Podcast: Ali Gündüz

I had a conversation with Ali Gündüz⁠, a private investor from Berlin who closely follows Evolution AB, the Swedish B2B gambling services company. We discussed what we perceive as Evolution's key issues, including increasing competition; its dependence on Asian markets to sustain its growth; the slow roll-out of game shows in the US; its difficulties in RNG; its need for a more consistent capital allocation policy; and the withdrawal and reintroduction of its 2023 management incentive programme.

You can find Ali on Twitter at ⁠@gnufs⁠. He also shares his analysis publicly at ⁠www.dontdistribute.com⁠, including quarterly updates on Evolution.

The following transcript has been lightly edited for grammar, punctuation and clarity:

Hi, this is Graham Rhodes, and you're listening to the Longriver Podcast. I'm delighted to welcome today Ali Gündüz⁠, a resident of Berlin and, I guess as Todd Coombs would say, the ‘axe’ in Evolution, the Swedish gaming company. Ali, welcome to the podcast.

Hi Graham. Good to be here.

Now, I really have to emphasize that nothing we discuss today is investment advice. We're just two people who follow the company exchanging ideas. You should always do your own research, right?

Yeah.

And of course, we're going to make mistakes. So if the listeners hear anything that is wrong or if we miss anything, we'd love to hear from you. So with that, Ali, why don't you begin by telling us a bit about yourself? I'm sure many of us recognize you from Twitter. But who is the man behind the excellent analysis on Evolution?

I'm originally from Turkey, and I come from a family of leather makers, like a family of tanners. We were a supplier to the global fashion industry. Basically, four years ago, we sold our family business, and I moved to Germany, to Berlin. These days, I'm a full-time private investor in public stocks and some real estate as well. What I do daily is something that I enjoy tremendously, which is mostly reading, taking notes, and thinking. And I hope to do it as my daily occupation for all my life.

One of the things I admire most about you is how deeply you go into your research. There are things that come through in your analysis or connections that you make that I don't see anywhere else, like amongst private investors or the sell-side. So I wanted to ask you, how many companies do you follow? And do you think focus is one of your strengths?

To be honest, Evolution is an exception. I invest in currently, I think, around 30 companies, and I follow a few more, obviously. But none of the companies that I follow do I go as deeply into as Evolution. It's a great business model on paper. It just jumps out at you with the margins and the growth and everything. There's no debt, not much financial engineering. It's a plus that Evolution is a consumer-facing business. So it's a little easier to understand and form your own opinion or get the opinion of others, the use of expert networks and alternative data, and so on. But yeah, for reasons that I cannot explain in a rational way, Evolution has become my obsession and also my hobby. So that's where I stand.

So I brought you here today, and sorry to pour cold water over your obsession. But I brought you here today to talk about Evolution's issues. And I think there's a few, so we're gonna have a little debate about that, or at least I'm going to pick your brains. But before we go into the issues, why don't you tell us a little bit about the company and why you think it's great?

Evolution is basically an online casino supplier. What that means is we provide online casinos with games. You can think of it as casino something.com and casino something else.com, and so on. But when players log onto those sites, the games are not actually made and run by those operators or those casinos. Traditionally, they get their games from actual suppliers.

Evolution's main focus and main success are in the live casino side of online casino games. This is where you have a camera and an actual human being who acts as the croupier, as the presenter of a game. These can be traditional table games like baccarat, blackjack, and roulette. You have a person presenting the game to you and controlling the game for you. These people are in front of a camera, and Evolution provides the servicing of these games to the operators. In return, they receive a commission from the casino's winnings on a percentage basis.

The good thing is that Evolution doesn't spend any budget on advertising to customers; they are a partner in the operators' casino winnings but not in their expenses.

Tell us a bit about live gaming. Why is it different from other forms of online gambling, and how has Evolution become the leader in this segment?

With live games, you see an actual person who is controlling the game, drawing the cards, or throwing the ball. This creates trust among consumers that there is someone physically handling the game elements, which provides confidence that the game is not rigged. Trust is crucial in gambling because losing money is an inevitable part of it, and players need to trust that they lost their money fairly. Another advantage of live games is the social aspect. People are social animals and enjoy seeing another human involved in the activity, especially if it's for entertainment.

