May 11, 2021

Online gaming industry
bets on consumers

Guest: David Cavanaugh, Senior Research Analyst
at Eagle Asset Management

In this episode of Markets in Focus

Consumers have poured into online gaming during the pandemic. Can iGaming companies keep up and adapt? David Cavanaugh, Senior Research Analyst at Eagle Asset Management, says yes – but they face a specific challenge. David joins Matt Orton, CFA, Director and Portfolio Specialist at Carillon Tower Advisers, to zero in on opportunities in the online gaming space.

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Matt Orton:
As we look at all of the economic data over the past few months, one of the key takeaways I think has been the resounding comeback of the consumer. Consumer confidence is finally improving as stimulus checks are spent and vaccines continue to be rolled out to the broader population. March retail sales also came in 17% above pre-pandemic highs, which I think is quite a feat considering that some parts of the economy are still closed and mobility is also restricted. And not surprisingly, many of the companies that are tied to the reopening of the economy have rallied strongly over the past few months. But with such strong gains already baked in, and many of the "reopening companies" trading above their pre-COVID highs, many investors are asking: “Where is there still opportunity?”

This is Markets in Focus from Carillon Tower Advisers. I'm your host, Matt Orton. Join me and my colleagues as we discuss the latest trends and developments driving the markets. Visit us at for additional episodes and insights. I'm joined today by David Cavanaugh, Senior Research Analyst with Eagle Asset Management, who specifically covers the consumer space in addition to business services and financials. Dave, thanks for being here today.

David Cavanaugh:
Thanks for having me, Matt.

Matt Orton:
So, I want to start by taking a deeper dive into the state of the consumer in the US. Too often, we think of the consumer as one colossal entity, but in reality, there's a lot of different consumers and not all consumers are created equal with respect to investing. So, maybe you can start by laying out how you look at the consumer and some of the broader trends that are driving their behavior right now.

David Cavanaugh:
Sure. Thanks again, Matt. Prior to COVID, there was a very strong consumer that we were observing. And what's really interesting about this environment is that we're seeing that the consumer has come out of this pandemic even stronger. What we've witnessed is that overall consumer balance sheets have improved. And in general, we've seen consumers use this time period to pay down debt. We've also witnessed house values in general, which are higher. And also, as we look across many financial assets that consumer have like stocks, for example, those are meaningfully higher as well.

What we've seen is consumers increased their savings. And in the instances where consumers' jobs have been impacted, we've seen unprecedented amounts of fiscal stimulus to combat that. So, what we've seen across the landscape of the consumer is both a high end of consumer that's emerging more strong, and then also a low end consumer who has seen their overall balance sheet improve. And so, the net result is a really healthy consumer backdrop.

Matt Orton:
So, yeah, that's definitely interesting. And given the positive backdrop, are there any specific areas that you're finding opportunities right now?

David Cavanaugh:
The area that we see the most opportunity in is in the travel and leisure space. Now, a number of these companies are great businesses that grow nicely in a stable economic environment. And now, a handful of these businesses should have the strong wind of pent-up demand at their backs. If we look more specifically, we see opportunities in the cruise line industry. Our opinion has always been that people that cruise really like to cruise, and so, we expect to see them cruising again. And we're seeing that in the cruise industry's forward booking patterns, and surprisingly, we're seeing pricing levels that are rivaling 2019 prices or even coming in excess of that.

We're more interested in those cruise lines that already have lined up additional capacity coming on in the out years, as that will allow them even more opportunity to grow. And then maybe to finish off in that space, we have a higher focus on those cruise lines that are focused on the North American consumers, just as we are seeing vaccination levels, and we're seeing mobility higher in North America. I would also touch on the casual dining space as another area that's been hit quite hard over the last year. And as the world and in particular, the US reopens, here we would expect to see business improve dramatically. I would note though that the casual dining industry going into the pandemic was under pressure.

In my opinion, as there were too many casual dining concepts out there, and consumer tastes were changing in terms of wanting the option to order digitally, to pick up their food or to have it delivered. What we think going forward as the winners in this space will have used the pandemic time period to rationalize their operating cost structures, while also incorporating the benefits of digital ordering and delivery. I'll touch on briefly one last area where we would expect to see dramatic growth as the economy and businesses reopened, and that's in the gaming industry.

