America might prove to be the land of opportunity for listed gambling companies. While UK investors might find it common to put money on their favourite team, sports betting has largely been illegal in the US since legislation in 1992 banned such gambling in all but four states. That law has now been overturned by the Supreme Court as “unconstitutional”, instead leaving it up to individual states to make their own rules. This could present a much enlarged market for UK-listed bookies, already under pressure from unhelpful changes to gambling regulations in Australia and at home.
In the UK, when Matt Hancock took up his role as culture secretary at the beginning of 2018, gambling fans, and investors in such companies, thought this was good news. Mr Hancock’s love of horseracing was well known, and so if he was open to that type of betting, surely he would not opt for the extreme £2 maximum stake on fixed-odds betting terminals (FOBTs), as was being discussed by the Department for Digital, Media, Culture and Sport.
But earlier this month, the £100 maximum stake allowed on FOBT machines was cut to £2 – the extreme end of the possibilities set out at the onset of the government’s consultation. In a statement, the Department for Digital, Media, Culture and Sport said the move was to reduce the risk of gambling-related harm. The government reasoned that a £2 maximum would be the most effective way to reduce the potential risk of large losses on the machines and to individual players and their communities.
Any option other than the £2 choice would have felt like a “halfway measure” in protecting “vulnerable” consumers, according to Mr Hancock. “While we want a healthy gambling industry that contributes to the economy, we also need one that does all it can to protect players,” the culture secretary said.
The stake cut isn’t the only thing the government has planned to address problem gambling. It’s also going to get tougher on online play, with stronger age verification rules and possibly a limit on how much can be spent by digital gamblers. A “multi-million pound” advertising campaign alongside GambleAware will launch later this year, and responsible gaming messages will appear alongside all gambling-related advertisements. The age limit for playing the National Lottery will be reviewed when the next licence competition rolls around, and Public Health England will conduct a review into the public health effects of gambling.
Before the announcement of the £2 stake was made, there was speculation that the government would be discouraged from choosing this option since it can collect taxes on this gambling income. Clearly, the government had thought of this too. In order to make sure that public finances are not affected by the decision, the Remote Gaming Duty will be increased to make up the difference. This will be paid for by online gambling operators, further details of which will be announced at the next Budget. FOBTs, or “B2” machines, make up the majority of the gross gambling yield in the UK.
Analysts at Stifel called the decision disappointing, but not surprising. The decision was felt to be politically motivated rather than practical. A number of betting shops are likely to close, leading to job losses, while the upside of reducing problem gambling is hazy. Gamblers can still access a number of online sites, the analysts argued, with “fewer controls and weaker supervision”.
So, what do the listed gambling companies think of all this? It’s difficult to argue with the promotion of responsible gaming. Analysts at Goodbody say that William Hill (WMH) is the most exposed to the changes. In a release, the bookie called the changes “unprecedented”, so the industry may not know the full impact for a few years. But to give an estimate, during the first four months of the financial year, 70 per cent of William Hill’s total gaming machine net revenue came from stakes made above the £2 threshold.
If punters cannot bet £100 in a single go, maybe they’ll just play more often, or perhaps branch out into a different mode of play. Accounting for an estimate of such flexibility, William Hill estimated that total net gaming revenue could fall by between 35 per cent and 42 per cent. Around 900 shops, or 38 per cent of the total estate, would become lossmaking and could be forced to close. Annual adjusted operating profit, even after any mitigation measures, is forecast to fall by between about £70m and £100m.
Despite the changes, William Hill is still aiming to pay out around half of its underlying earnings as dividends, but the risk remains that shareholders could encounter a dividend cut soon given the reduction in earnings these new regulations are likely to cause. Chief executive Philip Bowcock emphasised the importance of the company’s betting shops to high streets and to the local economies, and said the company will look for ways to evolve the retail business to adapt to this change.
The statements released by William Hill on the day the £2 cut was announced were meant to help investors assess the impact of the change on their own portfolios. But analysts at Numis reckon the estimates might be optimistic. In the case of William Hill, the company’s estimates equate to a 27 per cent downgrade to analysts’ full-year 2020 forecasts, whereas Numis’s in-house modelling had suggested closer to a 44 per cent downgrade, or a £150m impact. The closure of 900 shops looks feasible within a relatively short period of time, given that the average lease on a shop is about 3.2 years.
