RGB – Siding with the top bookies

Introduction

The history of RGB involvement in the gaming industry began way back in 1986 (through RGB Sdn Bhd, its wholly owned subsidiary today). To date, RGB has been in the industry for 30 years, being known as a leading supplier of electronic gaming machines and casino equipment in Asia region (known as SSM in later part of this article). It is also a major machine concession programmes operator in Asia (known as TSM in later part of this article).

RGB, the Group, was incorporated on 16 January 2003, listed on MESDAQ on 13 January 2004, and successfully transferred to the Main Market of BURSA on 31 January 2008. Just when everything seemed to be going well, Cambodian Prime Minister Hun Sen’s decision to cease the operations of slot clubs in Cambodia came as a shock to the Group, resulting in its first loss in FY08 ever since listed.

Just like the biography of every great man, their stories would not have been as interesting and inspiring without enduring the hardships. And this is how we would like to tell our story on RGB.

Business

In an industry with relatively few competitors, RGB is one of the industry leader in Asian region. The operations of RGB can be mainly classified into two main segments, i.e Sales Support & Marketing (SSM) and Technical Support & Management (TSM), which is illustrated as below.​

 

SSM Segment distributes electronic gaming machines, amusement machines, casino equipment accessories & slot management system in Asia including Malaysia, Philippines, Macau, Singapore, Vietnam, Cambodia and Nepal. The brands including in house brand RGBGAMES, R.Franco, Scientific Games, Aristocrat, GPI, IGT and Suzo Happ. In this segment, RGB holds no interest in the gaming machines, only as a distributor to sell the machines. Based on latest trailing twelve month (3QFY16), SSM Segment contributed 66% to the Group total revenue.

TSM Segment partners up with investors & gaming license holders by placing electronic gaming machines at concession venues (slot halls & casinos) mostly in Cambodia & Philippines. Partnership model includes i) Providing lease-to-own packages ii) Gaming machines profit-sharing iii) Providing management services for a fee. As reported in AR FY15, RGB has more than 6,000 units of machines in operation across 37 concession venues in Philippines, Cambodia, Lao PDR and Vietnam. (Timor Leste, Nepal, and Kathmandu). Based on latest trailing twelve month (3QFY16), SSM Segment contributed 33.86% to the Group total revenue.

Going forward, the Group aims to expand its markets by growing geographically as well as through strategic partnership and acquisition. While having presence in more than 8 countries, RGB derives 95% of its revenue from Asia-Pacific region. As published in The Star Online on 1st August 2016, RGB group managing director Datuk Chuah said that the Group is eyeing new markets in Europe and South America. We believe it will be the growth driver for RGB. The Group will also continue to identify viable partners to grow its TSM business.

In the same article, it was mentioned that the group will soon start its first TSM concession in Kathmandu, we see this as the opportunity to tap into a bigger market, as opposed to usual Southeast Asia market by the Group, given Nepal’s close proximity to India also means that it will be able to attract customers from India, the world’s second most populous country after China. By expanding the TSM Segment, RGB’s revenue and net profit will be more consistent as the income from TSM Segment is on recurring basis. Besides that, the profit margin of the Group will overall be improved, due to the high profit margin in TSM Segment (5 year average of 21.49% in TSM Segment vs 5 year average of 9.54% in SSM Segment, both excluding unallocated expenses).

However, we would like to remind investors that by involving more in TSM Segment, RGB also increases its risk sharing with the gaming license holders. Speaking of profit margin, in SSM Segment, which RGB acts as a distributor of gaming machines, RGB managed to secure a decent profit margin compared to traditional distributors who always have razor-thin margin. We suppose it is attributable to the on going Technical Support Services and Parts & Services provided by the Group to its customers and investment partners which gives them the peace of mind to buy and partner up with them. The Technical Support Services of the Group renders technical services, system maintenance services and consultation that support all brands under its distributorship as after sales service and service to all its TSM Sites. The Parts & Services department supplies low costs and high quality parts and components to its partners and customers, and even refurbish old machines for future use or sell. Such services can provide peace of mind to the customers and partners, and cost savings on a longer term, therefore manage to have them to prefer sticking with RGB, even maintaining a higher margin.

Management

Back in 2008, RGB was having its greatest time of all time. The business was experiencing tremendous growth, from FY03 to FY07, the Group managed to achieve CAGR of 35.92% in revenue and CAGR of 31.88% in net profit. The share price hit all time high at RM 0.60 in Nov 2007 (after adjustment for bonus issue), and successfully converted to Main Market in 31 January 2008. Intended to ride on the trend, in FY07 alone, the Group has placed additional 2,200 units of machines throughout all locations of operations, an upsurge of 65% from 3,400 machines previous year, funded by the additional borrowings RM 72.5 mil (+106% in borrowings compared to FY06) taken in that year. The Group also spent CAPEX as high as RM 120 mil (+97% compared to FY06), and 90% of the CAPEX was spent in Cambodia.

