Shares in Paddy Power, Betfair and FanDuel owner Flutter Entertainment (FLTR) have gained around 80% over the last year, handsomely outperforming the FTSE 100 and UK gambling peers which have registered losses.

Rival Entain (ENT) which operates the Ladbrokes and Foxy Bingo brands has seen its shares lose around 15%, while 888 Holdings (888) shares are down around 70% and bingo and casino operator Rank Group (RNK) are down 43% over the same period.

Investors will rightly be asking why there has been such a big disparity in performance across the sector.

CONTRASTING FORTUNES

The broad answer to the question is related to regulation, both here in the UK but more importantly across the Atlantic.

In 2018 the US PASPA (Professional and Amateur Sports Protection Act) was overturned which allowed sports betting to be conducted in all states. Five years on there are more than 30 states which permit sports betting although some only allow in-person betting.

Flutter has estimated the opportunity to be worth over $40 billion of annual gross gaming revenues in the medium term. Flutter took a stake in fantasy sports betting company FanDuel giving it an early lead in the fledgling market before buying out most of the minorities.

After toying with the idea of listing FanDuel in the US to take advantage of higher valuations of peers such as DraftKings (DKNG:NASDAQ), the company decided to opt for a secondary listing of Flutter on Nasdaq which has given the shares a big boost.

Berenberg sums up current investment sentiment: ‘The US continues to be the jewel in the crown for Flutter. In Q4, it was the clear number-one sportsbook with a 50% share, while continuing to gain share in iGaming (gaming conducted electronically).’

Flutter expects its US business, around 40% of group revenues, to be EBITDA (earnings before interest, taxes, depreciation, and amortisation) positive in 2023.

Meanwhile in the UK Flutter has proactively introduced safer gambling measures which have resulted in forgone revenues of £150 million (around 10% of UK revenues) and invested £60 million to prepare the business for upcoming changes to UK rules.

KEY METRICS TO THINK ABOUT

The penetration of online gambling is expected to increase and be a major driver of growth for the sector. Therefore, tracking growth in digital revenues is a key indicator to follow.

In terms of profitability, EBITDA margin and contribution margin are key indicators. Contribution margin represents the profit made after factoring in marketing expenditures and royalties paid to third parties.

For example, Entain is guiding for a contribution margin of around 40% for 2023 and an EBITDA margin of 26%.

REGULATORY BREACHES HURT 888

Positive sentiment towards Flutter is in stark contrast to the negative sentiment surrounding online gambling and gaming company 888.

The rapidly changing US landscape presented an opportunity for 888 to scale up in sports betting by purchasing William Hill International for £2 billion.

This was what was left over after William Hill’s US joint venture partner Caesars Entertainment (CZE:NASDAQ) acquired the part of the US operation it did not already own for £2.9 billion in 2021.

Part of the negativity around 888 relates to the big debts it took on to execute the acquisition of William Hill International. At the end of 2022 the company had net debt to EBITDA of 5.6 times which is considered high. The takeover catapulted 888 into third spot globally in terms of online revenues (£1.3 billion), and number three position in the UK and Spain and top five across several other markets.

The company is aiming to reduce net debt to EBITDA to under 3.5 times by 2025. 888 is also guiding to generate at least £2 billion of revenue and earnings per share of 35p in 2025.

In the US 888 operates the Sports illustrated Sportsbook brand in partnership with Authentic Brands (AUTH:NASDAQ).

On 31 January 2023 the shares dropped by almost a third after the company’s long time CEO Itai Pazner resigned following an internal probe into some of its VIP (very important persons) operations in the Middle East. An internal compliance review identified that best practices in AML (anti-money laundering) and KYC (know your client) had not been followed.

Investor nerves were subsequently calmed after the company revealed the internal investigation had not thrown-up any further issues and new robust procedures were now in place. However, at the end of March, the legacy William Hill business was fined £19 million for failing to protect vulnerable customers and having poor AML controls.

In a first quarter trading update (14 April) management said ‘significant remedial actions’ have been put in place leaving the compliance function in a stronger position.

888 gave an upbeat outlook and guided for ‘significant’ growth in adjusted EBITDA for 2023 and achieving an EBITDA margin of at least 20%.

SHARES’ FAVOURITE PLAY ON THE SECTOR

Entain is the most diverse player in the sector operating across more than 30 brands with 180 million unique customer profiles. It boasts the largest global sports betting and gaming platform based on net gaming revenues from domestically regulated territories.

The company has identified a total addressable market opportunity worth $167 billion by 2030 and looks well positioned to achieve double digit earnings growth beyond 2023 based on Shore Capital’s estimates.

We like management’s vision to become a leader in interactive entertainment. Entain envisages eSports and digital gaming becoming a hub for a rapidly growing audience which could lead to new betting markets evolving over time.

Entain has built a strong US presence with a leading iGaming position and number three in sports betting through its 50/50 venture with BetMGM which is part of entertainment group MGM Resorts International (MGM:NYSE).

MGM made an unsuccessful takeover attempt in January 2021 pitched at £13.83 per share while fantasy sports betting company DraftKings made an audacious approach pitched at £24.20 per share later the same year which was also rejected.

In February 2023 MGM ruled out making any further offers for Entain which may put the matter to rest. Although never say never. Berenberg notes that running the original terms of the deal against current metrics implies a 70% premium.

The BetMGM joint venture is expected to turn a profit in the second half of 2023 and become a meaningful contributor thereafter.

RANK TO BENEFIT FROM NEW UK REGULATIONS

New regulations are expected to come into force in 2023 following the government’s gambling review. For most firms stricter onboarding rules will be a headwind for sales and costs.

However, Rank Group could benefit due to the harmonisation of the 1968 casinos act with the 2005 gambling act which will enable Rank to increase the number of gaming machines to 80 per venue (from 20) and offer sports betting. The ability to provide table games based on a random number generator on electronic terminals rather than a live game enables blackjack and other games to be offered at lower stakes.

Leisure analyst Greg Johnson at Shore Capital believes the regulatory upside plus the potential for recovery at the casino estate and the opportunity to grow a meaningful digital business are not reflected in the current valuation of the shares.

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