’t care whether sales go through JIN, TAH, or Newsagents – the tax revenue is channel-agnostic – so they’re unlikely to favour one party over another. Simply, rates are universally applied to all resellers, and any changes to commission rates require ministerial approval. As such, commission rates won’t change for JIN. Conceivably, TAH could end its agreement with JIN, but on our analysis the costs to TAH in the form of immediately reduced sales volumes easily outweigh the benefits of recouping the reseller margin. And that’s before considering TAH’s 10% stake in JIN, which is now worth over $100m. 

In other news, JIN has once again started the year with string of jackpots following July’s $100m Powerball. There were no winners in last night’s $80m Powerball, meaning the jackpot increases to an attention-grabbing $100m next week.

Clime Group owns shares in JIN and HSN.

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