Another bookie highly exposed to the changes is Paddy Power Betfair (PPB). Management estimates that the stake cut would cause between a 33 per cent and 43 per cent fall in total machine gaming revenue. To put this into perspective, this would have equated to a fall in sales in 2017 of between £35m and £45m, or 2 per cent to 2.6 per cent of group revenue. Management said the changes, even before any mitigating factors such as the launch of new products or punters moving to other modes of play, would not have a “material impact” on the group’s UK retail business.
Even so, Paddy Power Betfair chief executive Peter Jackson called the change a positive development for the “long-term sustainability” of the gambling industry.
When GVC (GVC) bought Ladbrokes Coral, management knew the company would be increasing its exposure to FOBTs. To address this, a contingent value right (CVR) was added to the deal conditions, so that the amount GVC would pay in total for Ladbrokes would be dependent on the outcome of the government’s review. Now that the maximum FOBT stake has been cut to £2, these CVRs will be worth nothing. This means GVC won’t have to pay anything more for Ladbrokes on top of the £3.1bn base price. Management isn’t expecting the decision to have an impact on the minimum £100m of annual synergies expected from the deal.
Chief executive Kenneth Alexander said he was “disappointed” by the outcome of the government’s review, but it is unlikely that it was completely unexpected. GVC has spent the past two years creating a business that could withstand any structural or regulatory headwinds in any one of its markets. This means that the company can now expect to have repositioned itself over the next two years to be less reliant on gaming machines. In the first year following the introduction of the £2 maximum stake cash profits are expected to be cut by around £160m, falling to £120m after two years. Analysts at Numis had suggested a £175m loss, and that was for a stake cut to £20.
The £2 stake decision has at least given UK-listed gambling companies some clarity on regulation, but some questions remain. The suggested changes still need to be approved by parliament, and FOBT operators must be given sufficient time to adjust. Analysts think this suggests the change won’t materialise until around 2020. This also goes for the increase in remote gaming duty, which is expected to rise from 15 per cent to 25 per cent. If the rate were to increase to 20 per cent, analysts at Goodbody estimate cash profits at Paddy Power Betfair would fall by 2 per cent, 3 per cent at William Hill, 2 per cent at GVC, 7 per cent at 888 (888) and by 3 per cent at Rank Group (RNK).
Punters down under
The UK isn’t the only market that’s made some big changes to gambling regulation. Australian regulators implemented a ban on credit betting in February, which had accounted for about a third of wagers made in the country. A number of states have also started to tack on a point-of-consumption tax (POCT) on the bookies. South Australia was the first to do so in July 2017 at a rate of 15 per cent of net wagering revenue. Western Australia will introduce the same tax rate from the beginning of next year. The state of Victoria also recently announced a POCT to start from next year, but at 8 per cent of net gaming revenue.
Between the three states, around 45 per cent of the Australian gambling market either already has a POCT in place, or has a scheduled date of implementation. Analysts at Goodbody have forecast that all of Australia will be paying a 15 per cent POCT by the end of 2019, but note that the lower rate in Victoria offers “some encouragement”, but are waiting for a decision from New South Wales, which represents nearly a third of the Australian gambling market, before amending forecasts to account for a lower overall rate.
All this change manifested itself at William Hill’s interim results back in February. An exceptional £238m charge relating to a strategic review of its Australian business had wiped out profits for the period. Management had initiated the review on concerns that regulatory changes could hamper the long-term profitability of the business. One month later, the bookie announced its Australian division would be sold to CrownBet Holdings for A$300m (£169m). During 2017, Australia had accounted for 7 per cent of group revenue, at £120m on a statutory basis.
Paddy Power Betfair doesn’t appear to have similar plans with its Australian business, Sportsbet. At the preliminary results in March management said that while 2018 was likely to see more states implement the POCT, there were no concerns about Sportsbet’s ability to withstand higher taxes, and that it could benefit from any market consolidation resulting from the tax changes. At the time, a POCT was already in place in South Australia, which accounts for 7 per cent of Sportsbet’s sales, and had been announced in Western Australia, representing 11 per cent of Sportsbet revenue. At the full year, cost of sales increased by 30 per cent for Sportsbet due in part to the 15 per cent POCT in South Australia, while the cost of the tax in Western Australia is expected to be around A$12m a year. On the other hand, the ban on credit betting has had no “material” effect on the group.