Another aspect is the economics, as it requires a lot of money and operational expertise to build and staff a casino with talented dealers who can work across various languages and games. The fixed costs of this business are very high, which means that if you have the best games and can attract the most players, you can capture a significant share of the profit pool.

The moat is the eternal question when discussing the margins and growth of this business and explaining the business model. The first question that arises is, "What stops anyone from just putting a webcam in front of a roulette wheel and starting a competitor?"

There are many competitors, but the high fixed costs in the current state of the iGaming sector and the scale advantage make a big difference. Evolution's technical expertise is also crucial. Each of their studios, where games are broadcasted, is regulated like actual land-based casinos. This brings a lot of regulations and requires consistent and well-thought-out processes. Online trust is critical, and even small hiccups can lead to conspiracy theories.

It's essential to ensure the games are not cheatable from the casino's point of view, as making money quickly also means you can lose it quickly if players find cheats or exploit the game's probability distribution.

I want to ask you, Evolution has dominated this field for so long. Do you think it's becoming more competitive, and do you think that's affecting Evolution's business? About 15 years ago, there was one company that really dominated the space, and that was Playtech. But for various reasons, Playtech fell behind Evolution, this scrappy newcomer focused on one specific vertical, namely live gaming. Evolution grew the market and came to define it through games like lightning roulette and a string of game shows. For various reasons, Playtech couldn't fight back. But now, we have a serious competitor, or at least it appears so in the form of Pragmatic Games. They are well-funded, both from their venture backers and the apparent success of their slots business. It feels like they're giving Evolution a real run for their money, at least in terms of quickly copying Evolution's games and rolling them out to a global audience. What do you think about that?

That's a good question. Is it competitive? Yes, in the sense of the number of suppliers, the competition is definitely fiercer now. There are a lot more companies and money invested in this field because it's become obvious that it's a great business model, and everyone wants to be in it. But in terms of scale, right now, the scale is global, and reaching the level of profitability and expansion from there is very high. So I'm not sure if I would say that competition is a lot fiercer, even though more companies are involved.

Pragmatic seems to be on everyone's minds these days, but I have to be honest about my limitations in understanding Pragmatic. It's a private company that appears to be active in unregulated markets, although not exclusively. This lack of healthy data makes it challenging to compare the companies.

One lesson I take from Pragmatic, which I believe also applies to Evolution, is that Pragmatic originally started as an RNG (Random Number Generator) company, a slots company, not a live gaming company. They didn't seem to make many big acquisitions like Evolution recently did. What we see is a company that organically grew its expertise and slots game portfolio over the years.

The lesson here is that when it comes to game development and distribution, the company's culture, that intangible factor, is crucial, even though you can't clearly define it on paper. Yes, now they are entering the live gaming market, but I have no idea how successful they are. They seem to have found some success at least.

Applying this lesson to Evolution, I believe Evolution has that culture and expertise in live casino development and distribution. I don't see them easily losing that edge to other players. However, this is my observation, and I lack concrete data to support it. This also means I don't see much of a future for Evolution RNG (Random Number Generator) games as well.

One of the things that really defines Evolution, as I mentioned earlier, is the creation of the game show genre. For those listening who may not be familiar, they took casino games like roulette, mixed them with elements of slots, and created these all-singing, all-dancing spectacles. If you watch videos of Crazy Time, for example, it's incredible, mesmerizing, and, above all, quite fun. Evolution created this category and attracted new players to the market who were previously interested in RNG but now were drawn to live gaming.

Ali, the question I have for you is, it seems like the game show category is now maturing, and it's becoming easier for others to follow or, more bluntly, to copy. I've heard from some sources that the amount Evolution spent on Crazy Time might have been quite high. I wonder if they will get the same return on that investment as before. Is it still enough of a moat to be creative in a mature category?

