LAD - Ladbrokes

[yadayada]

Its trading at like 8x 2012 earnings now. They overhauled their online division in 2013 by outsourcing it to playtech. They have a pretty solid record with William hill. The transition caused their earnings to take a hit this year, hence why it is down. There is also worry that regulation in the UK will hurt their machine business. But this also seems to not be much of a threat if it really happens. if max bets go from 100 to 50, it would simply mean people would have to play 20% longer to offset that. There isn't huge margin of safety in this idea, but the stock will probably soar if they do manage to turn their online business into a succes story like william hill did. probably 50-100% upside? There is a good VIC on this, that adresses all the bear arguments pretty well. That is where i got the idea.

 

Thoughts?

[cr6196]

I really like this company although I just sold out of my position a few days ago.

 

At the moment, I think that regulation is the main driver here as WMH is down too. I think the main threat isn't cutting down the bet size but the number of machines per shop. There is already legislation in place limiting the number of machines (I think) but the threat is handing this power over to local councils. Logically, as local councils are far less invested in the revenue that these machines but face the resulting social/economic costs of their existence, this will lead to trouble. This isn't something that current government will do, it is something the Opposition threaten to do (utilities have also been hit by what they have been saying). I have no idea on whether this will actually come to fruition. I will say though that LAD is far more reliant on machines for growth/profit and that this kind of moral activism is generally unpopular in Britain but appears to be gaining in popularity.

 

Regardless, I think the margin of safety is fairly substantial here. The estate in the UK is extremely valuable and highly cash generative. The online division is also running at margins that are half the "normal" level due to the buildup in investment needed to try and actually win online.

 

The real problem here is management...it is difficult to describe how bad management at this company really is (a legacy I think of having been a subsidiary of a larger company, Hilton Group, until 2006). For example, guess when they online division was started...given how badly the company has done you might think it was a late starter...nope, the online division was actually pretty much the same size in 2005. Rather than invest in this offering, they starved it and starting building stores in Europe. Genius move! Now, WMH's online division is worth more than LAD as a whole and company actually makes less than in 2005.

 

The upside here is that online is still underpenetrated in the UK and, I think, there is a very small competitive advantage for competitors. Some categories are going to be really difficult to catch up in, poker for example, but the company has a huge brand and can channel the profit from physical stores into marketing. I also think that BetDaq was a very smart acquisition as the only long-term competitive advantage in sportsbook is going to come from betting exchanges.

 

If the company turns round online I see ~250p as the starting point. Without a turnaround this is still cheap and I would say ~175p.

[yadayada]

Thx for the analysis :) . Why did you sell it then? Found something with a better margin of safety?

 

Machine revenue is 33% of total. But i can't find how much operating profit these things generate. If they get reduced by 1/3 , shouldnt be a huge hit?

 

Also online seems to suffer from a low player yield. They dont really need to find much new customers, just improve what they get out of them. It seems pretty likely they can do this with playtech onboard now. WHO was v succesfull doing this with playtech over the past few years.

 

Also they have a younger outside CEO since 2010 now.

 

Also what I like about this one is the quick catalyst. You can sell it in a year if they dont improve the online department yet. If it doesnt come in a year, it's probably a failure.

[cr6196]

Thx for the analysis :) . Why did you sell it then? Found something with a better margin of safety?

 

Machine revenue is 33% of total. But i can't find how much operating profit these things generate. If they get reduced by 1/3 , shouldnt be a huge hit?

 

Also online seems to suffer from a low player yield. They dont really need to find much new customers, just improve what they get out of them. It seems pretty likely they can do this with playtech onboard now. WHO was v succesfull doing this with playtech over the past few years.

 

Also they have a younger outside CEO since 2010 now.

 

Also what I like about this one is the quick catalyst. You can sell it in a year if they dont improve the online department yet. If it doesnt come in a year, it's probably a failure.

 

I sold it because it went below 160. If my idea was correct it wouldn't have traded below there. It did so I am waiting to see what will happen.

 

I also should say that what I said about the machines was completely wrong. The theory is that betting shops are circumventing the current four machine per shop limit by opening multiple shops within close proximity to each other. The idea is to give councils the power to limit the number opening in their area. In addition, there is some kind of unspecific plan to change the nature of the software. Some links on where (I think) we stand at the moment:

 

http://www.bbc.co.uk/news/uk-politics-25461551

http://www.bbc.co.uk/news/uk-politics-25619683

http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/leisure/10560964/Betting-shares-hit-amid-fears-of-crackdown-on-gaming-machines.html

 

After central costs retail produces 68% of total operating profit. They operate from the same shops as OTC so you would probably be operating from pretty much the same cost base. If machine GW fell 33% then UK retail profit would be down 61% which would be 47% at the group level. However, the point is that this is, at best, unlikely to happen and impossible before 2015...I think.

