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Is Tabcorp’s demerger of the Lotteries & Keno division a good idea?

13072021_TAB

Is Tabcorp’s demerger of the Lotteries & Keno division a good idea?

Tabcorp has released the results of its strategic review into the structure of the company the board announced three months ago. The decision has been made to pursue a demerger of the Lotteries & Keno division from the company. While a trade sale of the Wagering & Media division has been rejected for the time being under this plan, the company intends to continue talking to the three bidders for the business.

The strategic review didn’t look at the Gaming Services business, but management noted that the business is going through a rationalisation exercise with some changes currently in the process of being implemented.

In detailing some of the expectations around the demerger and what the separated entities would look like, management made the following comments:

  • The demerger is expected to be completed by the end of June 2022.
  • The demerger will result in estimated one off costs of A$225-275 million and ongoing costs of A$40-45 million a year as a result of the need to duplicate IT costs across the separate companies, as well as duplicated head office and listing costs. These estimates are before any cost reduction strategies are implemented. Management noted that these estimates are conservative.
  • The Lotteries & Keno company is expected to be geared to a gross debt to EBITDA ratio of 3.5 to 4.0x while the Wagering & Media company would be geared to 1.0 to 1.5x.
  • Tabcorp has negotiated with the 25 holders of the US Private Placement debt securities and received approval to have this debt allocated to the new Lotteries & Keno company.
  • More details regarding the likely dividend pay out ratios of the two companies will be announced with the release of Tabcorp’s FY21 results in August.

The reasons for the company preferring a demerger rather than a trade sale largely relate to the time it would take for a bidder to gain the necessary approvals from all of the racing and regulatory bodies and well as legislation changes in NSW to allow one party to own more than 10 per cent of the shares in the NSW licensee. The demerger does not require any approvals other than from shareholders at a scheme meeting. The company has not yet received roll over relief for shareholders from the ATO but does not expect and issues.

Importantly, the board stated in the conference call that it “remains very open to future engagement with bidders and considering alternative proposals”  meaning that a trade sale of the Wagering & Media businesses could still occur.

Additionally, the company stated that it remains in discussions with Betmakers about the potential to work together in the rapidly growing US market.

We are not surprised by the announcement given the drawn-out negotiations that would be required from a bidder to secure the broad range of approvals that would be required to acquire the Wagering & Media businesses. We believe this outcome is a better one for shareholders in the long term as it will provide potential bidders a level playing field and greater transparency once the Wagering & Media businesses are held in a separate company.

Additionally, we expect the strong and stable cash flow generation of the Lotteries & Keno businesses, combined with moderate growth from the shift in channel mix to digital, to be materially rerated by the market as a standalone business. It could also attract attention for income seeking pension funds as a long duration source of stable, growing cash flow.

The market did not view the demerger as positive with the stock selling off after the announcement. We believe this is due to the perception that a trade sale would generate great value in the near term, that the demerger timetable is longer than expected, and that the one and ongoing costs from the demerger were higher than expected. While we are surprised a demerger would take 12 months to implement, we note that the duplicated cost estimates are at the conservative end of company expectations and that there are likely to be offsets as a result of each company being more focused on and in control of their strategies.

The Montgomery Funds owns shares in Tabcorp. This article was prepared 12 July 2021 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Tabcorp you should seek financial advice.

INVEST WITH MONTGOMERY

Stuart is the Portfolio Manager of The Montgomery [Private] Fund. Stuart joined Montgomery in 2015 after spending 19 years in research roles with JP Morgan in Australia and in New York. Stuart was appointed Executive Director at JP Morgan in 2005 and for 8 years was Deputy Head of Research. Prior to this he worked as an analyst in the Australian Equities team at Bankers Trust Asset Management for 3 years. Stuart is a CFA® charterholder.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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2 Comments

  1. So Roger, given that there may be synergies between TAH and BET, what do you make to Betmakers and their long, potential runway of growth ahead in the US market ?

    • Hi Chris, BET’s position in the US is still fairly speculative at present. It is aiming to be a supplier to the sportsbook companies rather than a direct beneficiary of the growth of betting spend as new states open up. While Australia has a relatively sophisticated racing product for historical reasons, the main game in the US will be sports betting. That is not to say there won’t be a big market in racing given the size of the US opportunity, but it won’t be as big a focus. That could mean they outsource their betting systems in racing which would present an opportunity for companies like BET. But there are plenty of other companies in this space, so it is far from assured that BET will be a winner. Tech is a key piece of the puzzle in developing a betting platform with a competitive advantage. This is why the sports betting companies are investing heavily in their technology stack. But the key source of competitive advantage is the customer list and a low customer acquisition cost. In the early stages of the market opening up, this is held by the two big fantasy football companies (DraftKings and Fanduel), and well know casino brands like MGM. Even if BET is successful in supplying betting systems to the larger players, it will not own the end customer. While the tech stack is important, the real value is in the customer list, as has been shown in the consolidation activity in countries like Australia and the UK. PBH has secured a deal with NBC Sports that will hopefully give it a much better ability to build brand equity such that its cost of customer acquisition falls in future. If it can build a valuable customer list, it could become a valuable asset in the market. This is our preferred investment on the US sports betting theme, albeit still a fairly speculative one at present. I hope that helps

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