I'm wondering if you might be a little too quick to call game shows a mature category. While there may not be a revolutionary leap like Crazy Time coming from Evolution in the form of a new game, it's essential to consider the bigger picture. The game show category still has significant growth potential, far from being mature. I'm not talking about market share, but the share of the overall entertainment industry globally. It's like how Apple doesn't need to introduce a new category-defining device every year or even every five years. The opportunity here remains substantial, and Evolution is still at the forefront of it. So when we keep the big picture in mind, I believe Evolution is in a great position.

I understand your perspective, but I want to push back a bit. What excites me about Evolution is that its success begets more success. With its scale and budget, it can invest more in R&D and new games than anyone else. They've launched numerous new live games this year, alongside their RNG games. But if the game show category matures and the return on that investment, whether in terms of market share or actual revenue share, decreases, it could weaken that aspect of their moat. Additionally, if Crazy Time becomes just one of many games in the category, doesn't that weaken Evolution's bargaining power with its clients?

So, the scenario you're outlining, if I understand correctly, is that live casino could become like the RNG markets, where there are many games, and the games themselves become commodities. In this scenario, Evolution would be just one of the game show providers.

Yes, at the most extreme end of the spectrum.

There is some truth to that, and there's some risk involved. So far, live casino games have been so unique that they have avoided commoditization. The trend might shift in that direction to some extent, but I don't believe it will change radically from here.

The reason is quite simple: running a game show is incredibly expensive, and it's a money-losing proposition. It's nothing like RNG. With RNG, you develop a game, and once it's created, it costs almost zero dollars to run it today, tomorrow, and the day after. But with game shows, especially if a game is successful and runs for multiple years, the running costs are much higher than the development costs.

However, I'm speaking in terms of degrees, keeping the big picture in mind. I'm not saying it won't get commoditized, but I have two points to make. First, especially for suppliers that are not among the top three (Evolution, Pragmatic, and Playtech), it's challenging to experiment with new game shows. You don't know if a game that isn't taking off right now will become popular next month. Do you want to keep investing in that studio and presenter that keep losing money?

Secondly, Evolution still appears to be the leader in terms of game development, IP, new ideas, and innovation. I expect some surprises and upside to come from Evolution rather than others. This doesn't have to be the case, but it's my prediction or estimation for the future. In the big picture, in aggregate, Evolution will likely come up with better new games than its competitors. Competitors, including Pragmatic and Playtech, will always need to catch up with Evolution, and their budgets are smaller. Their main concern is catching up, and whatever surplus budget they have for game development will be spent on creating innovative games, but that will always come second as long as they try to catch Evolution.

Regarding budgets on a per-game basis and the returns on investment, I would expect them to be lower. Obviously, replicating the returns on a game like Crazy Time is nearly impossible. However, even if a new game captures a smaller market share, the nominal profits and free cash flow it generates can still be significant. Evolution's game development quality still seems to be top-notch, and they have the scale advantage for every game they create because they start with a much larger consumer pool.

Okay. So earlier, you mentioned that one of the things that interests you most about the company is its future potential. So I have to ask you about Asia. It seems that a lot of the recent growth has been coming from Asia, and you've made some comments about this online. It feels like Asia is a bit of a black box, and there's potential for something quite bad to happen, as we've seen with Playtech. Ali, I understand you might not have all the answers, but could you share your thoughts on Asia?

Asia presents both a significant opportunity and a considerable risk. Most of the recent growth has indeed come from Asia. It's likely that the Asian market is more profitable than the rest of the world, given the economies of scale involved. Evolution operates a few studios in Eastern Europe and serves unregulated markets in Asia, which allows for high profitability. However, it's also a risk because Evolution is consistent in not disclosing which specific Asian markets they operate in.

Understanding Asia is a challenge. For instance, Europe used to be their traditional big market, and they would disclose specific regions within Europe, such as the UK or the Nordics. In contrast, there is no such disclosure for Asia. The crucial question regarding Asia is the role of mainland China. If mainland China is a significant part of their operations, it could pose a substantial risk due to difficulties in cash repatriation, geopolitical issues, and regulatory uncertainties.

