NetPlay TV - Target Price Upgraded

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IMPORTANT (March 2014): Changes to the Gambling Bill have meant the dynamic of the point of consumption tax have changed. Therefore, this article is no longer accurate and the site's position on NetPlay is under review

A strong operational performance at NetPlay TV (LSE:NPT) has seen the shares soar to a current price of 23.38p versus the site Buy price of 18.25p back in September. That equates to a 28% rise, but there should be more to come. The ~£69m company recently announced record key performance figures in January, and with traction being gained the general positive trend should continue. In the initial review I commented that "The technical position remains highly encouraging and an initial target of 25p is not out of the question - that is a level at which both technicals and fundamentals match up. A highly cash generative, cash-backed, growth play." That very much remains the case.

This article is a follow-on from the below post. For full context and information, read this article first:

The technical position of NetPlay is very pleasing with an upward sloping curve representing momentum and increased market interest (that is backed up by increased volumes). The shares have advanced strongly in recent weeks and have comfortably broken out of past trading zones. That has been aided by a lack of resistance (up until 25p and 30p beyond that). What the chart doesn't show are the large movements in institutional holdings and these has and should continue to revitalise the price movements.

The principal institutional activity has been Henderson Global Investors selling down their stake from the high 20%+ levels. More specifically, they reduced from 26% to 22% and now to circa 14%. That selling, combined with reduced stakes from HSBC and Miton Group, initially saw the price rises limited. It's difficult to pinpoint the reason for these sales especially given the rising price and Henderson's very high initial level. It could be a round of profit taking and risk adjustment, or something more severe. The fundamentals and bullish price movement itself, however, suggests that it's unlikely to be a deep-rooted concern. As part of the offloading, Investec took up a material ~7.5% stake in NetPlay. These institutional movements should revitalise the price, as it has been the selling that has held the price back. Investec and other institutions, will not be looking to sell at a loss hence they won't be selling much at or too near their purchase price. It remains to be seen whether Henderson are intent on selling the remainder of their interest or whether they will hold it.

NetPlay has released several operational news statements since the first review. The first was a trading statement in October. This showed that NetPlay experienced a strong third quarter with mobile and tablet contribution up 171% year-on-year (Y.O.Y) and an increased number of both depositing and active customers. However, net revenues were down on the previous quarter due to "exceptionally hot weather" which led to a decreased number of players. That negative impact was partially mitigated by effective advertising of their brand on the Big Brother series'.

The next trading update was released earlier this month and showed an excellent performance (aided by the acquisition of Total net revenues for Q4 2013 were at a record level, there was a further increase in the number of active depositing players, and mobile and tablet contribution continued on its upward trajectory. The best way to represent this data is on the table below:

The general trend for all the KPIs is extremely positive. Over the 24 month period, mobile and tablet contributions as a percentage of net revenues rose by 21%, new depositing players per quarter rise by 26%, quarterly active depositing players rose by 47%, and total quarterly net revenue rose by 55%. Those are very impressive, and if anything, momentum continues to be built across the KPIs. There are a few fluctuations within the overall trend, and these are the result of several factors including the timing of key advertisements and exogenous factors (such as the hot weather during Q3 2013). That was all shadowed by the impressive statement in the January trading update was that full year EBITDA was expected to be at the top end of market expectations.

Those figures should continue to improve and that will be partly down to NetPlay's shrewd acquisition during H2 2013. The acquisition was of (operates an online casino, bingo, poker and sports book) - a business formerly owned by Sportech (LSE:SPO) that had mixed success. During 2012, Vernons booked operating profits of £1.1m on revenues of £4.8m, but slipped to an operating loss of £0.7m in H1 2013 on revenues of £2.8m. No reasons for the financial decline were given, but what is important is that NetPlay have noted that "significant synergy opportunities will allow quick and efficient integration" that will "ensure immediate profitability". That means that the Vernons part of NetPlay will be earnings enhancing from the off  and along with the acquisition came a substantial 367,000 registered user base (will be lower when stripping out the inactive accounts). That user base is important as it means NetPlay will be able to cross-offer their other services. The marketing campaign for Vernons is set to start in early 2014, with the business already having secured the headline sponsor spot on STV for Loose Women throughout 2014.

