Where next for the gambling sector after major events in the US and UK?
The gambling sector has this year experienced a mixture of very good and very bad news, prompting wild share price movements.
Now is an opportune time to take stock of the sector, particularly as share prices have had time to price in forthcoming changes to the UK fixed-odds betting terminals market and the hype has died down about the opening up of the US sports betting industry.
The latter event is now the primary focus of investors as a legal sports betting market could eventually be worth up to $9bn in gross gaming revenues, according to forecasts by gaming consultant Global Market Advisors.
In May, the Supreme Court decided to repeal the Professional and Amateur Sports Protection Act (PASPA) of 1992, essentially allowing individual states to legalise sports betting.
The US may now be the land of opportunity for the gambling sector yet investors should note that legalising sports betting in individual states will take time.
TAXES AND FEES
One of the biggest issues is the potential impact of taxes and licensing fees as they can be a huge and render the market opportunity unattractive for operators.
For example, New Jersey has a tax rate of 8.5% on sports betting wagers but Pennsylvania is considering a 36% tax rate. Potentially high start-up costs could add to gambling operators’ financial burden, making it difficult for them to breakeven.
While some states are steamrolling ahead with legislation, political opposition could slow down progress. This is evident in Missouri, Oklahoma and Louisiana after failing to enact a sports betting bill in May.
Fortunately these setbacks have not deterred other states. Mississippi, Pennsylvania, West Virginia, Illinois, New York and Rhode Island are hoping to make progress with some potentially offering sports betting in a few weeks’ time according to investment bank Berenberg.
Every state has its own timetable, regulatory framework and each could face different competitive pressures.
WHY PATIENCE IS NEEDED
Michael Campbell, an analyst at stockbroker Whitman Howard, believes the market potential, which could be worth $6bn in gaming revenue in around five years’ time, will take some time to develop as operators prepare to get up and running pending state-by-state legislation.
Based on 22 states where daily fantasy sports is currently legal, Campbell argues this may be a reasonable guide for how many states would potentially legalise traditional sports betting, which could limit the overall market potential.
By 2020, he tentatively forecasts between 15 and 20 states may have legalised sports betting.
The analyst is wary of punitive taxes and integrity fees as this could deter operators which may be forced to offer odds on sports events to customers which are not as competitive as odds from unlicensed betting operators.
At least $150bn a year is wagered illegally on sports betting according to the American Gaming Association. Illegal sports betting is unlikely to stop, says Campbell, but legal means could appeal to gamblers due to regulation and consumer protection.
HOW DO UK-LISTED GAMBLING COMPANIES FIT INTO THE EQUATION?
It has barely been a month since the historic sports betting decision yet there are a deluge of deals emerging as Paddy Power Betfair (PPB), GVC (GVC) and William Hill (WMH) plan to take advantage of liberalised gamblers.
Paddy Power Betfair recently sealed a deal to combine its US business with fantasy sports operator FanDuel to take advantage of its strong brand and large customer base. The gambling firm will own 61% of merged business, increasing to 80% after three years and full ownership in five years.
Deals have also been secured with Meadowlands racetrack in New Jersey and Tiago Downs casino in New York.
Davy Research analyst David Jennings says these states are two of the ‘best prospective markets in the US’ as they are likely to be among the first to regulate sports betting and may benefit from low tax rates.
Paddy Power Betfair has soared by over $2bn in market value since the US sports betting breakthrough in May.
‘In reality, whether the US opportunity is worth that much today depends entirely on how patient investors are willing to be on the US front,’ comments Jennings at Davy.
He says without US sports betting or further M&A, the company is unlikely to materially grow earnings between now and 2020 due to the impact of gaming taxes and regulatory changes.
William Hill has operated in Nevada since 2011 through its US division. It is planning to grow its US presence by operating sports books for Ocean Resort casino and Monmouth Park racetrack in New Jersey.
The move is a sensible one as New Jersey is one of the biggest states so far to sign the bill into law.
There have been no tie-ups yet from GVC although the gambling company’s sports betting platform operated by its subsidiary Stadium Technology will be used to accept single-game sports bets in Delaware casinos.
GVC already has a relationship with MCM for online casino games in New Jersey.
Berenberg analyst Robert Ciaccia is confident there is significant upside for GVC’s share price even if the business does not fully take advantage of the US opportunity, which he argues is not factored into the share price at all.
The analyst highlights the strong management team, diverse geographic exposure and cash-generative nature of the business, as well as synergies from the recent acquisition of Ladbrokes Coral.
Ciaccia says synergies from the Ladbrokes deal could be significantly higher than the anticipated £100m and potentially double that level if revenue and capital expenditure
COULD M&A BE ON THE CARDS?
There has been a lot of speculation over potential consolidation in the sector since the opening up of the US sports betting market.
William Hill is seen as the prime choice for a takeover target among UK-listed gambling companies after suffering myriad problems. Over the past five years, shares in William Hill have fallen by more than 30% to 310.5p.
AJ Bell investment director Russ Mould believes William Hill didn’t adapt quickly enough to meet the shift to online gambling, unlike its faster rivals.
This led to online boss James Henderson losing his job in 2016 after the new sports betting platform Project Trafalgar encountered teething troubles in 2015.
‘William Hill lost vital ground during this period as more digitally aware rivals took share and also gained ground through strategic mergers and acquisitions,’ comments Mould.
OTHER STRATEGIC HICCUPS
The company’s attempt to enter Australia via the acquisition of assets from Sportingbet in 2013 also failed to pan out due to regulatory changes. William Hill sold the business at a loss this year to CrownBet, which is owned by Stars Group.
Another opportunistic target could be Sportech (SPO), despite it previously being put up for sale and not attracting any decent offers for the business.
Whitman Howard’s Michael Campbell says Sportech is among the best positioned in the US thanks to its footprint in Connecticut; its Quantum system, which supplies wagering software to customers in 37 states; and a recent deal with Sportradar to supply a fixed odds sports betting book.
Berenberg throws cold water on any US-related M&A speculation for the industry, highlighting it is too early for operators to assess the sports betting opportunity and commit funds for consolidation.
WHAT ABOUT THE REGULATORY PRESSURES IN THE UK?
The Government’s drive to reduce dangerous losses for problem gamblers has had a major impact on several UK-quoted companies.
Initially, the sector was hoping a cut to the maximum stake on fixed-odds betting terminals (FOBTs) would not be too extensive, but were proved wrong earlier this year.
Instead of the maximum stake being cut from £100 to £30 or below, it was slashed to £2 a spin and threatened a vital source of profitability.
William Hill has warned the new limit could hit total gaming net revenue by 35% to 45% and says 900 of its shops could become loss-making and potentially close.
For rival Paddy Power, the impact is expected to be slightly lower but still significant with an anticipated decline in a range of 33% to 34% in machine gaming revenue. This equates to approximately 2% to 2.6% of overall sales.
In light of the review, GVC anticipates a £160m impact on earnings before interest, tax, depreciation and amortisation in the first full financial year. There are reports the switch to the lower betting limit may take until April 2020 to be implemented.
It is widely expected that the Government will make other changes to the sector in order to recoup the lost tax from changing the FOBT betting limits. This could see a higher point of consumption tax which is a tax on bets placed online by individuals based in the UK.
Berenberg forecasts the point of consumption tax will rise from 15% to 20% from January 2020. This would cause another squeeze on industry profit, thus putting pressure on management teams to diversify their earnings away from the UK as much as possible.