Gambling on Tabcorp

Graham Witcomb

It wasn’t long ago we thought Tabcorp was a terrible bet. At the company’s 2016 result, we noted two factors working against it: growing competition from online operators such as Sportsbet and its network of expensive TAB retail outlets that put the company at a cost disadvantage.

Sportsbet’s business model meant punters lost around 5% in commissions, compared with the 15%-20% takeout at a typical TAB. Even Tabcorp’s online wagering tended to offer poorer odds, presumably to avoid pulling customers away from its lucrative tote.

Sportsbet was a better deal for punters, which may explain why it had grown from a standing start to a 28% digital market share in 10 years, double Tabcorp’s share at the time. Back then, Tabcorp profit growth was a dream.

But what if glamorous Sportsbet doesn’t conquer the online wagering market? What if the fuddy-duddy wins? That’s been the question nagging at us over the past six months, because there are signs Tabcorp now has the upper hand.

To start, the long-serving chief of Sportsbet’s parent company, Ireland-based Flutter Entertainment, left early last year. Breon Corcoran was, in our opinion, the most astute executive of any wagering business worldwide. He’s clearly a loss for Sportsbet.

Then there’s the merger of Tabcorp and Tatts. Due to overlapping wagering operations, management expects between $130 million and $145 million of cost-cutting benefits by 2021, with $64 million of that already bagged in 2019. These savings could flow through to punters as better odds and promotional offers, narrowing Sportsbet’s advantage.

Also narrowing the lead was the introduction of point-of-consumption taxes earlier this year. The levy comes straight off the top line of all operators – net wagering revenue – and replaces variable taxes based on where bookmakers held a licence.

The old system favoured online bookies, typically registered in the low-tax Northern Territory, while Tabcorp paid higher taxes in most states due to separate licences. The new set-up levels the playing field.

August’s full-year result gave us early evidence of the collective impact of these factors: Tabcorp’s digital turnover grew 7%, compared with Sportsbet’s 12%, for the six months to June.

Sportsbet is still gaining market share but the rate of gain has declined. Its 5% lead today is well below the 27% of 2016.

There’s also good reason to believe Tabcorp can win more customers. Point-of-consumption taxes are a nightmare for small operators, which account for almost half the market. Sportsbet and Tabcorp, as major players, are likely to benefit.

Sportsbet’s management said in August that there are “signs that operators are behaving rationally in the face of lower customer economic returns”. This is to say operators have increased their pricing to offset the taxes but, more importantly, marketing budgets are shrinking industry-wide as a way to save money.

This can only be a good thing. If Tabcorp maintains its marketing budget, while Sportsbet and smaller operators are pulling back, it may win a few extra eyeballs and gain market share this year. More likely is a reduced marketing spend, which should flow quickly to profits.

If Tabcorp can get marketing costs down to 2% of revenue (roughly where it was in 2015), it would save at least $55 million before tax and add around $39 million to net profit – a 10% increase. That said, Sportsbet still has some 50% more active online users.

The news that Sportsbet’s parent company intends to merge with Canada’s Stars Group, owner of BetEasy, the third-largest online betting operator in Australia, is perhaps more a sign of desperation than anything else. A combined Sportsbet and BetEasy would have a market share of just over 40% and offer the potential of cost cuts. The significant point, though, is that Bet Easy has about a third of the EBITDA margin of Sportsbet, a meagre 10%. We suspect the new pointof-consumption taxes may have swung the company to a loss, so it was a case of merge or bow out. If so, Tabcorp has another opportunity. Most local online operators are probably losing money. The company could grow market share by acquisition.

With savings flowing through from the Tatts merger, weakening competitors, more “rational” marketing budgets and a slowdown in the loss of market share, Tabcorp no longer looks like the sitting duck of 2016.

In fact, Tabcorp could be earning an extra $150 million-$200 million in pre-tax profits a few years from now if these trends continue. That would boost earnings per share by 25%-35%.

What’s more, the company’s money-spinning lotteries division, operator of all the major lotteries in Australia, is a high-quality monopoly that accounts for just under half operating profits. If Tabcorp can fix its online operation and benefit from industry consolidation, it could have two quality businesses rather than one.

Reflecting the strength of its lotteries business, Tabcorp trades on a price-earnings ratio of 24. We expect earnings to grow around 10% a year over the next few years. With multiple competitive advantages and a fully franked dividend yield of 4.5%, we’re upgrading to “buy”.