Tag Archives: POC

Paddy Purgatory

The last time I posted on Paddy Power Betfair (PPB.L) in March, I highlighted the rich valuation and cautioned better value may be had on future dips, ending with the comment that “the game of speculation is all about getting the best odds”. Well, PPB.L has been on quite a ride in recent months. First the prospect of disappointing operating results put the stock under pressure and last week the bombshell that the golden boy CEO, Breon Corcoran, wants to do something more meaningful with his time. The result, as can be seen below, is PPB.L down 15% since the start of the year and 20% since this time last year.

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The revenue for the latest quarter, even after adjusting for the lack of the Euro soccer tournament in 2016, disappointed analysts who are fretting about whether reduced net revenue margins are part of a trend.

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Despite the firm putting reduced net revenue margins primarily down to unfavourable sports results (increased promotion costs also contributed, doing things like paying out on Hilary Clinton prior to the actual election results doesn’t help!), the worry is that competitive pressures rather than bad luck are resulting in reduced net revenue and gross win margins. [Net revenues are gross wins less VAT and fair-value adjustments for free bets, promotions and bonuses]. Care needs to be taken when comparing gross win margins (i.e. gross win divided by amounts staked) and net revenue margins across firms as the make-up of the underlying portfolio is important (e.g. gross wins varies by sport type such as football, horses, tennis, etc and by geography) and firms may account for certain items differently. Also, the absence of the largest online player, the privately owned Bet365, makes industry analysis difficult for amateurs like me.

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Taking into account that gross win and net revenue margins can differ by around 100 basis points, the trend at PPB.L seems to be also present in William Hill’s results. Ladbrokes results have been all over the place in recent years and the impact of their merger with Coral needs to be further understood given their high margins of late.

Of course, this sector is haunted by regulatory risk. The predicted restrictions of the highly addictive gaming machines by the UK Government is expected to impact PPB’s high street competitors much more that PPB.L. For example, PPB.L only derives 6% of its revenue from gaming machines compared to 30% for William Hill. The reaction of PPB’s competitors to compensate for restrictions on gaming machine revenue is likely to have a bigger potential impact on PPB.L’s future results.

For me, the biggest disappointment in the Q2 results wasn’t the revenue line but the operating margins. The full year 2017 EBITDA projection was nearly 10% shy of my estimates. The firm acknowledged that the platform integration has been taking longer than planned and took up over 70% of internal technology resources in Q2. This is projected to reduce to 60% and 30% in Q3 and Q4 respectively before been completed by year end. Releasing these resources will allow a refocus on product development and on fixing other problem areas such as their online gaming offerings. As a result of the Q2 results, I have taken a knife to my earnings estimates (my revenue estimates only required minor adjustment) for 2017 and 2018, as the graphic below shows.

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My 2017 and 2018 EPS estimates have reduced to £3.72 and £4.01 respectively, down 10% and 12% from my previous estimates. That puts PPB.L’s current market cap at a PE of approximately 20 and 18 for 2017 and 2018. That’s not bad for a firm with EPS growth of 13% and 8% for 2017 and 2018 respectively although, if these figures turn out to be accurate, the share price is likely to have gone lower that it currently is on worries about reducing operating metrics in a fiercely competitive market.

These estimates are conservative in my view, possibly overtly so. They reflect a sense that Breon Corcoran’s reason to go off into the tech sunset now is really due to concerns about the medium-to-long term prospects for the sector. Corcoran obviously has put a different explanation forward, one which is suspiciously unconvincing given the amount left undone at PPB.L, although he still does have about £40 million of share options in PPB.L. No firm is simply about the CEO and at the end of the conference call an indication was given of ensuring more exposure to the full management team in future investor engagements. That should help investors get more comfortable with management depth at the firm. I know nothing about the new CEO, Peter Jackson, so he has a real challenge in gaining investor’s confidence. He has big boots to fill as far as investors are concerned.

So, yet again, I suggest the best course of action is to wait, both for existing and new shareholders, and see how 2017 develops for PPB.L. There can be little doubt that recent events mean that the odds on PPB.L have lengthened.

PS- PPB have already paid out on Floyd Mayweather prior to his 26th of August fight with Conor McGregor. In the unlikely event that the Irishman does achieve the impossible PPB’s Q3 net revenue margins will suffer……

Peaky Power

The last time I posted on Paddy Power Betfair (PPB.L), I highlighted it was looking pricey in the mid-to high 90s. It has since traded down to the eighties and recently dipped below £83 after the full year results. Although it has now quickly recovered up around £88, the initial disappointment over the online revenue in Q4 sent the stock down 6%.