Instead of worrying about what impact the POCT could have, Paddy Power Betfair seems more concerned with encouraging customers to keep playing. Around £35m was invested in customer promotions last year, such as the “Power Play” daily promotion that’s meant to improve customer loyalty. Such spending is expected to increase further in 2018. This may look like a suspicious way to encourage more gambling, but Paddy Power Betfair has also been working with other gaming operators to establish Responsible Wagering Australia, which works with the Australian government to develop ways of protecting customers from sliding into problem gambling.
When GVC bought Ladbrokes Coral, one of the motivations behind the transaction was to increase the group’s exposure to regulated markets around the world, Australia being one of them, to around 90 per cent of group revenue. Prior to the deal, GVC didn’t have any exposure to the country. In Ladbrokes Coral’s interim results from August last year, the company’s last before it was taken over, the bookie reported “market-leading growth” in its digital business thanks to new product launches during the reported period.
A number of Australian states are still expected to announce their plans for a POCT. That’s not all that’s coming for Australian betting businesses. As of March gambling advertising is no longer allowed on television, radio or online five minutes before the beginning of live sports matches, nor five minutes after play is over between the hours of 5am and 8:30pm. More is on the way in the second half of this year and into 2019, including changes to how long it takes to verify a customer, a national self-exclusion register, and a ban on sign-up offers.
The American dream
Stricter regulation in the UK and Australia, two significant regulated markets for gambling companies, might appear discouraging. But relief could be on its way from America. Just two days before the £2 stake cut on FOBTs was announced in the UK, the US Supreme Court overturned the Professional and Amateur Sports Protection Act (PASPA), declaring it “unconstitutional”. The legislation had been in place since 1992, making sports betting illegal in all but four US states.
This means that it will now be down to individual states to make their own laws around sports betting, and analysts have speculated that most states would probably be inclined to make such gambling legal since they would be able to add a tax to the industry. The appeal, which has been in the works for the past four years, was initiated by the state of New Jersey, so analysts think it could be the first state to approve legalisation.
Americans appear keen on those gambling opportunities that already exist in the country. Researchers at The Mellman Group found that around 54m people in the US, or close to one-quarter of American adults, participated in a sports betting pool last year. Those who participated did so through an average of more than seven different pools over the course of the year. The total spend across all sports was nearly $18bn, with NCCA college basketball being one of the most popular brackets. The most common motivation to bet? Participants thought it made watching their favourite sport more fun. But putting money on your favourite team might not be so innocent. According to the American Gambling Association, around $150bn (£112m) is gambled illegally every year in the US. It’s likely that state governments would want to take a chunk of these earnings.
The news that PASPA had been repealed sent shares in UK-listed gambling companies soaring on the day on the expectation that this could present a significant opportunity for expansion. 888 was the biggest mover on the day, despite the fact that it doesn’t have a sports betting offering quite yet. What the company does have is a joint venture with Avenue Capital, which is licensed and operating in Nevada, New Jersey and Delaware.
The second-biggest mover following the announcement was Paddy Power Betfair. Analysts at Goodbody observed that the company already operates both a casino and horseracing exchange online in New Jersey, and last year it bought fantasy sports website DRAFT. The bookie also owns a horseracing television channel and an online pari-mutuel wagering operator, where customer wagers are pooled against each other rather than betting against the house, that is active in more than 30 states already.
The US is currently Paddy Power Betfair’s smallest division at around 5 per cent of annual sales, but that should soon change. The week after PASPA was repealed, Paddy Power Betfair bought a controlling stake in US fantasy draft operator FanDuel to be better placed to take advantage of an emerging US sports betting market. FanDuel is the second-largest US fantasy sports operator with 40 per cent market share through its 7m registered customers across 40 states. Analysts at Stifel said the deal creates the industry’s largest online business in the US and should put Paddy Power Betfair in a strong position to target the deregulation of US sports betting.
