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Introduction:
GAN has received an acquisition offer from Sega Sammy at $1.97 per share. Sega Sammy is an international conglomerate in entertainment, gaming, and resorts with a $3.7 billion market cap.
Stock Performance and Probability Analysis:
The stock traded in the range of $1.62 to $1.75 on Nov 7th. That is about a 22% to 13% return at the lows and highs of the day if you hold until acquisition day.
Implications of deal success at $1.75 (79%) and $1.62 (67%)
During the intraday, the stock hovered around $1.65 for the majority of the day. Acquisition probability math:
At $1.65/share, our return if the deal closes is 19%. If the deal doesn’t close, then the stock could plummet back down to $0.90 (I personally don’t think it will drop that low if the shareholders do vote against the deal, but let’s just assume the worst). With these 2 assumptions, we need the deal to go through 70.1% of the time for it to be worth it for us to purchase shares at $1.65.
Sega Sammy (6460-TYO) Acquirer Fundamentals:
Share price: ¥2324.5/share
Shares outstanding: 241.2 mm
Market Cap: 560.7 bn
Cash and short-term investments: 203.7bn
(*excludes 51.2 bn of investment securities in non-current assets. These could be stocks, bonds, investments in affiliates or subsidiaries.)
Debt: 152.5bn
Net Debt: -51.2bn
EV: ¥509.5 bn
FX USD/YEN = ¥150.85
Net Debt (USD) = -340mm
Upon first glance at the deal, it seems 6460 has ample financial resources, making the $87 million USD payment effortless for them.
Sega Sammy has 340mm USD of cash in excess of debt. If shareholders are displeased with the offer, Sega can easily come back with $2.50/share which is only 110mm USD for them. Sega has plenty of cash to acquire GAN.
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What is the market narrative?
I think the bulk of the narrative in the special situation community might be that we bought at $1.20 USD or less, and now we can celebrate with this quick win. However, I think the special situation crowd is simply focusing on the double they quickly made on their sub $1.00/share entry price. We should also look from the acquirer’s perspective at how much they are willing to pay. Also, given that the stock traded below $1.20 only in the past 2 months, a potential majority of shareholders have a small gain, a small loss, or a major loss if they are bag holders.
In acquisitions, there are financial buyers and strategic buyers. Financial buyers are buyers that simply buy the business for its fundamentals, and the financial buyer has no existing business that synergizes with it. Think of conglomerates that have many unrelated businesses. Then there is the strategic buyer, who may have revenue and cost synergies.
From a financial buyer’s perspective, it might be next to impossible to value GAN given they have negative cash flow, and the market implication once it entered penny stock territory seems to be that they won’t be generating positive cash flow ever or go bankrupt before they are able to do so.
The methodology that gets the highest valuation for GAN is from the perspective of a strategic buyer.
Taking a slight detour, the funniest strategic acquisition I’ve seen was on the Canadian Dragon’s Den TV show. A contestant created a hat and sunglasses 2-in-1 product. Often, when you wear sunglasses, you take them off and put them on top of your cap. Your sunglasses can fall off when you bend over. This contestant created a product that combined both a cap and sunglasses. If I remember correctly, the contestant invested $250k into the business, and it wasn’t doing well. The contestant cried about their struggles and the hurdles they had to go through. The Dragon offered $250k for the business because his company often held corporate events where they gave away swag. The Dragon felt that based on the $ amount of swag they gave away, they could easily break even after a couple corporate events. Also, the publicity of having people wear their caps on the golf course could be treated as a marketing expense. I hope this example shows how businesses can be revalued based on a strategic buyer’s best use case, although I wouldn’t recommend practicing this Dragon’s valuation methodology.
What is the replacement cost of GAN?
Before we think about how much a strategic buyer is willing to pay, we should evaluate how much it costs to recreate GAN from scratch.
GAN as a strategic acquisition for a casino operator hoping to expand into online gaming makes sense. The barrier to GAN having a high valuation is replacement cost.
To quote Buffett (1993 Annual Shareholder letter):
“Coca-Cola, for example, owns the world’s most valuable trademark. In fact, Coca-Cola is the world’s most valuable trademark. If you gave me $100 billion and said, ‘Take away the soft drink leadership of Coca-Cola in the world,’ I’d give it back to you and say it can’t be done.”
Now if you gave me the market cap of GAN, could you create another GAN? The answer is YES.
Based on my software engineer friends estimates:
It would cost $15mm to make the iGaming arm and $5mm to make the sports betting arm in 3 months.