Based on my current understanding, mainland China does not seem to be a major market for Evolution. Technical challenges, including the Great Firewall and latency issues for real-time streaming, make it challenging to operate in China. Additionally, getting cash out of the country is difficult. While some companies may find ways to overcome these challenges, I don't believe China is a significant market for Evolution.

However, this is just the first question, and it's essential to consider the broader Asian market. In aggregate, Asia and unregulated markets offer opportunities rather than just risks. As long as Evolution maintains its reputation as the cleanest supplier and demonstrates a reasonable effort to comply with regulations, I don't see evidence to the contrary. Therefore, I view the Asia risk as more of an opportunity than a risk, and I find that promising.

You've made some excellent points, and I agree that there needs to be a distinction between mainland China, where online gambling is likely illegal, and the rest of Asia. Evolution's expansion into countries like India, South Korea, and others with the addition of various languages suggests significant growth opportunities. However, it remains a bit of a mystery.

Yes, I share your concerns regarding management's current level of disclosure. While I understand their hesitation to disclose too much, especially in unregulated markets, detailed disclosures can create their own risks. In situations where the regulatory landscape is unclear or ambiguous, providing too much information may not be in the company's best interest. I may not agree with all of their choices regarding disclosure, but I do understand the rationale, especially when it comes to unregulated markets.

You also mentioned the potential opportunity in the United States. I have a couple of questions regarding that. Let's start with a relatively straightforward one: Why hasn't Evolution launched Crazy Time in the States?

That's an excellent question, and I'm eagerly awaiting Crazy Time's launch in the U.S. I'm excited to see how American consumers will react to this genre. However, the situation in the U.S. is a bit complex. While online gambling has been regulated in some states, the regulators themselves primarily have expertise in overseeing land-based casinos, including table games and slots. The regulatory rules and processes were initially designed with this expertise in mind.

So, while Evolution is taking the right steps to introduce game shows to the U.S., it's also a novel category for regulators in this context. This creates a barrier to entry that takes time to navigate. However, it can also become a moat, as Evolution will be the only company with expertise in how regulators regulate game shows and adjust games to meet state-specific regulations.

Management seems confident in introducing the game in some states, possibly in 2024. In the long term, the exact timing of the launch may not be crucial. What's more important is whether Crazy Time and the game show category as a whole gain traction in the U.S. market. Different consumer tastes and reactions in the U.S. compared to other regions could present both challenges and hidden opportunities. Regardless, the game show category has numerous growth prospects beyond the U.S. market.

Now, let's shift our focus to the U.S. In the past 18 months, especially as sports betting and online gambling have evolved, it appears that market shares are beginning to stabilize, with FanDuel and DraftKings emerging as clear winners. It raises the question of whether it makes sense for other players to keep pouring money into competition, given the market's size. While the desire is understandable, the field seems to be settling. With that in mind, does Evolution face any challenges when it only has two potential customers in the extreme scenario in the United States? Does this affect its bargaining power?

I think it's a mixed situation, so I'll address this in two parts: RNG and live. In the case of RNG, which seems to be a constant market for Evolution, they are somewhat at the mercy of the operators. Whether there are only two or five operators, Evolution still relies on the operators' decisions. There is fierce competition with many RNG suppliers entering the U.S. market, and traditional slot developers are also active. RNG games are inexpensive to run once developed and approved. It's up to the operators to promote and give prime space to the games they prefer. Additionally, Evolution lacks premium IP that U.S. players are familiar with, which puts them at a disadvantage.

On the other hand, the live segment is different. Evolution currently offers the best product in this category. The U.S. market has its unique dynamics with state-by-state openings and studios mandated by each state. This means that each studio and table in the U.S. has lower profitability compared to European tables, addressing a smaller market in just one state. It's challenging for potential competitors to reach scale in this scenario. Competition will emerge, and it will take time to find a balance. However, competition is expected to grow over the years, but it will be limited by the fragmented state-by-state regulations, at least until federal legalization, which doesn't seem imminent.

So, it seems like your main question regarding the U.S. market is when Crazy Time will make its debut. Game shows could be the key to Evolution avoiding commoditization.