William Hill has had a presence in the US gambling market since it bought three different sports betting businesses, which it then merged into William Hill US. It operates more than half of Nevada’s retail sports betting market through 109 sportsbooks and a mobile app it launched in 2016. William Hill also has deals with a racetrack in New Jersey and Caesars Entertainment in Iowa, and supplies sports betting for the Delaware Lottery.
At the final results in February William Hill’s US net revenue was up by a third to £56.5m, while adjusted operating profit improved by nearly a quarter to £17.7m. At the time management said the company was investing in “readiness” for a US decision on PASPA. Chief executive Philip Bowcock said William Hill was already a leader in the US sports betting market and is “well positioned” to take advantage of legalisation in any new states thanks to a strong track record and good relationships it’s already built with American operators. The US is still only 3 per cent of group revenue.
America is another area where the acquisition of Ladbrokes Coral was transformational for GVC. Through the deal it now owns 79 per cent of Nevada-based Stadium Technology Group, which supplies sports-related products to casinos in the state. GVC also has a licensed casino and poker product at MGM casinos in New Jersey. Management stated that the repeal of PASPA presents an opportunity for “significant expansion” in America’s regulated sports betting market. The company is currently looking at how best to tap into the market there and expand its US presence.
GVC is also in talks with Playtech (PTEC) to extend its technology support. Playtech operated Ladbrokes Coral’s digital platform, but there was no certainty that this would continue after GVC’s acquisition. The gaming technology company also looks to be in a good position to take advantage of US sports betting thanks to some recent acquisitions. Goodbody analysts point out that it owns self-service betting terminal supplier BGT, which could be beneficial if states allow kiosk-style sports gambling.
Gambling illegally is widespread across the American market, and so US regulators should be careful not to get too greedy with their tax take so that it discourages punters from legal routes. Research from Oxford Economics found that adding a ‘League Fee’ payable to professional sports leagues brings a risk of creating a niche legal offering, rather than developing a competitive, accessible legal means of sports betting. They found the same goes for government tax rates. Gaming taxes are a significant operating cost for legal operators, and so if the tax is too high fewer operators will be motivated to enter the market. Those that do choose to operate legally might cut spending in areas such as marketing, technology, content and distribution. This could mean that illegal sports betting would maintain a significant market share.
That said, there’s still a long way to go before legalised sports betting could be widespread across the US. Individual states will have to decide whether they want to allow betting online or through physical locations, or both. There’s also the questions of who will be allowed to operate, what tax rates or licence fees will apply, any restrictions on marketing, and if foreign operators will be allowed to set up shop.
Will the American dream pay off for UK bookies?
The major gambling companies have been quite transparent on what the cut in FOBT stakes could mean for their businesses. While these are still estimates, since it’s impossible to tell whether customers will switch to another mode of play or gamble more frequently at the lower stake, shareholders have an idea of what to expect the next time results roll around. On Australia and America, there is less clarity. It’s expected that most states in Australia will soon adopt a point-of-consumption tax, although the rate they could charge is still unknown. Still, almost half of the gambling market there now has the tax in place, and a lower rate set in Victoria could give reason for optimism.
The big question for investors in gambling companies is the scope for growth in the US. New Jersey, the state behind the original push to repeal PASPA, is likely to be the first to welcome the bookies. The fact that so many Americans already bet on sports, albeit often illegally, gives an impression of the appetite for sports betting in the US. What is clear is that the companies themselves are keen to explore these opportunities.
GVC is still our pick among UK-listed gambling companies. It did well to base how much it would pay in total for Ladbrokes Coral on the outcome of the FOBT review. The deal also gave it exposure to Australia, where it had no presence before. And while the Australian market is undergoing change, the Ladbrokes business there still managed to deliver “market-leading growth”, in contrast to what happened at William Hill. GVC also looks well placed to take advantage of sports betting in the US, both through its existing contracts in New Jersey and those in Nevada that came with Ladbrokes. Management is already eyeing ways to push further into the market. So long as the individual states play ball, we think the American dream could come to fruition and lift the embattled UK bookmaking sector out of the doldrums.