Variables my friend factored in were:
-Cost of a game design team
-Cost of artists
-Cost of developers
-Time frame of execution: the longer, the cheaper
So if the replacement cost is $20mm, where is the rest of the $20mm coming from (pre-acq)?
(Keep in mind that $20mm is simply the cost to create the platform. This does not include the legal costs, marketing dollars, licensing fees, etc)
-B2B Client contracts (10-year agreement with Wynn Resorts, average contract: 3-5 years)
-4000 game catalogue (likely worthless in the eyes of SEGA given they have some of the best game designers and artists)
-Licensing fees and licenses to operate in different US states, countries and jurisdictions
-B2C arm hasn’t been valued yet (Q2-2023: 257k active customers, 20% marketing spend ratio, 8.5% B2C sports margin) (FY2022 - 559k active customers, 21% marketing spend ratio, 6.9% B2C sports margin)
-Speed. Although if the deal closes in Q4 2024, then making your own iGaming/Sports betting arm is faster
-Some sort of product track record. There haven’t been security breaches at GAN that I know of. MGM was hit with a cyberattack that cost them $100 mm.
-Sales and marketing dollars to build a B2C and B2B customer base and brand image. Roughly $74mm have been spent from 2019 until now.
-Potential proprietary tech. My software engineer friend simply commented that “proprietary” is simply a BS word meant to say that we made this tech for ourselves, we use it internally, and we don’t share it. There’s likely nothing really proprietary about it.
To use simpler numbers, GAN is being acquired for an EV of $90mm. Are the above items we mentioned worth $70mm above replacement cost or $50mm above pre-acq. market cap?
Potential Justifications for the Takeover Premium:
SEGA’s Reason for Acquiring
Here is a summary of what Sega gave as their reasoning for acquiring GAN:
Based on Sega’s press release, here are the reasons SEGA is pursuing the acquisition of GAN:
To expand into the growing U.S. online gaming market, especially iGaming which is expected to expand as more states legalize it. SEGA Sammy sees GAN's offerings as competitive in enabling operators to quickly enter the online gaming market as it expands.
GAN has become a leading turnkey online gaming solution provider, offering a comprehensive suite of products and services including a player account management system (can this be applied to their pachinko/pashislo and arcade business?), a remote gaming server, and a B2C sports betting platform.
SEGA Sammy believes the complementary nature of GAN's technologies/solutions and SEGA Sammy's gaming equipment, content capabilities, and land-based casino customer base will allow for increased distribution of SEGA Sammy's content and expanded customer reach.
The acquisition aligns with SEGA Sammy's stated growth strategy and focus on investing in the gaming business. They believe acquiring GAN will greatly contribute to expanding their gaming business and portfolio.
In summary, SEGA Sammy sees GAN as a strategic acquisition to expand into online gaming, especially in the U.S., leveraging GAN's leading technology and SEGA Sammy's gaming capabilities to accelerate growth in gaming. The timing and fit look beneficial for both companies.
From the above, the 2 main points are:
Expansion into the US online gaming market
Sega Sammy has the content capabilities that can complement GAN’s tech/solution
Reason 1: SEGA’s Unique Content Creation Ability
SEGA is a Japanese arcade producer. I love arcades. Japan is great at designing arcade games. The applications are endless for their in-house designers to make their content library way more aesthetic and pleasing. If you are talking about original content, SEGA has a track record of making original content. One example is Sonic the Hedgehog. Sonic has economic goodwill, as many people’s childhoods included playing Sonic the Hedgehog on some sort of TV or handheld console. If SEGA were to release an online Sonic Slot Game where Sonic collects rings as equivalent cash rewards, it would perform much better than some cookie-cutter rinse-and-repeat standard slot game where the company hired an unknown artist who works from home.
If we are truly talking about original content, SEGA has a library of nostalgic games that have economic goodwill that they can make iGaming iterations of. Sonic the Hedgehog is actually “proprietary” to SEGA.
To make this example more clear, let’s say you have 2 iGaming websites. The first iGaming website makes all their game designs in-house and hires random artists for each game. Another iGaming website collabs with Nintendo (Mario), Marvel (Spider Man, Ironman), Shonen Jump (Naruto, Bleach, Jujutsu Kaizen), and Sanrio (Hello Kitty). Which iGaming website are you more likely to go to if they offer the same odds on similar games?