Yes, one of the major questions for me in the U.S. market is whether game shows will gain popularity. I'm eager to see how this unfolds. Additionally, whether the U.S. market is an attractive one remains uncertain. It might turn out that the profit pool in some single Asian countries is larger due to regulations and market dynamics. So, my point is that the U.S. market's potential hasn't been definitively determined yet. These are bigger questions for me than the influence of powerful U.S. operators.

Let's take a step back and focus on growth again. In the third-quarter earnings call, Martin Carlesund mentioned that growth this year was hindered by a lack of capacity, specifically, they didn't have enough tables and hadn't built enough casinos. Do you believe this, and if so, how did they end up in a situation with insufficient capacity?

The lack of expansion has indeed been my main disappointment in 2023, although there is no clear disclosure on the specifics. I can share a theory, though I'm not entirely sure if it's accurate. It's possible that the unmet demand they mentioned was for local language tables, such as Dutch, Indian, or Korean tables, where the presenters speak in the language of the target market. It might have been challenging to find the necessary personnel for these tables, given that their studios are primarily located in Georgia, Armenia, Latvia, and Malta, not regions where you'd typically find Korean speakers, for instance.

This leads to one of my main concerns about management. We previously discussed the lack of transparency regarding regulatory matters, and while I may understand their reasons, I don't necessarily agree with them. However, when it comes to business performance, it's a different issue. When there's success, management is usually enthusiastic and provides detailed explanations about how they achieved it and the scale of that success. But when there are business failures, whether it's a lack of studio expansion or RNG losing market share, management often fails to provide clear reasons for these failures and their proposed solutions. This lack of communication is a recurring issue I have with the management. So, while this may not fully answer your question, the honest answer is that I don't know why they haven't expanded to meet unmet demand.

I agree with you. You're not the first person to tell me how terse management can be on the earnings calls. Often, you don't learn much. I understand your point.

Let's talk about Studio Expansion as one element of capital allocation. It's been a hot debate because, as you've worked out the numbers, more than three billion euros were spent on RNG. What's your assessment of that project? Firstly, was it necessary, and secondly, is it working, and when can we expect it to work?

It's clear that it hasn't worked yet. I'm not saying anything new in that regard. But was it necessary? I can try to present some reasons for it to provide a balanced discussion. When Evolution acquired NetEnt for 2.2 billion euros, issuing new shares, NetEnt was already involved in Live Casino, and they had plans to expand in the U.S. too. After Evolution's acquisition, they shut down the entire Live Casino department, which was already loss-making. While there may be some strategic reasons behind this decision, such as acquiring valuable IP for combined slot and live games, it's evident that this hasn't worked out.

They made some significant acquisitions, and so far, the growth has been disappointing. Looking back, these decisions may have been noble but perhaps overambitious. For instance, when Evolution acquired NetEnt, NetEnt was actually shrinking. If we exclude the numbers from RedTiger, another RNG studio that NetEnt acquired the year before Evolution's acquisition, it's clear that NetEnt was in decline. Similarly, NoLimit, although a private company with no concrete data, was likely at its peak or starting to decline, as it began shrinking shortly after the acquisition. So, there might have been known risks and mistakes in these decisions that the management should have been aware of at the time of acquisition.

You were emphasizing the importance of culture earlier, and you were comparing Evolution with Pragmatic's success in developing an organic RNG development culture. It seems that in recent years, Evolution has been the preferred exit strategy for RNG companies that might be past their prime.

I can understand the perspective of these sellers. Many companies rushed into iGaming, and some of them may have peaked or at least plateaued in their local markets. Evolution offered a significant cash price or shares in the highest-quality iGaming company in the world. From the sellers' point of view, it was a good move. However, I don't think Evolution made the right decision to buy these companies. Even with the data they had, especially after the NetEnt acquisition, it's hard to justify. While the acquisition of NetEnt could be excused due to the unknown factors in 2020, subsequent acquisitions like No Limit City didn't align with their strategy. No Limit City's games, with themes like mafia and drugs, would likely be too controversial for live games and face regulatory challenges.

Based on recent calls, it appears they're pulling back on putting more capital into RNG acquisitions. What do you think they need to do to succeed in the RNG market, which they seem to be aiming for with double-digit organic growth?