Matt Orton:
Thanks, Dave. And it's an interesting point you make on the digital ordering as well. I know I certainly don't really wait in lines anymore. If I go and order something, it's on an app, I go pick it up and you're done. And I think it's being validated at least when I'm out and about. But if we build on this reopening and travel and leisure theme specifically that you were alluding to, it's hard not to ask right now whether the good news is fully baked into prices.

Many of the consumer-oriented reopening plays have moved pretty significantly in what I think everyone would say is a very short period of time. And I look at some of the airlines right now that are dependent on business travel, and some of the recent earnings highlight that there are challenges ahead. And you look at some hotel chains, similarly, that are dependent on business and international travel, they're above pre-pandemic highs. And I wonder whether that's overdone, so maybe you can share some thoughts on where you're still finding value right now.

David Cavanaugh:
Sure. And picking up on my last comment, casino gaming's an area where we continue to see value, both today and moving forward. There are a number of trends at play, which we expect in the casino gaming environment to come together to drive quite strong earnings growth for a number of the providers in the space. To your point, Matt, gaming is a leisure activity and we would expect to see it bounce back before other business-related activities. What we expect is that we'll see drive to regional gaming properties in the US, doing well as the economy begins to reopen. And we're seeing this happen right now, we expect it continues as casino capacity limits are allowed to be raised. As vaccinations continue to increase, what we'll also expect to see is the return of the 55 year old and older segment.

This is a very important segment to the US gaming industry. And what we've seen is so far, the robust bounce back has come from a younger customer that the US gaming industry hasn't been as successful with in the past. So, this is very exciting for the US gaming industry. With the vaccination's increased mobility, we would expect to also see that 55-plus customer come back as well. So, we think the gaming industry is going to have gained customers that they didn't have prior to the pandemic. What these companies are also doing is they've really rationalized a lot of their costs. I'll give you an example: Buffets, which we all know of, they actually lose money in the casinos. So, we've seen a lot of gaming companies use this opportunity to scrutinize and rationalize their cost base, eliminating some of the buffets, also scrutinizing the level of promotions and the amount of promotions they give to certain customers.

And what we think we're going to see on the other side is much higher operating margins out of these businesses going forward. So, again, we expect to see the regional drive to casinos performing well, initially. Over time as mobility increases, we would expect ultimately to see the Las Vegas strips business begin to come back. And I'll touch on maybe another aspect of gaming that's maybe more exciting than the regional and Las Vegas stripped brick and mortar casinos, it's the move towards online gaming. And here, I'm talking in particular about online sports betting and iGaming. iGaming being online ability to play both slots and table games.

Matt Orton:
So, that's a really interesting point because I know at least for me, the concept of iGaming is just a little bit foreign and I think it's still something that's maybe catching on with folks, but sports betting has definitely been huge. And so, when we come out on the other side of this, how do you look at who can continue to win going forward, and how do you think about valuations right now? Because there's definitely some pretty big expectations baked into the share prices of a lot of these companies in the gaming space and especially the sports gamers.

David Cavanaugh:
Yeah, Matt, we think there are going to be a mix of winners in the gaming space moving forward. We are pretty excited about the opportunity and the growth potential for the online gaming space. If we step back and just frame some numbers around it, the online sports gaming market looks to be over time, a $20 billion market. Now, that's with a 100% of the US at legalization. The iGaming market, interestingly is being pegged to be twice as big as online sports betting. So, a $40 billion market again, when 100% of the US is at legalizations. So, where are we today? We only have about a quarter of the US population where online sports betting has been legalized. And then in iGaming, we're only at about 10% of the US population that's been legalized.

So, the point there is just, there is a lot of growth left in these industries, and that's what we find particularly exciting. We think we're in the early innings of this, and it's an emerging growth area. And what you find at this point in the cycle is that the players are all focused on customer acquisition and market share. How many customers can they bring in the doors and how quickly? Now over time, this is going to shift and the success factors will be who can acquire and retain the most customers and do it at the best economics.