 

I have some yield numbers for the games (although I would like a link to info about LAD customer type)...From Bwin...casino GW margin is 3%, bingo is 35%, and 2% for poker. Across the industry, sportsbook is about 7%. WMH have a 17% GW margin and my guess is that they have a much better casino and possibly poker book than Bwin. My understanding was that LAD had a volume problem though not a yield problem...but this seems to be wrong :D

 

Of course, one area in which Playtech are quite effective is in casino and poker. I am not actually too convinced by their poker offering (the software is terrible) although they have worked the economics very well (pooling players through multiple sites on their network) but they seem to be effective in casino...their marketing expertise may explain the excellent yield at WMH.

 

I like the fact that the CEO came from an online betting background (Sporting Index) but where are the results?

 

I also would add to your last paragraph that I don't see the company going much lower even if it does fail...at this price, no-one expects them to succeed as all the value is retail stores...they do also have some stuff going on Australia which is a really good gambling market.

[yadayada]

You still sound v bullish on the idea. If your conviction is high enough, then you should buy more at these levels instead of selling? I supose it would be interesting to do some research on the politics side and see how much they would crack down on this. The guy who wrote the VIC article

Hard to say if anything will happen. The noise was made a couple of weeks ago by the opposition, but a proposal to give more regulating power to local authorities was voted down by the coalition. There is currently a new study underway, commissioned by the government, to assess whether the machines are increasing problem gambling and the coalition's stated policy is that it will only take action if there is evidence of increased problem gambling tied to the machines. A recent Health Survey for England (released in December) actually showed a decline in problem gambling (which in the UK is already lower than in the rest of Europe) so it seems likely that there won't be real evidence of increased problem gambling. 

 

Anyway, this is politics so you never know. If something does happen it is likley to take the form of a reduction in maximum bet. However, even if the maximum bet (currently £100) is cut in half, the overall impact will be mitigated by a bunch of factors. Most imprtantly, players will probably just play a bit longer. JPM (the most bearish on the street) estimates that if players increase their average playing time by 1.5 minutes, the 50% cut will have no impact to gross win. Players tend to spend a certain amount of money. If bet sizes shrink then the number of wagers increases. This can also be observed in other areas of gambling. there is a negative correlation between payout ratios and wagers.

 

Also I think poker isn't really important. From experience it is dying because of the player pool segregation. ANd it is sort of a crappy business to begin with if your not v large. But mandatory to have as a betting company.

[cr6196]

You still sound v bullish on the idea. If your conviction is high enough, then you should buy more at these levels instead of selling? I supose it would be interesting to do some research on the politics side and see how much they would crack down on this. The guy who wrote the VIC article

Hard to say if anything will happen. The noise was made a couple of weeks ago by the opposition, but a proposal to give more regulating power to local authorities was voted down by the coalition. There is currently a new study underway, commissioned by the government, to assess whether the machines are increasing problem gambling and the coalition's stated policy is that it will only take action if there is evidence of increased problem gambling tied to the machines. A recent Health Survey for England (released in December) actually showed a decline in problem gambling (which in the UK is already lower than in the rest of Europe) so it seems likely that there won't be real evidence of increased problem gambling. 

 

Anyway, this is politics so you never know. If something does happen it is likley to take the form of a reduction in maximum bet. However, even if the maximum bet (currently £100) is cut in half, the overall impact will be mitigated by a bunch of factors. Most imprtantly, players will probably just play a bit longer. JPM (the most bearish on the street) estimates that if players increase their average playing time by 1.5 minutes, the 50% cut will have no impact to gross win. Players tend to spend a certain amount of money. If bet sizes shrink then the number of wagers increases. This can also be observed in other areas of gambling. there is a negative correlation between payout ratios and wagers.

 

Also I think poker isn't really important. From experience it is dying because of the player pool segregation. ANd it is sort of a crappy business to begin with if your not v large. But mandatory to have as a betting company.

 

Yes, I probably will be buying again but not right now. And that analysis seems very fair. The only thing that I would add is that the opposition's case is not based on problem gambling. An argument based on this point is pretty easy to refute, online gambling is available after all. The argument is more based on effect of these machines on "cost of living" and that this business is somehow "predatory". Utilities and payday lenders have also been grouped into this theme so it is somewhat incoherent but this is how the Opposition attacks the government. The Government generally rejects the "cost of living" argument, rightly so as it is a bit silly, and can't adopt the "predatory capitalism" route but is interested in "moral activism". This means they are happy to tell people what they should and should not do (for example, the Government recently began blocking pornography websites with users having to "opt-in" with their ISP if they wanted to remove the block).  The flaw in this is that it is the "problem gambling" argument and the next step is banning online gambling, something that the Government probably won't do. It also worth mentioning that this "moral activism" is very strange for a right wing party.

