A small company with Jumbo potential

Did you miss the investing boom of the late ’90s and early 2000s? Then consider yourself lucky – you missed the tremendous fallout as well. Besides, the best opportunities to ride the wave of promising online businesses may still be before you.

One such opportunity is Jumbo Interactive (ASX: JIN), based in Brisbane. This quite small company has a market cap just over $80 million and good growth prospects ahead, including expansion into international markets.

Domestic business

Today, Jumbo has an established Australian business. It operates the popular gambling site, among other related lottery and game sites. These involve customers buying buy lottery tickets, such as those sold by Tatts Group (ASX: TTS), with Jumbo acting as an agent and earning a portion of sales. This online lotto-agent business has high margins and may still grow following the incredible success of the last 10 years, in which net profits grew from a net loss to nearly $7 million for the 2012 financial year.

To keep current with technological trends, the company has also developed smartphone apps and a number of other innovative products that enable customers to purchase lottery tickets no matter where they are and to play lotteries with their friends through social media sites such as Facebook.

With the overall Australian lottery market worth $4 billion according to company estimates (and online lottery sales representing less than 10% of total lottery ticket sales), while Jumbo’s total transaction value looks to be between $102 million and $106 million for 2013, and in combination with the continuing trend toward online purchasing of all manner of goods, this company looks to be a winning ticket in years to come. Still, see below for the risks inherent in this business.

International expansion and opportunity

The international opportunity is especially exciting. Jumbo has recently expanded into Latin America, announcing a deal to help introduce and manage online lottery sales in Mexico. It’s also moved into Germany, having secured the rights to sell lottery tickets via web and mobile in one German state already, with plans in the works to acquire necessary licenses in other German states.

Most recently, Jumbo has moved into the U.S. market, signing a joint-venture deal with Retail Gaming Solutions, a privately held American company, to provide in-store rewards systems at about 1,000 convenience stores throughout the U.S. (Trials of the program found that lottery ticket sales rose some 38% following the introduction of the Jumbo/RGS rewards systems, suggesting the system is very much a win-win.)

Jumbo estimates that these new markets contain some 500 million potential customers and are worth over $70 billion in terms of lottery sales. (By way of proxy, consider that the portion of lottery sales completed online has reached 15% in the UK and 30% in Finland in recent years.) Should the company eventually capture but a small fraction of these customers and sales, it’s likely that Jumbo will move quickly out of small cap territory.

Still, such a win is not going to happen overnight, but over several years. Potential investors need to be patient when it comes to this company.

Balance sheet & valuation

Jumbo Interactive currently has a strong cash position and no debt. This should allow Jumbo to continue to pursue its expansion efforts.

Shares appear relatively cheap, trading for 14 times trailing earnings. However, full year 2013 earnings are likely to be much lower than 2012 earnings on account of the impact from expansion efforts and some accounting changes – another reason this play is one for long-term oriented investors.

The risk of being a third party

A key risk to bear in mind when considering an investment in Jumbo is the company’s status as a ‘third party.’ That is, the game owner/license manager could choose not to allow sales through Jumbo sites, but instead keep all the cake for himself, as it were. While some long-term agreements help to contain this risk, it’s important to recognise that the balance of power isn’t entirely in Jumbo’s favour.

Foolish takeaway

Those looking for a pure gamble may just want to stick to lottery tickets. But if you’re a patient, long-term investor looking for a bit of small-cap spice to add to your diversified portfolio, Jumbo Interactive shares could be a good bet.

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Motley Fool writer/analyst Catherine Baab-Muguira does not own shares in any company mentioned.

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