Tag Archives: Andy McCue

Paddy Power Betfair Revisited

It has been about 10 months since I posted on the potential for the Paddy Power and Betfair merger and a lot has happened since. Brexit and the resulting sterling volatility are obvious events of significance. In the betting sector, consolidation has continued with the Ladbrokes and Gala Coral merger having been announced and approved. The audacious proposed tie up by Rank and 888 on William Hill floundered with recent press reports suggesting Rank and 888 could get together. The consolidation in this rapidly changing sector is far from over.

The initial optimism on the future prospects for the two high achieving entities, Paddy Power and Betfair, resulted in the share price trading above the £100 level earlier in the year. Following Brexit, it traded as low as £80. The merged firm reported their H1 figures earlier this week which showed the full extent of the merger costs and provided an increased cost synergies figure for 2017 of £65 million. With 75% of EBITDA being sterling based, the currency impact was not as material as their multi-jurisdictional operations would suggest.

Top-line results for H1 do however indicate that 2016 revenue growth will likely not be as high as the 17% I had expected in November. The reality of issues in this regulated and highly competitive sector also served as a reminder that the path may not be as smooth as initially hoped for. Regulatory headwinds in Australia were an example. As a result, I revised my revenue estimates in November from £1.64 billion to £1.51 billion. The graph below shows the breakdown of my revenue estimates for the next few years with a comparison to overall average analyst estimates.

click to enlargePaddy Power Betfair pro-forma revenue split August 2016

Also, I have revised my previous earnings estimates with an operating profit margin of 20% for 2016, growing to 22% in 2017 and 23% in 2018. Based upon a share count of 86 million as at end June 2016 (which includes 2 million treasury shares), I estimate the H2 EPS at £1.55 which when added to the H1 EPS of £1.45 gives a full year 2016 EPS of £3.02.[ This 2016 estimate does represent an operating EPS of £3.79 which compares to my November estimate of £3.85 albeit that the November estimate was based upon suspect figures like the share count!!]. At today’s share price of £95.65, the PE multiple for 2016 is a hefty 31.6. The graph below shows the multiple based on my EPS estimates for 2016, 2017 and 2018 compared to those using the average analyst estimates.

click to enlargePaddy Power Betfair PE Multiples 2016 to 2018

In conclusion, I remain optimistic about the business model of Paddy Power Betfair particularly given the proven quality of the management team and their history of execution. However, quality doesn’t come cheap and the current valuation is priced for perfection. For new investors, it may be prudent to wait for a better entry point.

Gambling Problems

It has been about 6 months since I posted on the gambling and gaming sector (also earlier here) and there has been a lot going on. BWIN, after being on the block for some time, is closing in on a sale of its business with 888 and GCV (in conjunction with PokerStars and FullTilt owner Amaya) the speculated favourites. 888 itself rejected an offer from William Hill earlier in February this year. Meanwhile, Betfair and PaddyPower opted to return their cash piles of £200 million and €440 million respectively to shareholders rather than get involved in any M&A.

Ladbrokes, after a series of poor results, promoted the digital head Jim Mullen to CEO who is currently involved in a route and branch review of the firm with the outcome due to announced in June. His first move was to put the Irish business into examinership. Ladbrokes woes have continued with poor gambling Q1 results, continuing a run of bad luck after a disastrous boxing day football gross loss, as the exhibit below shows.

click to enlarge2014 Boxing Day 11 standard deviations

As can be seen by the graph below, Breon Corcoran’s rehabilitation of Betfair’s exchange model has resulted in an outstanding performance with a near doubling of the stock. The ex-Paddy Power executive has delivered on his plans for the betting exchange (as detailed in this post). [Update: Numis just released a note on Betfair’s rich valuation as per this article.] The tiny casino player 32Red has also had a good run due to solid 2014 results and M&A speculation.

click to enlargeShare Price 6months to May 2015 William Hill Ladbrokes Paddy Power Betfair 888 BWIN 32red

Internal candidates in William Hill and Paddy Power, James Henderson and Andy McCue respectively, also took over the CEO role.

The challenges for the sector are considerable. In the UK, the point of consumption (POC) tax of 15% has been in force in the UK since December and a new 25% rate of Machine Games Duty (MGD) applied from the 1st of March. Uncertain regulation across Europe and the lack of traction in opening of US markets are other headwinds.

Operator’s ability to reduce pay-outs to punters to counter tax increases is restricted by the competitive nature of the market, particularly online as the graph below on gross win percentages illustrates.

click to enlargeOnline Sportsbook Gross Win Percentage

Taking the commentary from the operators on the impact of increased taxes, I estimated the likely impact on net margins for a number of firms (as the graph below shows).

click to enlargeNet Margin estimates to 2015 gambling firms

The market is giving Betfair and Paddy Power credit for their recent revenue growth, strong operating results, product development and strong mobile adoption. Based upon my estimates, both trade on a 2015 PE in the low 30’s.

click to enlargeMarket valuations gambling firms

A brief review of the business profile of a selection of firms illustrates the differing models, as per the exhibits below.

click to enlargeGambling Sector Revenue Split & EBITDA estimates

click to enlargeGambling Sector Revenue Geographical Split 2015

It will be fascinating to see how the remainder of 2015 plays out for this sector. Scale is undoubting going to be a strength for firms in the future. What the large UK operators, Ladbrokes and William Hill, will do to counter headwinds will be intriguing. Although there is nothing to suggest it is remotely likely, it occurs to me that a tie-up between Paddy Power and Betfair would make a powerful combination.