One of Canada’s less known stocks has just made itself well known not only in Canada but also around the world. Amaya Gaming Group Inc. (AYA), a favourite at 5i Research ever since initiating coverage on the company at $2.30 in early 2012, has recently announced it is acquiring Rational Group for $4.9 billion.  Rational Group, owner of PokerStars and Full Tilt Poker, is a privately held U.S. company that runs the worlds’ most popular poker brands with 85 million registered players. Amaya, which was approximately a $650 million market-cap company before rumours of the acquisition started to fly, has impressively put together an all-cash deal to purchase a company being valued at around 7.5 times AYA’s pre-rumour size. Given the magnitude of this deal, we think it deserves some further attention.

The ‘Deal’:

Blackstone Group and an ‘investment manager’ are the two buyers of the deal and when it is all said and done, Blackstone could potentially end up with a position in the company in excess of 20%. The deal is being completed through $2.9 billion in credit facilities, $1 billion in convertible preferred shares with a $24 conversion price, $500 million in subscription receipts (with an option to purchase more) at a $20 price and the remainder in cash. Management notes that they expect rapid debt repayment due to the significant increase in cash flow.

The Flop:

For 2013, the combined revenue of the two companies would have been $1.3 billion and EBITDA would have come in at nearly $475 million. Adjusted EBITDA for 2013 was nearly $474 million and the expected EBITDA for 2014, assuming the deal completed in January, 2014, is $600 to $640 million. To gain an appreciation of the increase in size, the expected 2014 revenues for Amaya pre-merger was just under $197 million and expected EBITDA was $80 million. The acquisition provides AYA with a dominant position in the online gambling segment and should act as a strong complement to Amaya’s casino based business. Amaya has already made in-roads in states where online gambling has become regulated so there could be strong synergies if AYA is able to introduce such a strong brand into markets where the company already has a foot in the door. The deal also provides Rational Group a convenient way to gain access to the public markets, versus going an often expensive and sometimes risky IPO route.

The Tell:

This deal has essentially created a brand new company that will appeal to a whole new group of investors. AYA is likely to be viewed as a pure-play in the online gambling space and may find it-self being owned by many funds with the change in size. While it can be hard to tell how successful a merger of this size will fare, we think there are a few signals that show why this deal could be very successful:

• Little fish eats the big fish – This rarely occurs and we think that the backing of a company like Blackstone Group helps to corroborate the idea that this deal will add value. If they felt the debt was not manageable, they simply would not be providing the financing and would not be taking an equity interest.
• Cash deal – In mergers, a good sign of how much confidence there is in a deal can be inferred through the way it is purchased. Typically, if it is an all cash deal, it means that the buyer is confident in the prospects of the deal, as they are retaining all of the ownership. On the other hand, if it was a stock transaction, one could imply that management is not confident in the prospects and wants to share the risk by giving shares to the target company.
• Market reaction – At the market open, Amaya is up right around 40%, hovering just below the $20 deal price. This provides some confidence that the market generally likes the deal and that it has support.
• Past transactions –AYA has proven its ability to execute on large transactions time and again. The company has a strong track record with acquisitions exemplified by the purchase of Chartwell Technology, Cadillac Jack and Cryptologic to name a few. Management has gained/proved their credibility and the markets/investors have confidence that AYA will make PokerStars work just like it has made past transactions work.

Doing a ‘back of the envelope’ calculation, with the addition of 25 million shares ($500 million at a $20 price), AYAs outstanding shares would increase to 119.26 million and next years EBITDA per share would come in at $5.03. A share price of $20 amounts to nearly 4 times next years EBITDA. If we assume the $1 billion in preferred shares are also converted at $24, an additional 41.667 million shares are created. This implies an EBITDA per share of $3.73 and a $20 share price at nearly 5.4 times, which does not seem like a huge stretch on the valuation, keeping in mind the simplified nature of the above breakdown and lack of detail. This transaction is huge for Amaya and makes it an even more interesting company than it was previously. We think the ability to put this deal together is further testament to the strong management team.