Uh oh. Let two things be recorded here today. First, I was wrong when I said that the GVC takeover bid for bwin.party would fail, and that bwin.party would stick with 888. Wrong wrong wrong! On July 22, I wrote:
Well, it turns out that after offering a $400M premium over 888’s highest offer, the bwin.party board decided to give in to temptation and go with the racier, riskier, more dangerous, fun, and faster growing suitor. With a much less stable business model.
Second, I fear this will not end well. For the sake of GVC and bwin.party shareholders, I hope I am wrong.
True to form, 888, which I have said repeatedly is one of the most responsibly managed companies in the gaming sector, bowed out saying that it could not justify a higher bid for the company. I have no doubt that the 888 board members have all played poker before and know very well that sometimes, it is more wise to fold and wait for a new hand to be dealt. And that they did.
As a result, 888 will continue to have a near perfect balance sheet with no debt, and continue to be a net creditor. 888 would have taken on a substantial, though manageable debt load had the deal gone through. It would have probably been worth the risk considering growth opportunities with a Bwin.party merger. Instead, 888 is going to let GVC take the risk, which includes up to €400M in debt, plus about 190.55M new GVC shares to be issued to bwin.party shareholders. Current GVC shares outstanding are about 61.3M, so the new total will be 251.8M, and that’s before an additional €206M in new equity that will be used for working capital. That’s another 36.7M shares, so the grand total will be 288.5M, a 370% increase.
Why did the bwin.party board change its mind in the end? This will be the subject of historical debate for years to come, but the two most readily apparent answers are cash and SpringOwl’s Jason Ader. Cash is cash. When someone offers you more money for something, it makes sense at least on a superficial level to take the higher offer. Behind the scenes though was Jason Ader, head of the SpringOwl hedge fund.
Ader had taken ownership of about 7% of the company back in September 2013 at some point during that month when he flew to Israel to meet Ruth Parasol in Herzliya. The median price per share of BPTY during that month was around 115 pence. The price is now around 104. Not too much of a successful position for Ader, but at least he gets some dividends. (Full disclosure, my own long call last year on BPTY turned out to be a wash.)
Ader has a few of his people on the bwin.party board and through them he was able to maneuver into a premium sale to GVC. The case is a bit confusing because Ader is known to have publicly supported the 888 deal over GVC in the past. Apparently he changed his mind for the premium. But is it really so premium? My contention is no. My feeling is that it is a mistake and it will lose shareholders value in the medium to long run.
To explain why, first a bit about hedge fund managers in general. I have nothing against Jason Ader or activist investors. Activist investors are a good thing. Anyone who controls enough capital to become involved in the executive boards that control this capital should do it and look out for the preservation of that capital.
My problem with Ader is just that I think he’s wrong in this case. Like most hedge fund managers, Ader has good knowledge of the sectors he invests in, particularly gaming. He knows a lot more about it than I do, and he always will. But hedge fund managers are like ecologists who study the rainforest all their lives but know little about weather patterns.
Take two experts. One of them knows everything about the rainforest and every tree and plant in it. What they need to grow in the best way possible, the lifecycle, the diseases, everything. The other one is a meteorologist with a satellite who can spot a typhoon or drought before it happens. He knows very little about the rainforest itself other than that plants need water and sun and typhoons or droughts will wreak havoc on rainforests.
Which one do you think will more accurately predict what happens to the rainforest?
For those who trust Ader’s judgment, I urge you to watch this video, particularly the second half. This is dated June 12, 2013, with Ader speaking the investment-case praises for Las Vegas Sands, Wynn, MGM, Melco Crown, and SJM holdings. Since that interview, Melco is down 30%, Wynn 47%, LVS 17%, and SJM is down 67%. Only MGM is up 37%, mostly because MGM did not have a substantial Macau presence. That is not to say that Ader was long all these companies when he gave the interview, but the real irony is that he says in the interview that Macau’s growth prospects are great because the Chinese government protects Macau by closing its competitors. It was specifically the Chinese government that absolutely decimated Macau through its money laundering crackdown schemes.
Hedge fund managers know their sectors and can forecast much better than those who only read what is available in public filings, if we ignore the business cycle. In other words, in a world where there is business cycle caused by money printing, hedge fund managers would easily win the forecasting game. Not only do people like Ader know their sectors. They also have inside connections. But very few of them understand governments or the business cycle, because almost all of them have a Keynesian blind spot when analyzing overall economic conditions.
As for GVC, the risk with them is actually not debt. They actually have a pretty healthy balance sheet and €400M is a lot but not unmanageable. The problem is that it has an incredibly dangerous business structure. Up to 92% of its current business comes from unregulated markets in Brazil, Germany, and Turkey. Both the Brazilian Real and the Turkish Lira are in freefall, and Turkey seems to be in the beginning stages of a civil war. Ader I presume is not an expert on the instabilities of fiat currencies and war politics. Germany is about to spend €6B on State welfare for 800,000 refugees from Syria, while trying to manage a Euro-wide debt crisis. Yes, there is a lot of money in these markets and GVC is currently doing a great job getting their hands on it. But these markets are incredibly risky and it could all blow up at any time.
Further derisking the financial side of the deal, there are rumors that Amaya is still involved behind the scenes here, as some are speculating that the regulated portions of bwin.party will be spun off to Amaya once the ink is dry on the GVC merger. So really the only issue is the inherent risk of GVC’s business structure over 888’s much safer model.
Given that, I don’t understand why Ader pushed bwin.party into taking the GVC route over 888 for only $300M. Besides a Turkish civil war, Brazilian monetary chaos, and who knows what could happen in Germany, unregulated markets could be under attack from capricious government regulators that are all going to be in very bad moods once interest rates and global price inflation rocket higher. Regulatory expulsion happened to 888 and bwin.party. It can easily happen to GVC.
The first evidence of the unstable nature of this route is the market response to it. BPTY tanked 5.3% on the news. GVC was down almost 6%. How is this possible if GVC is offering a combined 129.64 pence a share for BPTY? Shouldn’t BPTY rocket up to that premium instead of trade down to a low of 100 yesterday?
The answer is the equity backing behind the deal. 25 pence in cash plus 0.231 GVC shares per BPTY share. The lower GVC goes, the lower that relative 129.64 goes with it.
In the end, bwin.party may grow quicker with GVC than with 888 at least initially, so long as GVC’s jerrybuilt rickety business model stays intact, but in time I fear this merger may not be any more successful than the bwin.party merger itself was.