An Alchemist’s Dream, Dust into Gold By Andrew Tottenham, Managing Director, Tottenham & Co December 20, 2017 at 7:57 pm The European gambling landscape is quite mature, with very few opportunities for meaningful expansion. There are still ways to grow profits, such as improving revenues through better marketing programs and doing cost reductions, but without new licenses becoming available the only way to substantially increase profits is to acquire other businesses. All three options have their risks and none are guaranteed to work, but otherwise you’re stuck with a business that will only increase revenues when there are positive macroeconomic trends. Since the 2008 crisis, most European land-based gambling businesses have seen year-over-year revenue changes which tracked GDP per capita growth, meaning a lacklustre 2% to 4% increase per annum. Regulatory changes offer the possibility of positive impacts, but in nearly all cases these have in fact been negative: restrictions on the numbers of machines or locations, increases in taxes, reductions in maximum bets, and so on. The intrinsic lack of growth opportunities and the actions of regulators and governments are impacting valuations of machine-operating companies in Europe. These businesses are having a hard time increasing their valuations to exceed six times EBITDA. Gamenet, an Italian operator of over 55,000 slot machines of one form or another, plus an online presence, priced its IPO at 6.2 times EBITDA and in the end had to lower the price to 5.8 times in order to have a successful IPO. Sisal, a similar Italian business, was sold to CVC at a price equivalent to less than 6 times EBITDA. Even casino operators are not faring much better: a recent sale managed only slightly less than 7 times EBITDA, perhaps reflecting the comparative lack of regulatory risk. When opportunities for internal growth are rare and interest rates are low, consolidation is the name of the game. GVC, a pure online gambling operator, has made a bid for Ladbrokes Coral, a retail betting company with a significant online gambling operation. Ladbrokes Coral’s UK-based retail betting outlets, of which there are almost 4,000, have an average of around four Fixed Odds Betting Terminals per outlet. These machines represent about 58% of the £1.4 billion of revenue from its UK retail business, and the UK retail business approximately 62% of the company’s EBITDA. The revenues from these machines are under threat from a public consultation being conducted by the UK Gambling Commission, with a view to reducing the stakes from where they are currently, £100, to as low as £2. You might think that now is not be a good time buy a company like Ladbrokes Coral, given the risk to a major portion of its business. So GVC’s offer has part of the price contingent on the outcome of the current UKGC consultation. Some in the financial world have called it a “stroke of genius”, but I wouldn’t go that far; it’s just a method of trying to calculate the value in the event the worst case happens. If nothing happens, the offer is worth £3.9 billion (about 9 times EBITDA); in the worst case the offer would be worth £3.1 billion (7.4 times). So the difference between a £100 maximum bet and a £2 maximum bet is worth £800 million! GVC, led by the irrepressible Kenny Alexander, has come from nowhere to become one of Europe’s largest gaming companies. One reason: back in 2013, when financial analysts ascribed almost no value to online gambling revenues from unregulated markets, with some even going as far as giving them a negative premium, William Hill decided to try to acquire Sportingbet, an online business that had a rather large chunk of revenue coming from “grey” markets. Not wanting to take on the perceived regulatory risk, William Hill teamed up with GVC; the two acquired and then broke up Sportingbet, with William Hill taking the regulated markets at a premium price and GVC getting the “dark side”. GVC’s strategy has been very canny. By building a diversified portfolio of revenue from unregulated markets, it has been able to persuade the financial community that its revenue stream, taken as a whole, is secure and should be valued in a similar way to that from regulated sources. As confidence grew, it allowed GVC to acquire some premium assets operating in regulated markets, such as beating 888 to buy BWin Party. Slowly but surely, having won over the financial community, GVC is replacing grey with white. Now it’s making an audacious bid for one of Europe’s largest gambling companies, and not paying much of a premium for doing so. Will Mr. Alexander pull it off? I wouldn’t bet against him.