I'm not sure if it's even possible because, as Warren Buffett said, when good management meets a bad business, it's often the business that retains its reputation. While Evolution is a great company with excellent personnel, the same team might not succeed in a completely different business like video game development. I can't predict that RNG will fail miserably, but I don't see pure RNG or slot games playing a significant role in their future success.

So you don't believe Evolution is at a strategic disadvantage if it doesn't have strong slots in its portfolio?

I don't think it does. While it's beneficial to offer a full package to operators, I don't see Evolution providing RNG slots as a major factor in operators' decision-making. Even if Evolution acquires all available RNG studios or releases more games, they will still have a tiny portion of the overall RNG market, which includes thousands of games. So, they will continue to be just one of many RNG suppliers.

Let's delve deeper into this. It seems that Pragmatic is actually doing quite well in the RNG market. They've established a strong base, releasing games regularly with good traction and profitability. Operators are eager to have them, potentially creating opportunities for cross-selling live products. So, based on what we know, what do you think Pragmatic is doing right?

While we lack concrete data on Pragmatic's performance, the feedback from industry insiders and consumers suggests their success in the slot games segment. In my opinion, two key reasons could contribute to this. First, their culture and background as RNG suppliers have allowed them to organically develop and fine-tune their expertise in the field. They have a deep understanding of the industry, having experienced both failures and successes. This internal expertise guides their management in making informed decisions about which opportunities to pursue and which to let go of.

In contrast, Evolution lacks a similar history of successfully developing and marketing RNG games. Moreover, there appears to be a lack of consolidation in the development of RNG games within Evolution. For instance, No Limit City's game development seems somewhat independent of Evolution, as mentioned by the head of No Limit City in an interview. This fragmentation results in a situation where Evolution does not operate as a unified RNG studio but rather as separate entities, including NetEnt, RedTiger, BigTime, No Limit, and more.

Wasn't the idea that each studio would retain its unique culture and strengths, and that this diversity would be a strength?

While the idea of retaining each studio's unique culture and strengths may sound appealing, it raises questions about Evolution's role in this strategy. If Evolution isn't adding significant value to these studios, then why did they acquire them? Large operators were already integrating studios like No Limit, Big Time Gaming, NetEnt, and RedTiger into their systems. The presence of these studios alone wasn't a significant barrier for operators.

If Evolution isn't enhancing the studios' performance or quality of their output, it becomes a matter of betting on the right horses, with limited influence on the outcome. The view that a one-stop-shop approach alone will lead to sudden success in the RNG market appears incomplete. While it has worked for live studios, the same principle doesn't necessarily apply to RNG games, where adding another game to a pool of thousands doesn't guarantee a significant impact.

I completely agree. The irony, and you briefly mentioned this, is that perhaps the best acquisition was DigiWheel. If I understand correctly, DigiWheel was the inspiration behind Crazy Time, right?

Yes, indeed. DigiWheel not only provided the inspiration for Crazy Time but also created a unique advantage for Evolution. Pragmatic, for example, might find it challenging to replicate games like Funky Time or upcoming Evolution games. I recently saw a new Pragmatic game with a video feed featuring a large wheel in the middle, a common feature in game shows. However, the wheel seemed to be made of cardboard, resembling a traditional analog game wheel. This could be due to Evolution holding a patent through DigiWheel for digital wheels, creating a competitive advantage and making it more challenging for competitors to copy their games.

Shifting back to the topic of capital allocation, we've discussed the challenges Evolution faced with RNG and the recent buybacks. What are your thoughts on the recently announced 400 million Euro buyback?

Before diving into the specifics of the buyback, I'd like to take a broader view of Evolution's capital allocation. Evolution has already surpassed the minimum scale threshold required to make substantial profits. Currently, they are generating a significant amount of cash flow. Ideally, in such a profitable and growing business, you'd want to reinvest these cash flows into new ventures and expansions to compound the returns.

