For a company that is arguably the most ‘future-proof’ in a sector moving inexorably towards mobile, the shares are now trading at 19 times expected 2017 earnings, falling to 16 times 2018 earnings. That rating has dropped fairly steadily since its merger became effective early last year. But it is still a premium to the group’s five closest peers, which trade at 14 times their expected 2017 earnings.
If there are lessons to learn from the current bad run, they are more to do with managing succession than with overall strategy. But there are hurdles approaching. A competitive online gambling market and a litany of sector-wide regulations are making investors nervy. On this reading, those earnings forecasts look vulnerable to higher taxation or regulatory intervention.
The Competition and Markets Authority together with the sector’s regulator, the Gambling Commission, are currently investigating practices at the online bookies. Enforcement action was launched in June against operators with questionable promotions to attract customers: Paddy Power Betfair was not one of those subject.
The company expects a further update on the joint probe in December, which could involve measures to improve customer protection around withdrawing money, challenging bookies’ decisions or altered bets. But established players could also benefit if some of the sharper practices are stamped out.
Then there is the government’s high-profile review of gambling machines, including the social poison dispensed at fixed-odds betting terminals. There has some question that this would go ahead, given the tightened belts at HM Treasury, but the mandarins say the review will be published in autumn, as planned. Whether or not Philip Hammond soothes his spreadsheet over his conscience, Paddy Power Betfair will be largely unbothered: if the limit was reduced from £100 to £20, JP Morgan Cazenove sees just £3m in lost 2018 cash profits for the group, versus £22m for William Hill (WMH) and £35m for Ladbrokes Coral (LCL).
Much of the extra gambling taxes should be in the price, the extra costs already laid out: a new horseracing levy will cost an extra £10m a year, according to the company, while changes in the UK point-of-consumption tax will have a £6m annual impact, and Australia’s version will mean £4m in extra costs.
If regulation is a headwind, it is less severe for our subject than its rivals. And sectoral change should be a more lasting tailwind. Paddy Power Betfair’s tenth of the total market is more like 17 per cent of the online market, making it the largest player in the latter.
Traditional betting shop and gaming machine revenues, taken together, account for just a fifth of its top line, according to JPMorgan Cazenove figures. Online betting on sports alone accounts for 58 per cent. This is a market that the broker expects to achieve a compound annual growth rate of 6.6 per cent between 2017 and 2021, much faster than traditional over-the-counter wagers.
Given the uncertainties, it is fair to suggest that the current premium might reflect this digital strength (see chart). But in terms of reacting to a capital loss of that seen in the past week, we think Paddy Power Betfair should listen to the Mayor of MacDougal Street. There’s no need to reach for the pistols just yet.
