The Aristocrat Leisure Limited (ASX: ALL) share price is outperforming the market and its peers after the gaming machine developer was upgraded by Morgan Stanley after being compared with US gaming app star Zynga Inc.
The ALL share price jumped 1.8% to $29.71 when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index gained 0.4% in after lunch trade.
The NASDAQ-listed Zynga is the creator of popular gaming apps like FarmVille, Zynga Poker and CitiVille. It's also a popular stock with investors as the Zynga share price has surged by around 60% since the start of this calendar year.
While Aristocrat is better known for its poker machines in pubs and hotels, it expanded in to digital gaming through acquisitions in late 2017, which now account for around 30% of its earnings.
Aristocrat's $63 billion opportunity
Australian investors probably aren't used to valuing app developers and I believe that was one of the key factors holding back the Aristocrat share price.
But this also means that the market is undervaluing the upside for Aristocrat with Morgan Stanley estimating that the market opportunity for the group's digital division could be as large as US$44 billion ($63 billion).
The next question is whether Aristocrat has a competitive advantage that would allow it to capture a good chunk of the market. The broker thinks its track record in developing (land based) poker machines will give it an advantage over rivals in the "Social Casino" category (which are essentially gambling apps) but not the more general "Social Casual" market.
However, Aristocrat may not need to dominate the Social Casual space to outperform. Morgan Stanley pointed out that this category is growing at a around 10% a year and just having exposure to this market and growing at a similar clip is enough to send the stock higher.
Large upside prompts recommendation upgrade
"Based on our DCF value ALL's Digital business is worth A$9.9bn or A$15/share. This implies an EV/EBITDA multiple of 18x versus Zynga on 21x and SciPlay on 11x," said Morgan Stanley.
"We believe ALL should trade below Zynga given its less proven track record in the Social Casual space, but above SciPlay given its portfolio and geographical diversification."
The broker's analysis of the digital opportunity was enough to convince it to upgrade the stock to "overweight" from "equal-weight" as it lifted the price target on Aristocrat to $35 from $29 per share.
Most brokers share this bullish view on Aristocrat with seven of the nine brokers polled by Reuters recommending the stock as a "buy" while two rate it a hold.
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