However, Evolution faces a challenge in this regard. They can't invest this surplus cash flow organically due to the limitations of their business model. A small percentage is allocated to studio expansion and game development, leaving a substantial surplus. The main options become returning this cash flow to shareholders or making external investments. While they already allocate half of it as dividends, the question arises about what to do with the remaining portion, assuming the dividend policy remains unchanged.

If they opt for external investments, it's essential to generate good returns on these investments. Management likely has concerns regarding this approach. When you look at Evolution's growth, it primarily stems from the live casino segment. While it maintains a consistent growth pattern, the percentage growth rates decline over time due to the expanding sales pool. Management may desire higher growth percentages, which can be challenging to achieve with their current business model.

So, the recurring question becomes how to allocate the surplus cash flow effectively, either through shareholder returns or external investments, while maintaining growth. This will likely remain a topic of discussion for shareholders in the coming years.

In a way, it seems like management has arrived at a similar conclusion to yours, and the investments in RNG were an attempt to answer the question: Can we leverage our expertise from live gaming and use our cash reserves to expand into other areas? However, it appears that the answer to that question so far is no.

I think they were considering it as an internal investment, treating RNG expansion as an extension of our current business. But in reality, I would argue that it's an entirely different business altogether. It's comparable to acquiring a sportsbook or entering the gambling sector; it's a whole new domain. Even if some operators offer both live and sportsbooks, they are fundamentally distinct. Let me present the case for an alternative scenario, one that I advocate for. We could choose to keep the kingdom small, and we would still achieve excellent results. While the kingdom may not grow as rapidly, we could distribute dividends.

Next comes the buyback option. I believe that Evolution, even with the same 50% dividend payout policy, could become an ideal share cannibal. They generate a substantial amount of cash, even after dividends, and given that it is trading at a sin stock discount, shareholders' cash could buy more shares, potentially resulting in significant long-term returns for shareholders. However, in this scenario, the kingdom would remain small, which might serve as a counterbalance in terms of incentives.

We'll delve into the incentives shortly. What struck me about the buyback announcement last month was that it seemed to be made reluctantly and almost under duress, possibly due to pressure from numerous American investors. It felt somewhat ad hoc and lacked the sense of smart capital allocation that you've advocated.

I completely agree with you. While I'm pleased they decided to go through with the buyback, I share your bewilderment regarding their reluctance to commit to a transparent capital allocation policy. Many companies implement such policies, which are not particularly complex. You outline how you plan to utilize your cash, specify your dividend policy, and, depending on the stock's valuation, commit to considering share buybacks as part of the decision-making process. It's an approach that provides clarity and predictability. As you mentioned, the decision appears ad hoc this year, but the concern is that they are unwilling to commit to a specific approach for the future. This issue is far from a one-time occurrence; it will become increasingly significant as Evolution continues to grow, and its cash surplus expands.

I'd rather not find ourselves in the same position in the fall of 2024, wondering what they're going to do with all that cash.

If everything goes as planned, we'll likely find ourselves having this same discussion in 2030.

It's quite interesting, isn't it? Typically, companies reach a stage of maturity where they accumulate substantial wealth. When growth starts to slow down, and the need for significant capital investments diminishes. However, as you hinted earlier, Evolution has always been in this situation. I don't believe they went public to raise capital; it seemed more like an exit opportunity for existing shareholders. Please correct me if I'm mistaken, Ali, but it appears they've maintained a net cash balance sheet ever since.

To the best of my knowledge, that's correct.

Perhaps a more systematic approach would be beneficial.

It's possible. I'd like to add a quick note here. It's conceivable that they've found themselves in this "embarrassment of riches" situation while still being a growth-oriented company. If they were a mature company, they might adopt a more mature capital allocation policy, balancing investments, dividends, and buybacks. However, they're viewed as a growth company, so there may be pressure on management to deliver growth percentages. As those percentages diminish, they might feel compelled to find ways to boost them.

That makes sense. Now, let's address what is perhaps the most controversial question in this podcast: executive compensation. What are your thoughts on the compensation plan, which was initially released, then withdrawn, only to return with a strike price that I can't recall offhand, but it was around 30 percent lower than the original one?