The graph below shows quarterly revenues, which met expectations largely due to the favourable A$ rate with Australia revenue up 34% in sterling but only 18% in the underlying currency. Management make a point of stating that “approximately 70% of our profits are sterling denominated, and accordingly, we are not exposed to FX translation fluctuation”. Events such as the summer 2016 Euros contribute to the revenue spike in Q2 2016.

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They exceeded my expectations on the bottom line with an operating profit of £182 million for H2 over my expectation of £160 million, with the merger expense and intangible write-off impacts of £300 million for the full year stripped out. The EPS of £3.30 for 2016 on average 80 million shares was impressive. I messed up on the average share count (again!) in my previous EPS estimate.

PPB stated that they “expect to complete the integration of our European online platforms by the end of 2017” and “until then, new product releases on the Paddy Power brand will be relatively limited, but on completion customers will see immediate benefits”. Despite their market beating margins on their dominant online segment, they caution that “a lot of the sportsbook operators acknowledge that gaming got harder in the second half of last year” and  they always emphasis that they operate in a very very competitive market. It looks to me like PPB management are trying to carefully manage expectations for 2017 and are likely nervous that large competitors like William Hill and Ladbrokes could possibly recover from recent online slumps and (just maybe) finally get their act together online.

There is an ongoing regulatory headwind in this business and 2016 bought items such as the online gaming point of consumption tax, the statutory Horserace Betting Levy, and the UK Competition and Markets Authority (CMA) investigation into UK online gambling (update due in April) to the fore. In addition, South Australia announced a 15% consumption tax effective from July 2017. The UK Government’s Review of Gaming Machines is a much bigger deal for PPB’s larger competitors as it only makes up 6% of their revenue.

PPB have substantially completed the integration of risk and trading functions which means that Paddy Power proprietary pricing and risk management tools are now used for over 85% of the bets on the Betfair sportsbook across 19 sports. They stated that “operating two individual brands on an integrated shared function is also proving to be beneficial for efficiency” and that the “pooling of analytics data has improved our econometric modelling, giving us greater insight into the effectiveness of marketing activity and leading to improved optimisation of spend”. These are critical factors in why PPB is differentiating itself operationally from its peers and are important to the success of the business model envisaged by the merger.

So, although I have likely got the share count wrong again (I am assuming an average of 85 million this time across 2017 and 2018), my new projections are below. I estimate growth of 5% and 11% for revenue in 2017 and 2018 respectively and EPS growth of 14% and 20% respectively. I factored in a degree of topline and bottom line upside in 2018 from the soccer world cup in Russia (assuming politics hasn’t messed up the world order by then!). That represents a PE multiple of 19.4 on an 2018 EPS estimate at a share price of £88 (2017 PE of 23.3). Not bargain basement cheap but not crazy mad either. With a targeted payout rate of 50%, my estimates could mean a dividend yield of 2% and 3.5% for 2017 and 2018 (again at a £88 share price).

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That looks like a better dynamic that the one at a share price in the mid to high 90’s, as per my post in August. If only I wasn’t so negative about overall valuations across the market, I would have added to my PPB position on the dip after the results last week. [Customary caution: PPB is not for the faint hearted, it is the gambling business after all!]. My instinct tells me markets will be bumpy in the coming months, valuation wise (e.g. rising interest rates, politics!). That may prove an opportune time to get more of PPB at a good price. After all, the game of speculation it is all about getting the best odds!

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.

Trinity Biotech valuation leaves little room for error

Trinity Biotech plc (TRIB) is a developer and manufacturer of diagnostic products for the point-of-care (POC) and clinical laboratory markets.

Trinity’s POC products primarily relate to testing for the presence of HIV antibodies and made up 23% of 2012 revenues. Within the clinical laboratory product lines, there are three product portfolios – namely infectious diseases, diabetes and life science supply.

Trinity’s largest and most diverse clinical laboratory product portfolio, at 37% of 2012 revenues, relates to tests for diagnosing a broad range of infectious diseases including kits for autoimmune diseases (e.g. lupus, celiac and rheumatoid arthritis), hormonal imbalances, sexually transmitted diseases (syphilis, chlamydia and herpes), intestinal infections, lung/bronchial infections, cardiovascular, lyme and a wide range of other diseases.