The price of Vernons was also attractive - it included a cash consideration of £3m and Sportech pledged £0.1m towards restructuring and integration costs. This suggests that Sportech were actually keen to offload Vernons, and that tallies with the business not being a perfect fit into their offering. The price only amounted to approximately 2.7x FY2012 profits and considering that NetPlay chucked off £2.6m in cash in H1, it will hardly dent their robust balance sheet, which has cash and equivalents of £14.9m at the last showing.

Looking back the the 2013 forecasts, revenues were forecast to come in at £28.1m, pre-tax profits of £4.60m and EPS of 1.55p. We now know the revenue figure and it amounted to £28.6m, so slightly (but not materially) above the forecast. The EPS figure seems sensible given that the diluted H1 EPS amounted to 0.80p. For the following calculations, assume a conservative £13.5m FY2013 cash pile estimate. At 1.55p, NetPlay is trading on a prospective PE ratio of just 15 which is not demanding itself. Strip out £13.5m and the share price falls to 18.78p which translates through to a PE of just 12. Broker Daniel Stewart has predicted FY2014 EBITDA of £6.3m along with an EPS of 1.9p. That potentially means NetPlay is trading on a 2014 forward PER of 12.3, which drops to single figures when stripping out the cash. Assuming symmetric cash generation throughout 2014 (£2.6m for each half), then the cash pile would rise to £18.7m and the share price net of cash falls to 17p. Thus realistically, the net of cash 2014 PER could be just 9.

Let's use some conservative calculations. Assuming that the 2014 cash generation only amounts to £2m per half, the FY cash balance would stand somewhere around £17.5m (all other things being equal). Given that cash on the balance sheet is of little help to investors, let's say that it should only be valued at 50% (i.e. £8.75m). The share price thus falls to 20.4p. Taking a lower EPS figure than estimate at 1.8p, NetPlay would be trading on a half-cash PER of 11.3 should the share price be at the current level at the time of reading. At the very minimum a PER of 15 should be expected, and that equates to approximately 30p/share.

What do those figures mean in simple terms? Taking the current share price, factoring in discounted cash generation in 2014, stripping back half that cash pile and then applying a lower than forecast EPS figure, and NetPlay is still 'cheaply' valued. Taking the predicted EPS of 1.9p, using cash generation of £2.6m per half year, applying a 0% cash discount and stripping out the cash and the PER of 15 translates to 34.87p. A quick table on the right shows NetPlay's relative undervaluation compared to 32Red, which is arguably their closest peer when looking at past growth trends, and future growth potential.

In response to the January update Sanlam Securities upped their target price to 26p from 22p whilst Daniel Stewart upgraded their target price from 25p to 27p.

The issue that is holding back the share price is the point of consumption tax that I outlined in the initial review. Several discussions by the government have been completed and the tax has passed the stages, but it is yet to be formally announced, thus there is a small chance the 15% net revenue tax will be changed. However, the chances are that it won't given that it is being set to be in line with what the mainland UK based companies have to pay. The reality is that the tax is overblown and NetPlay would shrug it off should it continue to grow at current rates. Y.O.Y total net revenues are up by 32% alone. Furthermore, CEO Charles Butler has commented that he believes at least half of the 15% tax can be mitigated through passing on a portion of the tax to television broadcasters, and through careful cost reductions. If remains to be seen whether that will hold true.

With both technical and fundamental progress gaining momentum, there is certainly no reason to take NetPlay off the Buy rating at the current price. Indeed, in light of excellent financial progress (with EBITDA at the top end of expectations), an earnings-enhancing acquisition, and a strong share price chart, I have upped NetPlay's target price to 28p, with the potential for 30p to be reached beyond that (on a 12 month time frame). In addition to the fundamental progress, the company is backed by a robust balance sheet that can be deployed for more acquisitions, or to pay an improved dividend. In any case, the performance of the company is pleasing, and assuming that the current trends continue, the shares remain priced at an undemanding level. NetPlay is set to release FY preliminary results in April 2014.