And just like the myth of Icarus, who flew too high and the sun melted his wings, the sudden regulatory changes in Cambodia towards operations of slot clubs in December 2008 was a nightmare to the Group,  forcing 1,500 units of machines were removed from operations in following the closure of 23 clubs. Two months later, following a directive issued on 26 Feburary 2009 which decreed that all slot clubs in Cambodia to cease operations, a further 21 slot clubs with 1,800 units of machines were closed. Given their large exposure to Cambodia during that time (Cambodia segment contributed 37% to the total revenue and 52.62% to total assets in FY07), the regulatory issues in Cambodia caused the Group to incur first losses in FY08 and also subsequent years.

 

The losses were mainly caused by 3 reasons:

1) Lower revenue contribution from Cambodia (loss of revenue from 3,300 machines) 

2) High mobilisation costs i.e. removal, storage, relocation and reinstallation for affected machines to other TSM concessions.

3) Impairment costs of the affected machines that failed to rearrange to new TSM concessions. 

With the loss of 3,300 machines from Cambodia, revenue of RGB’s TSM segment almost halved in FY09, not to mention still having to serve the interest of more than RM 9 mil on the back of RM 147 mil borrowings, resulting in the Group suffered greatly in their bottom lines. With 3,300 idle machines, the management responded quick and decisively enough to promote the TSM concession arrangement to casino operators in Macau and Philippines, by leveraging their long-standing relationship. The Group managed to refurbish and deploy 58% of the idle machines into new concessions, while this is commendable, the cost of setting up further affected the net profit of the Group. The remaining machines failed to be arranged into new TSM concession subjected to impairment cost that further drag the Group into losses for the consecutive financial years. 

We opine that the management did a fantastic job in handling the Group during turbulent times. The management took only 4 years to turn around the company to be profitable again in FY12. In fact, the EBITDA of the Group has always been positive despite in turbulent times, it was only the impairment cost from affected machines turned the Net Profit into red. More importantly, the Group has learned the lesson to be extra careful in managing its CAPEX and debts. RGB made it its first priority to pare down its borrowings in FY11, and the borrowings have been reducing significantly over the past few years, turning into a net cash position in FY15.

We believe that assessing a company’s management capability and integrity is as important as assessing its business prospects, financial performance and valuation. Retail investors are always of the opinion that they are not in the position to evaluate the management of a company. The case study of RGB proved that, they can too. A management team that proved to be the veteran in the industry, able to fulfill its promise to the shareholders, did what was necessary during turbulent times and learned from their mistakes, we have no reason not to grade them as one of the top management we have come across.

Risks

Over-concentration in Cambodia back in FY07 has caused the group suffered greatly. Today, the Group seems to have diversified its operations by making its presence in more than 8 countries, but in fact, it hasn’t. Based on the latest Annual Report FY15, segment from Philippines and Cambodia contributed 67% and 12% to the total revenue respectively. In terms of geographical non-current assets, Philippines and Cambodia’s non-current assets made up 32% and 50% of the Group total non-current assets. When we look into the TSM Segment, where greater risks lie (due to the risk-sharing nature), most of the Group TSM concessions are located at Philippines and Cambodia. To clarify, we don’t see geographical diversification as one of our checklists in making our investment decision. However, for a company like RGB that subjects to high regulatory risks, geographical diversification matters.

Besides that, more people nowadays go online in search of entertainment they used to access in other ways, and gambling is no exception. It is believed that online gambling will be taking more market share from traditional gambling, due to several advantages it offers including convenience, comfortable, anonymity, privacy etc. And compare among few forms of gaming, slotting machines are definitely more replaceable by online gambling due to the gaming nature. This is a risk investors should consider if they are planning to invest in RGB for a very long period.

Conclusion

RGB has got a top management team that is able to navigate the Group through turbulent times, and fulfill its promises to the shareholders. This is the kind of management that value investors would seek. In gambling, there is a saying: “The House Always Win”. With TSM Segment expanding, investing in RGB is equivalent to siding with the House in gambling, which is a proxy to invest in typical casino business that often comes with higher valuations. We would like to see RGB to diversify away its TSM Segment from Philippines and Cambodia to mitigate its regulatory risk from these countries. In this post, even though we have quoted some figures to support our analysis, it is mainly the business analysis of RGB, aka qualitative analysis. However, good business is not equivalent to good investment, as valuations of a company plays a bigger part in value investing. In next post, we will further analyze RGB in terms of financial numbers, so that our readers can decide whether RGB is at its right valuation to invest in.

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