As I mentioned, it's very early in the journey, but what we think is the companies who will be successful will have a number of characteristics. They will own their own technology, and what that means is they will be able to move out new games quickly and develop games that their clients and customers want, bring endorsed new technologies, be able to quickly roll into new legislated states. So, owning your technology is going to be a real differentiator over time. It also allows folks to understand how much they're spending on their individual customers. Are they making money on the customers? How much should they bonus and give promotions to their customers? So, over time, the shift is going to move towards how many of the customers that you obtained during the land grab phase can you retain, what type of profits can you make off of them.

And then I'll also touch on, there is going to be an ability, right now, the majority of the mind share is focused on the online sports betting market. And you can see that, that is further along in its adoption than iGaming, but let's not forget that iGaming is proposed to be twice the size of the online sports betting market. So, the players who can cross-sell and participate in both of those markets, we think will be very successful. And if one looks back at the brick and mortar casinos for just a little bit of history, it turns out that table games and slots, which is the iGaming piece in the brick and mortar world, those are more profitable to a provider than an overall sports book. So, it just highlights that while online sports betting grabs a lot of mind share today, there are really two big markets out there for these folks to compete in.

I'd probably be remiss, Matt, if I didn't mention that there are obviously risks with an industry like this. And I would say, the first and foremost is just legislative risk, which states pass legislation, allowing online sports gambling, and iGaming. When do they pass it? What's worth knowing is that each state that passes it, approaches it with their own market structure, with their own tax rate, with their own licensing fee, with their own number of participants and licenses that they are willing to offer. So, this goes state by state, and I think that's probably the biggest risk as one looks at this area is just, what is the pace of this and what does each state look like? Just in the past month or so, we've gotten news that New York is looking to legalize online sports betting, but right now, the details aren't quite flushed out.

We also heard within the last week that Florida is looking at passing online sports gaming. So, there's clearly momentum here, but I would say the legislative details can always be a risk. And then I would also just touch on the ultimate economics of this business. Circling back to my comments earlier, we are in the land grab phase where the big providers are looking to acquire customers. It really will take a little bit of time to see did you acquire the customers and were you able to hold on to them, and then how frequently did those customers transact with you. And so, over time, there is the risk that the economics of the business possibly don't pan out to what investors thought. So, those are the two risks I would highlight in this space.

Matt Orton:
Yeah, I think all of that is really, really important. And you made a lot of good points there, and I just want to dive a little bit deeper into a few of them. I mean, first, I'll just say it's hard to believe that some states haven't already gotten to the point of legalizing things. I can just think of being in New York City and having to take the PATH train across to New Jersey to top off an account so you can go bet on the Kentucky Derby or something. It's hard to believe that they'd be passing up on that revenue. So, hopefully, they'll be able to do something going forward. But in addition to just legalizing it, what about regulation? What about for the people who say the perpetual gambler just wakes up in their sleep and now has access to go play on slot machines? Is there any threat for increased regulation around some of these companies or iGaming, or are we still too early for that?

David Cavanaugh:
I don't think that's going to be the case. I think you're at a really unique period where you've actually seen some of the stigma, at least online sports betting, I think you're seeing that come down with the widespread adoption of it. You're also seeing that a lot of these states are at real interesting points in terms of their budget shortfalls. So, I think that's driving them to be able to legislate and fill some budget gaps. There was also always the thought that the online adoption of whether it's sports betting or iGaming, iCasino would come at the expense of the brick and mortar businesses. So, that's always been a thought of a threat while you're starting to see, as we've navigated through a few of, I can think of New Jersey, Pennsylvania, some of the markets that have been open a little longer, that hasn't been the case.

So, what you're seeing is that the advent of these online offerings, as well as the brick and mortar, has actually served to grow the space, which I think if you spoke with people going back a couple of years, that thought would have been different. So, I think that's a little bit compelling and what you're going to see now is just it's the pace of the legislation, and then it's what the devil being in the details about things like tax rates and license fees and how many people can participate in the different markets. That will be the focal point here over the next year or two.

Matt Orton:
That's really interesting and definitely good points to look at the states that have had this around longer. And just to dive into risks a little bit more, as we look more broadly across the consumer space, which areas in particular do you think could face some increased risks, either because they've moved too far too fast, or because they might have some fundamental challenges going forward?

