The stakes are higher for the gambling sector after M&A splurge

Three major collaborations - worth more than £10bn - have changed the complexion of the UK-listed gambling brethren and so now investors' attention is focusing on which deal will work out the best and where the biggest savings, and thus potential value, can be found.

One goliath has emerged from the deals - Paddy Power Betfair (PPB). The announcement came shortly after Ladbrokes (LAD) announced its move to buy the unlisted Coral Group, in turn quickly stealing the limelight. The view seems to be that PPB will be the market leader in regulated markets.

David Jennings, an analyst at Davy Research, said he expected the enlarged entity to win market share over time given that it has created the "most powerful business". According to Mr Jennings, the Paddy Power Betfair deal essentially sparked many of the other deals that have been announced or considered, and now the smaller operators are grappling with how to compete with such a behemoth.

This is particularly true in the online space, with PPB now the largest single entity when it comes to online market share in the UK (see chart below). It boasts 17 per cent of the market, followed by William Hill with 14 per cent, according to data from Gambling Compliance and Numis.

But there are questions about what exactly the numerous drivers of improved revenue growth or efficiency could be in light of management's announcement that it would now find £65m of cost synergies a year earlier than the £50m it had originally pledged.

"When you look at how well run the businesses were anyway, Betfair was converting almost 60 per cent of revenue to cash profits each year," Mr Jennings added. "And gaming tax eats up 15 per cent, so it gives you a sense of how efficient it was."

Analysts at Numis said mergers in the sector had led to cost savings of 7-14 per cent of the combined controllable cost base (excluding the likes of betting taxes). The large variation can be explained by geographical overlap between the merging parties and the split between retail (fewer cost synergies) and online (more synergies), according to the brokerage.

This is why GVC's level of synergies are greater, because it and target group Bwin Party are both online businesses. And it is this deal that analyst Simon French of Cenkos Securities said was the "transformational" deal of the three major ones in the past couple of years. To acquire a competitor that much bigger - GVC's market cap was £250m versus Bwin's £1.1bn - "is a significant undertaking", says Mr French. Additionally, the fact that such a vast amount of cost synergies were identified - €125m (£106m) according to a recent trading update - is "significant relative to the cost base" of the combined entity. This, coupled with the fact that management has refinanced the debt used to fund the acquisition at a lower level of interest, has helped the shares to re-rate. All in all, that deal "is probably more transformational than the PPB one", according to Mr French.

Another attractive quality of that deal is the geographic split of GVC's revenues. Many gaming groups now proudly highlight the percentage of revenue they get from regulated markets - largely because they are deemed more visible, reliable and less susceptible to sudden legal changes - but Mr French said he thought receiving income from a wide spread of jurisdictions was more important.

"You can wake up and find yourself taxed out of profitability in regulated markets, so a mix of higher-margin unregulated and higher multiple regulated sources of income can provide an optimal earnings stream," he said. GVC's three biggest markets - Germany, Australia and the UK - only make up 40 per cent of sales compared to 80 per cent for PPB (Australia, UK and Ireland).

The Ladbrokes deal is in some analysts' eyes the weaker of the three deals as both groups are heavily UK-focused and there are likely to be fewer synergies given the businesses will continue to run as separate entities. Numis notes that Ladbrokes suffered a 26 per cent fall in cash profits because of its high exposure to the UK market, which meant it was hit by recently introduced government tax levies - namely, the 15 per cent point-of-consumption tax and 25 per cent machine gaming duty.

But Ed Meier, a UK equity fund manager at Old Mutual Global Investors, said he and his team were "quite heavily involved behind the scenes" in terms of the Ladbrokes deal. Beyond the fact he believes scaling up is a "natural consequence" of the increasingly taxed and regulated UK market, he said the Ladbrokes/Gala tie-up propels the combined entity into the position of the UK's second-largest gambling company. This is perhaps not reflected as clearly in the shares' rating as with PPB. Mr Meier added that the growing popularity of 'omnichannel' betting, which effectively means punters can bet in retail shops or online from one account, is potentially underestimated.

Even if retail shops are in decline, he says there is a question now "about the pace of it". Brokerage Numis agrees with this sentiment, claiming that the seamless shop versus online gambling experience "challenges the view that shops will be irrelevant in the near term", something that could cheer William Hill investors. Mr Meier added that an omnichannel approach continues to be successful here, and that some of the cash flow generated at the group could be used to foster its European business and thus help it diversify further.

Of course, these big deals overshadow acquisitions by smaller players Playtech (PTEC), which still boasts several hundred million in cash on its balance sheet, and 32Red (TTR), which snapped up online casino business Roxy Palace last year. So investors need to make sure they're not entirely distracted by the biggest mergers.

IC VIEW:

In terms of major M&A sparking up again, analysts and fund managers seem circumspect on overseas players snapping up UK assets because of sterling's current weakness. But any further regulation could once again make it necessary for the gambling companies to become even bigger and it could be at this point that the world comes shopping here.

Favourites:

We're bullish on GVC. We tipped the company in November 2015 and the shares are up 80 per cent since then, at 722p. There's likely to be further to run with this one once the dividend is reinstated, too. Payouts were paused while it subsumed Bwin. We also like Playtech and its significant net cash pile could give it financial headroom to pick off smaller rivals. We're also looking at the long game where William Hill is concerned: the fact it has decided to go it alone, making small acquisitions and boasting its own proprietary technology helps us stay positive.

Outsiders:

There's no doubting the awe the PPB deal has inspired, but we feel the combined entity's shares' forward earnings rating fully reflects this monopoly status. Any near miss on growth forecasts could be felt harder in terms of a sudden derating compared with its rivals.