Let's briefly recap what transpired this year. There was an initial proposal for the incentives, which, not necessarily every year but quite frequently, comes with a three-year horizon. This year, they presented a new incentive scheme, and for the first time as far as I'm aware, it was rejected by shareholders. Subsequently, they introduced a second proposal, which reduced the number of warrants by half. This occurred when the stock price was slightly higher than its current level. Following the calculation period, the stock price continued to decline. Eventually, they suggested a price adjustment, essentially starting the entire process anew, which brings us to the present situation.

From my perspective, the issue itself isn't a major concern for two primary reasons. Firstly, I believe that the dilution we're discussing, at least up to this point in Evolution's growth, is relatively minor. Secondly, and perhaps more significantly, Evolution's success is not solely due to its first-mover advantage. As we've discussed previously, they were not the first entrants in this space. Instead, their success has been driven by their execution, particularly in game development and distribution. This execution depends on Evolution's key personnel, which brings us back to the issue of key man risk, at least partially. Consequently, I believe it's important to keep these key individuals reasonably satisfied, happy, and aligned with the company's operational success.

I understand that they likely receive job offers from competitors and startups, possibly on an annual basis, and it's essential to retain their satisfaction. However, I'm not pleased with the way the board, especially the board, handled the situation this year. Had we only had the existing incentive program, the initial one that was accepted, we probably wouldn't be discussing this issue now, considering the relatively minor dilution it represents. However, the manner in which they mishandled the situation, from my perspective, was regrettable. The whole process was marred by missteps. What concerns me is that if this situation repeats itself, I'm uncertain whether they'll devise a new incentive program for 2024, given that this year's incentive program was implemented so late in the year.

But let's assume they do introduce one in 2025. I believe the board should significantly enhance their communication with shareholders in advance. When mismanagement occurs, it's not only about the negative perception but also about the internal strife it creates within the company. Shareholders are part of the company, and pitting different segments of the company against each other in negotiations where their interests don't align is problematic. Moreover, it's evident, as we saw with the last proposal, that company insiders are paying close attention to the stock price. This focus on short-term stock price fluctuations is detrimental in the long run and fosters a culture where insiders obsess over daily stock price movements. In the grand scheme of things, this is not a healthy development.

I completely agree. As you've articulated, this internal strife breeds suspicion, and such suspicions erode the trust that shareholders should have in management to reinvest capital well on their behalf. Indeed, it's crucial for them to improve their handling of this matter in the coming years.

I believe the responsibility ultimately rests with the board on this issue.

Yeah, I completely agree.

I'd like to add something briefly. I was pleased to see more Americans joining the board, with almost half of the board members now being Americans. I believe that compared to European corporate culture, American corporate culture tends to be more rational in terms of capital allocation and other aspects. I had high hopes for this change, both in terms of board composition and the presence of major American shareholders like WCM and Capital Group. I hoped that it would lead to more rational capital allocation. While it may take a few years for these changes to fully materialize, I am still hopeful, although the results haven't matched my initial expectations.

Okay, let's conclude our discussion here, Ali. It would be great if you could remind us why you regularly share your updates after each quarter's results, especially since you're a private investor. What motivates you to do this and what do you gain from it?

There are two main reasons. First, it serves as a form of self-discipline. When I establish such a routine for myself, it creates an expectation that I need to meet. This helps me stay on top of the company's developments. Second, and perhaps even more importantly, I want to be wrong. I'm open to being corrected publicly because it allows people to provide me with better ideas and insights. An additional benefit is that I get the opportunity to connect with successful investors like yourself and industry insiders who offer fresh perspectives that I may not have considered. Overall, it has been a rewarding experience.

On that note, for anyone who wishes to reach out to you or get in touch, what is the best way for them to do so?

Ali: You can find me on Twitter with the handle @GNUFS, spelled G N U F S. Additionally, I have a Substack on don'tdistribute.com, which was a play on reverse psychology.

I'll include both of those links in the show notes. Ali, it has been a pleasure speaking with you, and I've learned a lot from our conversation. Thank you once again for agreeing to participate in this podcast.

Thank you. It's been a great experience. Thank you.