David Cavanaugh:
I'll touch on a couple, and the first one I touched on a little bit earlier, which is just the casual dining industry. And the point here is it's set up to see a big rebound in demand, clearly as all of us just want to get out, meet with people, sit down and have a meal. But what hasn't gone away is a number of the fundamentals that were hanging over that industry, in my opinion, as we went into the pandemic. I still think there are too many restaurants, casual dining concepts, and you're also seeing things like rising wages, some rising commodity prices. And as we touched on this shifting consumer preference towards wanting to order digitally, towards wanting to order digitally and then go pick up your food, or ordering digitally and then having your food delivered.

So, I think there's going to be a period where there'll be a ton of pent up demand that hits casual dining, but I think there's real risks out there fundamentally that these businesses have to challenge, work through, and find the right structure. Another area of risk worth noting is just those areas where the consumer really did spend a lot during the pandemic. And I'll use the examples of boats. Boat sales really improved during the pandemic. The sale of pools and other things related to the home, that's where the consumer took their money and spent their money during the time of the pandemic.

Now, so far, we've seen that those type of spending patterns have persisted, but I just highlight that as an area where we could see dollars get reallocated from those areas towards some of the areas I talked about earlier in the travel and leisure space. Just as the world reopens as mobility increases, we want to keep our eyes on those places that saw a lot of dollars during the pandemic. And as again, that's just an opportunity that those could be places dollars get reallocated away from.

Matt Orton:
Yeah, that's a great point for our listeners to consider. And before we end, I do want to ask about one more potential risk. And this is one that's been in the news a lot, because many of these, these companies that we've been talking about, or the companies that operate in the areas we've been talking about have gone public recently and they've done so via SPACs. And SPACs have been hit pretty hard over the past month or so, increased regulatory concerns and souring investor sentiment. Do you think there's a future for SPACs? Do you think there's increased risks to new companies going public via SPAC? Maybe you can just share your thoughts there before we conclude.

David Cavanaugh:
Yeah, Matt. SPACs have been a real interesting area and we've seen a lot of companies in the consumer space come public by way of SPAC. And let me just frame it to give you the impact. So, I think if you looked from 2013 to 2019, there were 170 SPACs that came public. So, for frame of reference, that was over the 2013 to 2019 period. In 2020 alone, there were over 225 SPACs that came public. So, a huge amount in 2020. Then if we look at the first quarter of 21, there were over 270 SPACs that came just in the first quarter of this year alone. I think we're going to have ended up seeing that will have been the peak in SPACs Q1, 2021. So, that just gives you a frame of reference for how many SPACs have come public over a very short period of time.

And to your point, what we saw as a number of these SPACs came public in 2020, we saw almost the whole complex move up into the end of the year 2020. And then what we've seen as the SEC has started looking more closely at the whole complex, we've seen the whole complex, almost in unison trade down through the first third of this year. I guess, to answer your questions, we think the SPAC is a real vessel through which companies can come public. And we have had successful investment ideas in our consumer space that have come public by way of SPAC in the past. What we think happened here is that you just had so many of them come so quickly. And when you see something like that, clearly the quality deteriorates of those ones that are coming or scrambling to come quickly.

So, this improved an increased scrutiny that we're seeing from the SEC, we ultimately think is going to be healthy. Its already manifested itself, just this increased scrutiny. If I looked at Q2 of 21, I think under 10 SPACs have come public this quarter. So, what you're seeing is the scrutiny the SEC is providing around some accounting and then around also the ability to give projections has caused the market to slow down, which we think is a healthy thing. But really what it comes back to is, as I mentioned earlier, we think the SPAC vehicle is going to remain a viable way for companies to go public. But at the end of the day, the success of the investment of that stock will be, how does the asset do? How does the asset grow? What does management do with the asset? That will be the ultimate determinant of success over time. So, we think SPACs will remain. We think we are seeing a correction across all of them, which will ultimately be healthy. And we will see the ones that have good businesses, well-run in great growth areas, will distinguish them themselves over the upcoming years.

Matt Orton:
All excellent points. And I know we've taken up a lot of your time today. So, Dave, this has been a great discussion and hopefully has shed some light on a topic that's very tangible to all of us listening today. I certainly appreciate your time and thanks as always to our listeners for your support. Take care. Thanks for listening to Markets in Focus from Carillon Tower Advisers. Please find additional episodes and market insight at You can also subscribe to our podcast on Apple Podcasts, Spotify, or your favorite podcast app. Until next time, I'm Matt Orton.


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