Tabcorp Holdings (ASX:TAH) has confronted a number of operational and structural challenges that have made us cautious about investing in the Company’s shares. We recently revisited the Company to gauge the extent to which these challenges may have moderated and whether TAH stands to benefit from any easing of COVID-19 restrictions.
Tabcorp Holdings is an integrated gambling and entertainment company. It has 3 core business divisions: Lotteries and Keno (~60% of earnings), Wagering and Media (~35% of earnings), and Gaming Services (~5% of earnings). The Wagering and Media division provides the provision of totalisator and fixed odds betting and retail wagering networks, and also operates a global racing media business. The Lotteries and Keno division encompasses the recently acquired lottery operations from Tatts Group and TAH’s existing Keno game.
What challenges does Tabcorp face?
1. Recent Strong Trends In Lotteries Reversing
The Lotteries and Keno division generates the majority of its revenue from three lotteries: Powerball, Oz Lotto, Saturday/ Monday & Wednesday Lotto.
Financial results for the Lotteries division in FY19 were very strong, given that a favourable run of 49 jackpots and changes to the Powerball game resulted in revenue (+23%) and EBITDA (+29%) growth. Further, the Company has reported strong growth in digital turnover. This momentum has been supported by COVID-19 restrictions, a step-up in digital penetration as more people work from home, and the fact that TAH only has one main competitor (Jumbo Interactive who is a licenced reseller).
In contrast to the strong revenue growth reported in FY19, we expect revenue declines by 1-2% in both FY20 and FY21. This is given that the Company is cycling prior period of strong revenue growth brought about by the exceptional run in jackpots. However, the impact to earnings may be more muted given that additional digital lotteries sales (which are higher margin) could mitigate the impact of a lower jackpot run in future period. Further, operating leverage is likely to return in FY22, assuming a ‘normal’ jackpot year and improved lottery sales as the Australian economy recovers from COVID-19.
The Wagering business continues to face a number of challenges. These include issues at both at an industry/structural and Company-specific level.
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At an industry level, the consolidation in the Australian wagering market to three major players has resulted in TAH’s dominant market position being progressively eroded. TAH’s turnover market share of ~39% in 2019 was slightly below its share in 2014, despite the acquisition of Tatts’ UBET platform in 2018. The key factors underpinning this have been the shift to online wagering at the expense of the retail channel. There has also been an increased prevalence of sports betting (to which TAH is underweight), as well as the transition to fixed odds betting.
Racing currently accounts for around 2/3rd of overall industry turnover and a much higher portion for TAH’s overall wagering turnover. The migration towards online wagering has negative implications for racing turnover as the shift has resulted in smaller racing prizes, and a lower number of races with fewer horses. More recently, field sizes have reduced materially, as many horses (within Australian states and international horses) have been physically unable to access races in other states. As such, online bookmakers are likely to: i) Absorb the lower level of content (i.e. a lower number of races), as well as ii) Compete harder on prices and promotions, in order to maintain and grow their share, target TAH’s retail channel customers and iii) Take advantage of relatively lower user acquisition costs (i.e. as opposed to higher acquisition costs which are likely when content resumes).
At the Company-specific level, the number of active accounts for Tatt’s UBET brand has been in steady decline since the commencement of the integration in November 2018. Tabcorp is hoping that the integration onto a new platform could revive some of these UBET customers. While this was planned for 2H20, this is likely to be delayed as a result of the disruption to the business brought about by COVID-19.
Can The Return Of Sport Help the Wagering Division?
Sports betting has grown from ~13% of Australian wagering turnover in FY10 to ~33% in FY19, primarily driven by: i) Increased use of smartphones for betting, ii) Expansion in markets for local and international sports events, and iii) The entrance of international corporate bookmakers with greater expertise in sports betting products.
Based on figures released by TAH, there are four major wagering sports which account for more than 70% of Australian wagering volumes. They are: Soccer (English Premier League; La Liga), Basketball (NBA), AFL, and NRL. With the exception of NBA, all of the above competitions have resumed from COVID-19 postponements.
While the recommencement of major wagering sports is a clear positive, the shift to online betting as a result of COVID-19 may accelerate market share losses for TAH in both racing and sports. This is given that: i) The sports betting channel remains highly competitive and ii) TAH is underweight sports betting, constituting <10% of its wagering revenue.
3. The Balance Sheet Remains Stretched
The gearing level (on a gross debt to EBITDA basis) is expected to increase to well above the top end of the Company’s 3.0x – 3.5x target range, which is likely to be either close to, or in breach of, covenants.
To help alleviate the gearing level, the Company has cancelled the final dividend for FY20 (with dividend payments likely to remain suspended over the next 2-3 years) and has implemented a number of internal measures to reduce short-term costs and improve liquidity. Further, the Company’s bank lenders have (not surprisingly) been supportive, by waiving covenants for the next two testing dates (30 June 2020 and 31 December 2020).
Despite these measures, we consider an equity raising at some stage in FY21 is likely. This would be to reduce gearing levels and regain balance sheet flexibility for future acquisition opportunities.
Overall, we remain cautious on TAH. The shares are currently trading on an FY21 P/E multiple of ~24x, which we consider unappealing in light of:
i. Mid-single-digit EBITDA growth in FY21. TAH has historically reported low earnings growth.
ii. Notwithstanding that TAH is aiming to reduce short-term costs, the Company is incurring additional costs in the underlying business. In particular, the one-off integration costs in order to achieve the stated synergy targets from the merger with Tatts has increased by over 40%.
iii. The prospect of an equity raising, which would not be as well received, given that it would likely result in lower EPS growth at a time when earnings growth is already challenged.
TAH shares are slowly meandering higher and the uptrend from the March low remains in place for now. The chart will turn negative if it falls under a previous low, which for now is at $3.14. If it gets close to $4, then that will offer significant resistance because it was a major support line for the last few years.
Michael Gable is managing director of Fairmont Equities.
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