Back in October we looked at the UK bookies. Ladbrokes (LAD), William Hill (WMH), and Paddy Power (PAP) weren’t doing all that great, but signs of a nascent recovery were starting to show. New taxes were and still are threatening that recovery. Ironically, the higher tax, being the 25% sales tax on machines, is actually the less threatening one because the market is shifting heavily towards online and mobile. A high tax will only shift demand further in that direction, more reshaping the market faster than it would at its own pace, buLAt not shrinking it significantly.
The real problem is, and will continue to be, the 15% POC tax that took effect in December last year. That tax can’t simply reposition demand as it is a suffocating blanket that covers the whole market. The full impact of it has yet to be seen, and so far, the slow, fragile recovery continues for all three, some more fragile than others.
Beginning with Ladbrokes, the positive highlights are mobile sportsbook, with staking up 110% and active players up 62%. While these numbers are nice, Ladbrokes is still heavily weighted towards retail rather than digital. Digital is only 20% of total business, with retail at 70%. That Ladbrokes is still heavily reliant on its retail business exposes it to that 25% tax, in addition to it being less balanced than its competitors. The consequence is that overall net revenue in 2014 dropped by 2.4% even though digital revenue increased by over 20%.
To be fair, those numbers take into account the horrible performance of the first half of 2014, so considering that, an overall drop of 2.4% is pretty good, and it means the company is going in the right direction. The crown performance was a 114% rise in mobile staking, and 239% net revenue increase from Australia. But even these number we need to see in context, because Australian operating profit was only £2.6M. So there is a long way to go here yet.
We should expect Ladbrokes, like the rest of its peers, to shift more strongly to digital and away machines, so don’t be surprised by even stronger growth there in upcoming quarters as the market naturally shifts anyway, aided by wise government policy of higher taxes course.
One potential fault line in 2015 is in Spain. The remaining 10.5% of its business comes from Belgium and Spain, while Belgium is not a particularly dangerous place to be in, Spain is, especially now when local Spanish elections yesterday have given huge victories to Spain’s equivalent of Syriza, the Podemos party, which doesn’t like austerity. It doesn’t even like fake austerity where debt constantly increases anyway. It is impossible to know when the fiscal earthquake will be triggered in Spain, but a bond attack could start at any time. Ladbrokes’ Spanish business is even now operating at a loss of £1M in 2014 after a £3M loss in 2013, and it could get much worse.
10.5% is a lot, but it’s not incredibly high and Belgium is not a danger. Lad can recover from any trouble in Spain. Bad developments there just won’t be so good for its share price.
One good thing about Ladbrokes, and the rest of the big British bookies also, is that its debt is protected. 73.4% of its debt is fixed, and a 200 basis point (2%) rise in interest rates would have only cost it £200K last year. So debt is not an issue, which means LAD is an OK option for a long term hold if you’re an income investor and don’t care much about gyrations in share prices.
While earnings for William Hill in 2014 were down slightly, EBITDA and revenues were higher. That’s the good news. The bad news is, new taxes could negatively affect Hill on paper more than they would Ladbrokes or Paddy Power. While this is to a degree an accounting issue, it will show up on earnings statements soon and it won’t look all that great. This is because previous tax credits have skewed earnings up slightly, and those tax credits are no longer applicable. Total taxes before credits for 2014 were almost double what they were in 2013, so we are starting to see the effect here even now.
Hill is also placing bets on Italy and Spain, where 9% of its revenues come from. These countries are very connected, so if one of them falls or gets stuck in a Greece-like state of limbo, the other will, too. Again, not an existential threat, but doesn’t warm the cockles of my heart, so to speak.
William Hill’s biggest strengths now are its balance, with 40% of its revenue through mobile, and mobile gaming up 117%. This somewhat mitigates the effect that higher taxes may have on it. Hill places #3 in Australian market share at 21%, and unlike Italy and Spain, there are no immanent and obvious problems with Australia. That market will keep growing.
Also to William Hill’s credit, Interest rate risk is minimal to nonexistent. 93% of its debt is fixed. Nothing to worry about there. All in all, while Hill may have some minor problems with expired tax credits, its balanced business structure and safe finances counteract its risky exposure to Italy and Spain.
Paddy’s Power strongest points are that 77% of its operating profit is from its online segment, and 55% of that is mobile revenue. Paddy has no debt, and a very strong presence in Australia with 24% market share making up a very nice 30% of its revenues.
Its weak point is, again, Italy, where losses continue and will get much worse if Italy’s debt chickens come home to roost this year. That, and you can tell that Paddy is nervous about the effect of new taxes, because it reiterates several times that a weakening Euro counteracted any effects that higher taxes had on its bottom line.
Paddy claims it is prepared to absorb the tax increase, and its biggest asset on that front is its strong online segment, especially when compared to Ladbrokes.
All said, all three companies are stable long term. I can’t make any trade recommendations though. Ladbrokes still looks like the weakest of the three comparatively due to its heavy reliance on the retail segment of its business. Neither William Hill nor Paddy Power have that problem, and we’ll have to wait and see how exactly each company will deal with higher taxes. Stay tuned for upcoming interim 2015 reports in the next month or two.