GAN’s 4000 game library, if I am to speculate, likely has games created by different artists with a different artistic style from one to the next. You can’t build original content overnight. As gambling is an endeavor that has a minimum age requirement of at least 18 around the world, you can’t build economic goodwill from just playing slot machines. This is where SEGA has the advantage. SEGA created characters and games that were part of someone’s childhood. The nostalgia alone is a competitive content moat that is hard to surpass.
The reason Japanese arcades are much better than other arcade producers is because they know how to make fun and entertaining games with great design.
Think about why people buy the Nintendo Switch. It’s not because Nintendo has some sort of superior technological advantage over PCs; it’s simply because their games are fun, and those games are exclusive to their consoles. There are people who purchase the Switch (or its predecessors) only to play 1-game; such as Mario Kart, Smash Bros., Pokémon, and several other Nintendo halo titles.
GAN was attempting to pursue an original content strategy. SEGA specializes in this area. If SEGA is able to combine GAN technology with SEGA’s capacity for superior game design, content library, and artistic talent, this could provide them with a competitive content moat that will allow to charge higher take rates in the future.
What is this idea on steroids. Just like how certain titles are exclusive to Nintendo Switch, what if SEGA uses its domestic Japanese relationships to its advantage to create an iGaming platform/hub where they become the exclusive distributor for any company interested in creating gaming content for US casino iGaming operators? SEGA becomes the middle man for Nintendo, Konami, Bandai, and Capcom, just to name a few.
Reason 2: SEGA’s Cash and willingness to invest to grow their gaming business
6460, like a lot of Japanese companies, has a ton of cash. GAN’s problem is that they are burning cash, and if they were to raise debt on their own, it’d be very expensive. This is resolved completely by a cash-rich Japanese company that can borrow at lower rates than most US buyers.
SEGA mentioned the following:
“As part of our investment strategy through the fiscal year ending March 31, 2026, we plan to invest a total of up to ¥250.0 billion in growth, including ¥100.0 billion in the gaming business.”
GAN is currently unprofitable, but GAN under the SEGA umbrella, could definitely be profitable in 5 -10 years. This would give GAN time to wait for state-by-state legalization of iGaming and sports betting. Waiting is hugely painful for existing shareholders of GAN if GAN were to stay an independent business, but SEGA can subsidize GAN’s growth with their excess cash and profits from their other segments. With SEGA’s backing, they could even make their B2C segment profitable by being more aggressive with their ad spend and pushing unique SEGA gaming titles exclusive only to their B2C business.
Reason 3: SEGA’s Pachinko and Pachislo Slot Machines
Reading Sega’s business summary, the immediate thing that caught my attention was that they develop, manufacture, and sell pachislo (slot) and pachinko machines.
Pachislo are slot machines that use tokens.
Pachinko is similar to Pachislo, except instead of using tokens, metal balls are used. Pachinko is kind of a pinball slot machine.
In Japan, gambling is illegal, but Pachislo and Pachinko parlours take advantage of a loophole where gamblers can exchange tokens or pachinko balls for prizes. You can keep the prizes, or you can take them to an off-site location to exchange for cash.
^Above are the Pachinko balls. Here is Pachinko explained in a YouTube video by “Abroad in Japan.”
SEGA isn’t stepping into a gambling world they are not familiar with. Japanese people love to play Pachinko. SEGA can leverage its unique slot library and content creation advantage on the GAN platform. Furthermore, as I am not familiar if Pachinko parlours sign up members, potentially GAN tech can be integrated with SEGA’s current line-up of slots in Japan.
SEGA can also become the go-to iGaming and sportsbetting omnichannel expansion provider in Asia. SEGA is a Japanese company, but kids who grew up in China, Korea, Hong Kong, and other Asian countries grew up playing arcade games. Outside of the US, SEGA would have an advantage in understanding Asian content preferences. They can apply GAN tech at Paradise City Casino in Korea where they have a JV with Paradise City. Osaka is opening its very first integrated casino resort. Who knows, if Japan further relaxes its views on gambling, SEGA could have the first-mover advantage as the go-to company to perform JVs at future integrated resorts in Japan.
SEGA was a JV partner for the Yokohama integrated casino and resort, but the plans were scrapped after local pushback on concerns on gambling addiction and other social issues.
Reason 4: Minor Economic Goodwill
When Haier acquired GE Appliances, the rationale the CEO had was that there were 2 routes to success in the US. One was to create a brand from scratch or to buy an existing brand. GE Appliance has been a household name for years, dating back to the early 1900s. Haier believed it was better to acquire it, given that it would take many years to create a brand that rivalled GE Appliance in the US in terms of economic goodwill. (Paraphrase)
This is a stretch given GAN’s limited history relative to GE Appliance, but its definitely less of a headache to acquire an existing brand than to create one from scratch.
