Around the Markets:
The S&P 500 gained 1.6% for the week-ended February 3, 2023 after the Federal Reserve raised rates by only 25 basis points and Chairman Jerome Powell stated “we have no incentive and no desire to overtighten.” Weaker-than-expected earnings from Amazon and Alphabet as well as a stronger-than-expected employment report for January weighed on risk-assets on Friday to close out the week on a lighter note.
Meta Platforms rallied over 23% Thursday, its best day since July 25th, 2013.
The company previously known as Facebook reported fourth quarter sales of $32.2 billion vs. consensus $31.7 billion, while Meta’s outlook for first quarter 2023 sales of $26 to 28.5 billion was in line with estimates. For the full year, Meta now expects total expenses of $89 to 95 billion, down from its prior view of $94-100 billion and below consensus of $95.16 billion.
In addition, the company now expects 2023 capex of $30 to 33 billion, down from its prior view of $34 to 37 billion and below consensus $34.35 billion. All in, its revised guidance — at the midpoint of the ranges — calls for an additional $9 billion of operating and capital expenditure savings combined. As of Friday’s close, shares of Meta are up 55.0% year-to-date.
Matthew's Take:
The big takeaway is that Meta is serious about cost cuts and making its operations more efficient as it balances its highly-profitable social advertising business with investments in its future metaverse ambitions. As CEO Mark Zuckerberg said, 2023 “is the year of efficiency” for the company.
The core advertising business is nearing an inflection as it begins to lap the full impact of Apple’s platform changes and the macroeconomic impacts on advertiser demand. But the revised cost cut targets for 2023 are the real deal, especially after concerns mounted following the company’s third quarter results that showed a sharp decline in cash flow amid hefty investments.
In addition to cost cuts, Zuckerberg provided some good color on the outlook for investments in its nascent metaverse business within its Reality Labs (RL) segment, which posted an operating loss of $4.3 billion in the fourth quarter and lost nearly $14 billion for the full year. He noted that within RL there are three major areas of focus that carry different investment cadences. The biggest area of investment within RL today remains augmented reality technologies which aren’t yet commercial, while virtual reality investments are smaller than AR and are generating revenue.
And the smallest area of investment today still remains its metaverse software and social programs, which he claims may eventually prove the most important part of the metaverse technology stack. Given that software is less capital intensive than hardware, this suggests the capital intensity of RL should decline over time and profitability should improve as the business mix shifts from 100% hardware towards having a blend of hardware and software.
Investment Themes
Metaverse
Entain reported a record quarter for both online net gaming revenues and active customers.
The U.K.-based gaming company’s online net gaming revenues were up 12% year-over-year, bolstered by the World Cup. Entain also raised its profit outlook, now expecting fiscal year 2022 EBITDA in the range of £985m to £995m versus prior guidance from October of £925m to £975m. Last week, Entain and MGM provided an upbeat outlook for their joint venture BetMGM, projecting EBITDA profitability beginning in the second half of 2023. Additionally, Entain and MGM are expected to invest an additional combined total of $150 million in 2023 into BetMGM. Entain CEO Jette Nygaard-Andersen told analysts this week that once BetMGM becomes profitable, the company would end its financial support.
Will's Take:
Speculation regarding the future of BetMGM may begin to pick up again now that the company is targeting EBITDA profitability in the second half of 2023. The UKGC’s regulatory whitepaper is now expected for March, and may provide a catalyst for MGM to re-engage with Entain, depending on what happens.
In terms of potential outcomes, analysts are likely to see three possibilities: (1) MGM seeks to purchase Entain’s 50% stake in BetMGM, retains full ownership; (2) MGM seeks to purchase 50% stake, and spin BetMGM into standalone public company; (3) MGM to bid for entirety of Entain. We view option 3 as most likely, given MGM’s appetite for non-U.S. online assets, evidenced by the company’s purchase of LeoVegas. Thereafter, the company could look to sell non-core assets such as retail betting, similar to Caesars post William Hill transaction closing. Any potential transaction remains highly speculative, however, and it remains unclear exactly how such a deal could be financed and remain accretive.
Investment Themes
Sports Betting, iGaming
Electronic Arts reported weak earnings and guidance.
Shares of EA fell 9.3% on February 1st after the company reported lackluster December quarter results and provided a weaker-than-consensus forecast for the March quarter. This included delaying its upcoming Star Wars game and shutting down high-profile mobile shooter projects. Net bookings for the fiscal third quarter of 2023 were $2.34 billion vs. consensus $2.44 billion and adjusted earnings per share were $2.80 vs. consensus $3.05.
