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Paddy Power Betfair and the difficulty of picking exact bottoms

TAGs: Breon Corcoran, Editorial, paddy power betfair

The problem with spotting great buying opportunities is that when you find them, they look scary. That’s what makes them buying opportunities. If they weren’t scary, more people would buy them and the price wouldn’t be so low.

Paddy Power Betfair and the difficulty of picking exact bottomsIt’s a corollary of why it’s so hard, almost impossible, to pick a bottom. Bottoms happen typically on very low volume because nobody wants to buy at the bottom. Mathematically, the amount of traders who pick exact bottoms is equal to the exact order book order volume on the exact lowest tick down in price, divided by the cumulative volume of very single other trade before and after that down tick. It means the percentage is vanishingly small.

But it’s actually even smaller than that. If we are talking about exact bottoms, it is very unlikely that anybody, not a single investor or trader or fund or institution, picks the exact bottom. Say a hedge fund places a large order just around what turns out to be the bottom of Paddy Power Betfair in this instance. The fund will probably establish its position over a number of weeks or even months consisting of many different orders around the bottom in the best case. The best chance to get the exact bottom can only be by retail traders, whose orders are small enough to be fulfilled at one single price point. If they are savvy enough to pick close to the bottom though, they probably scaled in on downticks rather than believe themselves prophetic enough to buy at the exact right time.

The best one can realistically do to find a bottom is buy good companies that are depreciating in value for no good fundamental reason. Paddy Power Betfair is one of the best examples of that right now. Here we have a company clearly going in the right direction, growing in the right areas and metrics, heavily affected right now by beta market conditions for reasons unrelated to its own financial health, and which has had a string of bad luck perceived as ominous for the company but which probably won’t affect much if anything fundamentally.

Here’s a chart of Paddy Power Betfair versus its five main competitors. Over the last year, it is performing the worst of the six.

Paddy Power Betfair and the difficulty of picking exact bottoms

There are many reasons for this, but there is no good reason. The biggest one I can think of is expectations. The Paddy Power Betfair merger of 2015 brought with it colossal expectations of immediate synergies and incredible performance. We have seen synergy and superior performance, but it hasn’t been as lightning fast as most investors apparently expected. Those tempered expectations coupled with Brexit and regulatory fears and the sudden departure of CEO Breon Corcoran and the company’s bizarre suspension from Twitter, and in my opinion poor monetary growth this time of year are all what has led to the decline.

None of these factors are fundamental to the company itself. I don’t believe the decline will last much longer, barring some crazy geopolitical event or continued stalled monetary growth in the US, neither of which do I expect in the near term.

The numbers speak for themselves. A 9% growth in first half revenue (3% constant currency) not jaw dropping but not bad either. A 10% rise in sportsbook stakes, despite falling revenue of 1.5%. Most importantly, a 3.7% rise in EBITDA margin for the group. The dividend has gone up by 25%, which is not what companies do when they are in trouble. It’s what they do when they can afford it and they want to attract shareholders. I say take the bait.

The less-than-spectacular growth can be attributed to investment decisions. Heavy investment in technology integration between the Paddy Power and Betfair platforms that has yet to bear fruit but will according to management come 2018. Heavy investment in Australia that should pay off soon as well. The words of CEO Corcoran on Australia before he left shows that the company is playing the long game here. Speaking about the Australian market, Corcoran had this to say in the last conference call:

Many of our competitor’s will struggle from profitability and sports bets can thrive as a result. Even overnight, there’s more regulatory news in Australia that credit betting is now possibly within 6 months of being banned and many of you all know that that’s 30% of the revenues of one of our competitors down there. So regulatory and compliance costs will go up. Being large is definitely a better place to be, even if it’s easier to grow top line from a smaller base.

As for the departure of Corcoran, it doesn’t seem to have anything to do with negative results, but rather just a personal decision of his. Sometimes you just gotta do what you gotta do. Priorities and values change, markets will forget about it soon and the strategies he has put in place will take hold in his absence. It seems clear that he made sure a strategic plan for fully integrating the two companies was in place before he left.

For all these reasons, Paddy Power Betfair is a big buy. The bottom looks close if it isn’t already in. Bottoms are almost impossible to pick exactly, but they way to get close is to look for situations like these.

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