The next largest clinical laboratory product portfolio, at 28% of 2012 revenues, come from Trinity Biotech’s 2005 acquisition of Primus Corporation and primarily relate to instruments and products for in-vitro diagnostic testing, using patented HPLC (high pressure liquid chromatography) technology, for haemoglobin A1c used in the monitoring of diabetes. One of the key drivers of future growth for TRIB is its latest device, Premier Hb9210, for detecting and monitoring diabetes which was launched in 2011.

Trinity’s final clinical laboratory product portfolio, at 12% of 2012 revenues, relates to reagent products used for the diagnosis of many disease states from liver and kidney disease.

A split of TRIB’s revenues for the past 3 years by product portfolio and geographical regions is as per the graph below.

click to enlargeTRIB Revenue Split

TRIB has been on a rollercoaster ride through its past as the graph below of its share price and diluted EPS from 2000 to today shows.

click to enlargeTRIB Historical Diluted EPS and Share Price

TRIB’s shares dropped from a high of $20 in 2004 to a low just above $1 in 2009 and have since climbed steadily over the past 5 years to around $19 today. In 2007 and 2008, $19 million and $86 million of goodwill were written off in each year plus a few million in restructuring expenses and inventory over the two years after a number of missteps and lacklustre results.

In 2010, TRIB sold its lower margin coagulation business for $90 million which resulted in a net gain of $46.5 million for the 2010 financial year. Acquisitions have always been a key aspect of TRIB’s business model and following the sale of the coagulation business, TRIB acquired Phoenix Bio-tech Corp in 2011 and Fiomi Diagnostic in 2012. These companies made products for the detection of syphilis and tests for cardiac arrest and heart failure. In July 2013, TRIB announced the acquisition of Immco Diagnostics Inc for $32.75 million. Immco is a US diagnostic company specializing in the speciality autoimmune segment, where the competition is limited to a small number of key players, for conditions such as Rheumatoid Arthritis, Vasculitis, Lupus, Celiac and Crohn’s disease, Ulcerative Colitis, Neuropathy, Hashimoto’s and Graves disease.

Generally, the entire Diagnostic Industry is set to gain from the ageing population and a rising demand for rapid test evaluations. TRIB has some core product catalysts over the next few years including the ramping up of sales of the Premier instruments for diabetes, its new cardiac product portfolio from Fiomi, a new range of POC products, and now the Immco acquisition. Gross margins are around a healthy 50% with net operating margins around 20%. With no debt and a healthy cash pile (albeit a reduced one to about $30 million after the Immco acquisition), TRIB’s valuation has screamed ahead. The graph below shows its current EV/EBITDA multiple (adjusted for Immco purchase) against its peers using the analyst expected EPS growth from 2012 to 2014 (sourced from yahoo).

click to enlargeTRIB EV EBITDA Peer Multiples

TRIB’s valuation is clearly at a premium to its peers (Chembio and Orasure have their own issues and are smaller and less diversified than TRIB). So is it justified?

The first thing to note is that TRIB’s intangibles have risen steadily since the 2007/8 writedowns on recent acquisitions to $75 million at year end 2012 and may touch the $100 million mark following the acquisition of Immco (this level of intangibles has not been seen since 2007). The company does provide detail in its 20F filing on its impairment methodology and the discounts used in its goodwill calculation.

Based upon the company’s own guidance and the latest conference call, I have calculated initial EBITDA and EPS projections. Analysts estimate 0.80 and 1.06 EPS for 2013 and 2014. My projections generally agree with these EPS projections and also show EPS growth of 20% a year thereafter for 2015 to 2017. Based upon TRIB reverting to a more normal sector EV/EBITDA multiple of 15 in the medium term, I can see a reasonable target for TRIB of $30/$35 by 2016/17.

However, there is a lot of assumptions and execution risks in my analysis. My current risk appetite means that I would prefer to wait on the side-lines for a better entry point than the current $19. It seems to me that $16 or below would be an attractive risk/reward for a 3 to 4 year play (subject to relative macro-economic stability). That strategy risks the possibility of the boat already having sailed on this one as flawless execution on the Q3 and Q4 EPS may push the stock into the mid 20’s.

TRIB is a quality company with hard won experiences and an exciting product pipeline. For me, it’s a pity about the frothy valuation.