Not much has changed with NetEnt since January. The powerhouse continues to grow impressively, with lots of wind at its back, extremely confident and slick executive management, exciting products, and it’s still situated on dangerous fault lines. The question with NetEnt is as it has been for some time now. That is, not whether it is a good company, but whether its valuation is too high and already priced for the rapid growth that it has been experiencing for years.
Since the beginning of 2012, NetEnt shares have increased by an enviable 710% while the top line has increased 142% and the bottom line 223%. The fact that shares are outpacing top line growth by a factor of 5 and bottom line growth by a factor of 3.2 is not itself worrying, as growth stocks like NetEnt almost always rise faster than the actual growth of the company’s earnings. The question is how much faster than proportional is warranted, and in an environment like Sweden’s that is a very hard question to answer.
Part of it is investors pricing in future growth, which is understandable. But another part of it is Sweden’s ultra loose monetary policy that has actually gotten even looser since we last covered this stock in January. See Swedish interest rates, negative in January 2016, even more negative now:
Negative interest rates force investors to take money out of banks and to put that money anywhere (literally anywhere) where it will not be eaten away by time. If any of us had our money in a Swedish bank we’d all be chasing the best companies just so our deposits will not shrink over time due to crazy Riksbank policy. So the question is, if interest rates were normal in Sweden, and if not normal at least above zero for heaven’s sake, then how much would NetEnt shares have outpaced the company’s growth? Perhaps by a factor 3 top line and 2 bottom line instead of 5 and 3.2? These are all numbers out of a hat and there is no way to know, which is why buying any more NetEnt stock now is a gamble on how much longer the Riksbank can maintain negative interest rates. Gambling is for punters, not investors. It’s fine to do both separately, but it is unwise to mix the two into the same endeavor.
Incidentally, take a look at the longer term interest rate chart in Sweden.
Rates went up slightly from 2010 to 2012, and have been going down since. When rates peaked at the end of 2011 (hard to call 2% a peak but that’s the world we live in now) that was when NetEnt began taking off. It’s an example of perfect synergistic timing between monetary policy and a company breakout. When will rates start to rise? The answer is the same for any country – when the central bank is forced to raise them due to obvious price inflation. That has been slowly trending up since 2014 in Sweden, and don’t forget that Sweden has experienced double digit inflation in the early 90’s and rates had to go above 8% to quell it. This time they will have to go much higher because they have been so low for so long.
This must happen eventually, and not even NetEnt stock will be able to withstand it. The company itself will probably be fine, but the parabola in NetEnt stock will eventually fall back down to tropospheric, as opposed to stratospheric levels. Equity growth will still outpace top and bottom line growth counting since 2012, just not by as high a margin. While there is no reason to sell positions yet and just looking at the company is reason to buy, buying into negative interest rates is too risky.
Why not sell now though? Because inflation is still pretty low and the company is doing too well. An appropriate sell signal would be 3% or higher price inflation, which could start the trek back up to positive interest rates.
NetEnt still has one of the most efficient workforces in the gaming industry. In January they employed 513 people at a market cap of SEK18.9B, and now they have 657 at a market cap of SEK17.8B, or £2.47M in equity value per employee. Down a bit from January, but still orders of magnitude higher than any of its competitors.
CEO Per Eriksson knocked it out of the park in his latest quarterly presentation, nothing but smiles and a perfect hair day, lining up NetEnt’s achievements one by one. A new launch in Romania and growth in the key UK market despite Brexit stress and a collapsing pound. Eying a Canadian market entry in the footsteps of his pioneering ancestor Leif Eriksson, the first European to reach North America 1000 years ago. Mobile gaming revenue increase of 83%, everything you’d want to see as a shareholder. The one weak spot the company has is still its heavy reliance on slot gaming. It’s still nearly 90% of its game win, but that may soon start to change with its new live casino product which Eriksson is visibly proud and excited about in his presentation.
If they can really break into new and different games successfully, they look almost unstoppable. In fact Eriksson is almost cocky about the new live casino platform, a good sign he seriously believes it is the best on the market. With numbers like NetEnt, one would do well to believe him. 11 new licenses, 8 new customers, and 32 customers already booked that are still yet to launch, all but ensuring growth in the quarters to come when they do.
For all these reasons, despite being in a precarious monetary jurisdiction through no fault of its own, NetEnt is a hold, and should keep trending higher as long as price inflation in Sweden does not become obvious to the everyday Swede.