Looking ahead, EA’s guidance for fiscal fourth quarter 2023 calls for net bookings of $1.68-1.78 billion vs. consensus of $2.22 billion and adjusted EPS of $1.20 to $1.40 vs. consensus $2.21. Notably, this shortfall includes the delay of the upcoming Star Wars Jedi: Survivor game into the next quarter, whereas consensus was baking it into the March quarter outlook.
Matthew's Take:
Let’s assess the good before diving into areas of weakness to assess what parts of EA’s business are holding up rather well in the face of a broader macro slowdown in the gaming sector. FIFA had an absolutely terrific quarter across all platforms and overall its sports business was very strong. The December World Cup in Qatar seemed to provide a massive lift to engagement and revenue from FIFA, with revenue for the franchise in the nine-months through December up 15% at constant currency. FIFA 23 is on pace to be the highest selling installment in franchise history, with record engagement in the fiscal third quarter and unit sales in North America up over 50% from a year ago.
The core sports business was “the good”, but now let’s look at some of the weaker areas in EA’s report and what it means going forwards. Apex Legends was clearly an underperformer, likely hurt by a very strong Call of Duty: Modern Warfare 2 and Warzone 2.0 launch. It’s also important to note that Apex Legends bookings were up 40% in the year ended March, 2022, so there are some difficult year-ago comparables on top of the competitive factors.
Looking ahead, with the four-year anniversary update for the game due in the March quarter and engagement already improving in January, this wobble could prove short-lived. Apex generated roughly $875 million of bookings in fiscal 2022 and is on pace to becoming a billion dollar annual franchise even with near-term weakness.
Mobile game sales were also weaker in the quarter and EA’s decision to abruptly wind down Apex Legends Mobile and cancel development on Battlefield Mobile raise concerns over its long-term mobile strategy, especially after a run of large M&A to bolster its presence in the sector. EA spent over $3 billion buying Glu Mobile and Playdemic since 2021.
Lastly, the outlook for the fiscal fourth quarter was weak but mostly due to the Star Wars game delay and foreign exchange impacts. If Apex Legends can rebound with the anniversary update and sports trends remain strong, EA’s outlook for its core franchises remains bright despite its struggles with mobile development. And for those concerned about giving Star Wars development an extra month to clean up bugs and polish the game, consider the quote famously attributed to Shigeru Miyamoto, creator of Mario, Zelda and Donkey Kong games for Nintendo: “a delayed game is eventually good but a rushed game is forever bad.”
Investment Themes
Gaming
Senate Democrats are looking for a way to pass marijuana banking legislation this Congress.
After failed attempts to attach the SAFE Banking Act to the National Defense Authorization Act and the year-end spending package, Democrats face a tougher path in 2023 with a Republican-controlled House. Prior to meeting with Senate Majority Leader Chuck Schumer this week, Senator Jeff Merkley (D-Ore.) told The Hill that they’re trying to find the “formulation of Safe Banking Plus that can allow us to end this cash economy that’s doing so much to hurt so many across the country.” Meanwhile, Senator Ron Wyden (D-Ore.) emphasized they are going to “stay at it” until marijuana banking legislation is passed. On the legalization front, a bill to legalize marijuana in Minnesota cleared its sixth House committee this week.
Drew's Take:
Introduced in 2019, the Secure and Fair Enforcement (SAFE) Banking Act is nearly four years in the making and has yet to make meaningful headway through congress. After SAFE failed with a Democrat controlled House in 2022, a Republican controlled congress in 2023, coupled with increasingly weakening support for the act by top Democrats, makes a passage of SAFE this year highly unlikely. Even though SAFE did not pass, according to OpenSecrets, the cannabis industry's lobbying efforts amounted to a record spending year of $5.4 million.
Despite the dismal outlook for SAFE, the long tail view is promising for MSOSs which have proven resilient as more and more states explore legalization. One estimate by Cantor Fitzgerald earmarks US cannabis sales at $100 billion, of which 25% were legal, and an additional $100 billion in international sales. In 2023, those legal sales could expand. At present, 21 states have legalized cannabis for recreational use, and 37 states have done so for medical use. Legalization efforts in Florida and other states appear to be picking up steam this year, as positive legislation sentiment grows, as polling from Pew Research has shown that a growing number of Americans (88%) have indicated they are for legislation.
Investment Themes
Cannabis
Sony raised its outlook as PS5 demand accelerates.