They also didn’t have to spend $74mm on marketing.
Will the deal go through?
“The proposed merger is subject to the approval of GAN shareholders. The Company will ask its shareholders to consider and vote to approve the Merger Agreement at a Special Meeting of Shareholders, which is expected to be held no later than March 31, 2024.”
The most important variable we need to focus on for this stock to not go through is whether the proposed merger will be approved by GAN shareholders.
The decision tree looks like the following:
Do I believe GAN is worth more than $1.97/share. Yes or No!
If No, approve bid.
If Yes, disapprove bid
If you don’t approve the bid the following can happen:
Sega Sammy raises their bid
Sega doesn’t come back with a higher bid and stock falls
$0.90/level if the market believes another buyer will come
By March 31, 2024; the company would likely be in a worse economic state, hence, bankruptcy potential is looming unless we receive another bid. Could drop to replacement cost or lower. $0.45/share or lower if market view is another buyer won’t come.
Based on the list of major shareholders below, there aren’t any active investors on our side. Dermot Stopford Smurfit is the former CEO of GAN and he has already filed a Form 144 stating his intention to sell. This being said, you can file a Form 144 to state your intention to sell, but don’t have to actually sell. If I was the CEO, even if I didn’t want to sell, I’d file a Form 144 just in case, because it gives me extra optionality in case I change my mind.
Based on the most recent GAN 8K, we see that they aim to close the deal by Q4 2024.
Are shareholders likely to agree to the proposed takeover price?
As an investor who purchased shares at below $1.00 per share, I am of course quite happy with this outcome, but a majority of shareholders are not individuals who recently purchased shares at sub $1.00/share. The shares only got this cheap over the last 2 months or so. A portion of shareholders are likely experiencing a small gain or a small loss.
And unfortunately, some are bag holders if they never sold.
Don’t get the false impression I use technical analysis, but the stock traded with solid support at $1.20 and resistance at $2.00. Currently, there is some support at $1.60.
Given that the company has entered into a definitive agreement and plan of merger, without knowing the exact details of the agreement, there may be a provision not allowing the management the ability to shop the company around. If this is the case, then from now until March 31, 2024; potential offers from other strategic buyers won’t be available.
I have emailed GAN IR about the specifics of whether they can still shop their business around or receive higher bids. If I receive news, I will post it in a subsequent post.
For now, my impression of the facts I’ve uncovered thus far is that if shareholders request a higher bid, SEGA has the capacity to pay more, given:
They have deep pockets and are capable of paying more. Why waste additional effort to find another GAN like alternative. Does the management of a ¥ 500 billion market cap company want to waste time on a marginally ¥10 billion yen decision that is in all likelihood +/- ¥2 billion yen difference.
GAN’s problem is cash; if they have enough cash injections, they could eventually become profitable. State-by-state legalization of iGaming and sports betting is happening at a slow pace, but SEGA has the balance sheet to wait it out.
Sega can leverage its content advantage on GAN’s platform
The Asian gaming market is constantly expanding. SEGA and it’s design team understand Asian tastes and can create product offerings combined with GAN tech for Macau, Asia, Korea, and the upcoming Osaka integrated casino resort
GAN technology can be applied to their current fleet of Pachinko and Pachislot slots.
Arcades are still a thing in Asia. A non-gambling application of GAN technology can be used to keep track of reward points and member sign-ups. At Japanese arcades, competing arcade brands still make users purchase arcade cards that are exclusively used for certain types of arcade machines made by different companies. i.e. when I was in Japan, there were these Gundam-like arcade machines where the seat moves and has air suspension to mimic someone being in a mobile suit. The problem was that you couldn’t simply put coins in the machine; you had to pay $10 for a card to play that game. It was too much of a hassle for me, so I played other games that didn’t require that process.
Disclosure: I currently hold no position in GAN, Gan Ltd.
GAN Part 3: SEGA SAMMY PRICE DROP TODAY (Quick Pitch/Update)
GAN Part 4B: Decision Tree Analysis (Factoring Chilean Operation Risk)
*You should read Part 4B before Part 4A. Part 4A was my original decision tree analysis, but I have since factored in Chilean Operation Risk.
GAN Part 4A: Decision Tree Analysis
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Link to my post factoring in regulatory risk in Chile: https://open.substack.com/pub/continuouscompounding/p/gan-part-4b-factoring-chilean-operation?r=28rmoq&utm_campaign=post&utm_medium=web