Shares rose 6.2% in Tokyo after the company modestly raised its operating profit outlook for the fiscal year ending March 2023. Sony is also seeing accelerating trends for the PlayStation 5 console, boosting its forecast to 19 million unit shipments of the device in fiscal 2022 vs. its prior view of 18 million, following a record quarter for shipments and as supply constraints ease.
Matthew's Take:
Sony’s strong quarter of PS5 sales and improving supply bottlenecks suggest its set to widen its gap in the latest console generation to Microsoft’s Xbox Series X and S. The 82% and 119% growth in PS5 unit shipments and total hardware revenue in the quarter vs. the prior year contrast to Microsoft seeing Xbox hardware revenue down 9% year-over-year adjusted for currency fluctuations.
Sony has to date sold through over 30 million PS5 units compared to just over 20 million Xbox Series X/S, according to VGChartz. Although this is a better ratio for Xbox than being outsold more than 2:1 in the prior cycle, Sony’s strong slate of first-party games have continued to enable it to keep an edge over its main rival. In the nine months through December, Sony has sold 34 million copies of first-party games, up 16% from the prior year.
Macro risks remain if consumers pare back spending on expensive items such as game consoles and the upcoming PSVR2 headset but it looks as though Sony’s gaming division is so far navigating these risks well. A consistent cadence of exclusive games is needed to sustain demand, a strategy that fueled Sony’s dominance in the prior console generation cycle. Major exclusive games for 2023 include Final Fantasy XVI and Marvel’s Spider-Man 2.
Investment Themes
Gaming
Evolution Gaming’s operating revenues increased by 36% in the fourth quarter.
The B2B online casino provider also grew EBITDA by 35% year-over-year. Evolution’s Live Casino segment was a standout, with revenue increasing 41.1% year-over-year driven by strong demand. Despite delivering a profit margin of 55% in the quarter, CEO Martin Carlesund stated that they “charge far too little” for their product and that they should “charge more.” The company continued its expansion into North America during the fourth quarter, launching the second New Jersey Live Casino studio. For full-year 2022, Evolution reported an EBITDA margin of 69.2%, in-line with consensus. Carlesund said the performance “reflects [their] competitive offering and strong execution.” Shares of Evolution Gaming rose 13.2% this week.
Will's Take:
As a back-end technology provider, Evolution doesn’t receive the same kind of media attention nor public recognition as its B2C clients. However, the company remains one of the most efficiently run companies in all of online gaming globally. Evolution grew its revenues from $366 million in 2019 to $1.5 billion in 2022, while EBITDA grew from $183 million to $1 billion over the same period.
Looking ahead, Evolution projects an EBITDA margin for 2023 of 68% to 71%, in-line with consensus at midpoint. Given the competitive operating environment and inflationary pressures on expenses, this should be viewed as encouraging and demonstrate that the company can maintain its strong profitability as it continues to grow, with consensus projecting nearly 25% top-line expansion for 2023. Top-line growth continues to be driven in part by expansion in the U.S. market, where online casino ramps in existing state markets. Positive state-level regulatory reform for iGaming remains politically challenging, but any incremental expansion into new states would materially increase Evolution’s total addressable market. Overall, North American segment revenues grew 66% during 2022 and are likely to continue to outpace overall group revenue growth.
Investment Themes
Sports Betting, iGaming
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We are pleased to announce the addition of David Mazza as the firm’s Chief Strategy Officer and Matthew Kanterman, CFA as the firm’s Director of Research.
In his role as Chief Strategy Officer, Dave will oversee the firm’s product development, capital markets, and research functions as the company seeks to expand its fund lineup into additional categories. An accomplished ETF veteran, Mazza is a well-known thought leader within the ETF industry, frequently appearing on CNBC and Bloomberg. Most recently, Mazza was Managing Director, Head of Product, at Direxion, where he led the research and development of new products and the ongoing product management and strategy for the firm, as well as overseeing the firm’s strategic partner relationships.
An experienced equity analyst, Kanterman spent eight years with Bloomberg Intelligence covering the technology sector prior to his most recent position as Director of Research for Ball Metaverse Research Partners. Matthew is a CFA Charterholder.
“We are excited to introduce Dave and Matthew as the newest members of the Roundhill team as we enter our next phase of growth,” said Will Hershey, Chief Executive Officer. “Our goal remains to become a leading ETF platform in the coming years, and we believe today’s additions position Roundhill for tremendous success in 2023 and beyond.”
For more information, read our full press release.
Chart of the Week
Sony announced this week that it expects the PS5 to double the PS4's peak shipment record for the March quarter (6.2 million vs. 3 million).
PS5 shipments in the October-December quarter reached 7.1 million units, up 82% from the same period the year prior.