 

Either way, the sum of it is that the Government focuses on individuals and the effect of gambling on them and the Opposition focuses more on businesses and how they are exploiting gamblers. This means differences in implementing any action, the Government, for example, would probably never give local authorities more power but focus on changing software. It also leaves quite a lot of room for agreement between the two sides. However, I think that the Government would be unwilling to be seen to sanction any of the Opposition's arguments (cost of living/predatory businesses) and the Opposition would not want to come out and say gambling is wrong as it wouldn't sit well with a lot of their working class voters. That is my analysis of the situation.

 

If you are interested in machines you might also be interested in: http://www.amazon.com/gp/product/0691127557/ref=s9_simh_gw_p14_d0_i1?pf_rd_m=ATVPDKIKX0DER&pf_rd_s=center-2&pf_rd_r=0CNDF9VERBMYQDF1Q9HW&pf_rd_t=101&pf_rd_p=1688200382&pf_rd_i=507846 Although I think legislation is unlikely it is worth bearing in mind that these machines are made to be extremely addictive.

 

So I take it you play? I do too. What do you mean by pool segregation? PokerStars obviously has something of a better business, bigger rake, etc but IPoker network seems a pretty effective way to combat PokerStar's huge share.

[yadayada]

v interesting, you seemt o know your stuff on this :) .

 

I used to play for several years. I badly worded it, but countries in europe are now limiting play within their borders by regulating it. It should in theory be bad for the games, especially if the rake is increased by alot in some situations. And segregating good and bad players, and removing high stakes shows how bad it is getting for all rooms really.

 

I do remember that microgaming had a reputation problem with pro poker players. They badly managed all the seperate poker skins, and some even managed their own money. Which went wrong a few times resulting in players losing large deposits sometimes. And microgaming not really doing anything to make up for it.  I don't think the software was really bad, but their marketing wasn't really up to par compared to what sites like 888 and ipoker i guess did.

[cr6196]

I wish! If I knew my stuff I wouldn't have lost money. I am very interesting in online gambling though as I think the trend has a bit further to run, probably in casino and sportsbook.

 

Yes, I didn't actually realise how big this was. It looks like (in order of importance) France, Spain, Italy, and Sweden (maybe 10k players overall, about half of PokerStars regular player pool I think) are the major ones. I wondered why all the high stakes Swedish players lived overseas? Another issue is possibly tax, the UK is generally friendly in this regard as gambling winnings aren't taxed. The argument here is then that if you segregate markets the total volume of players is less than it would be if those barriers weren't in place...I think I agree with this, the market share of PS (~50+% I believe) suggests that being the largest is a significant advantage. So there is a volume issue which does look to inhibit the profitability of this line. However, if you are running a casino then the cost/marketing synergies with poker are probably substantial. I think you can actually use the numbers from pokerscout to work out how much rake IPoker produces...they have the same number of players as 888, 888 did $90m rake in 2012 for poker so presumably it is around the same level for IPoker. That would suggest there isn't much profit in it.

[yadayada]

Earnings were down due to bad luck with their sports book. And double charges in their online business:

Ladbrokes also hinted that sports results hadn’t been going their way either, not helping with picking up forward momentum. Another factor which has stifled summer profits has been for example, Match Day One of the Champions League, where 15 of the 16 favourites won and in the Premier League the number of draws which has happened (a result which is generally favourable for the bookmaker) is down 35% from last year.

 

Both one time events really. And the market is really being shortsighted and results oriented here.  So even if online doesnt materially improve, and they return to their old 2012 levels (which seems very likely) and would get a 10x multiple on that, there is about ~30% upside at the very least this year.  If online starts showing signs of succes, and they can even get maybe 190-200 million in earnings this year, then it would yield more like a conservative 12x multiple. Which would imply a ~65% upside this year.

 

If online turns out to be wildly succesfull, it might even go higher to 100-150% upside this year and next year. Because online yields a higher multiple?

 

So I guess it all comes down to how much regulation will mess this up, and that seems to be the only risk here really. William hill is getting a 11x multiple, but half their earnings come from online. Their retail has a pretty similar size (in revenue at least). So they are almost as depressed as ladbrokes really.

 

It is pretty easy to put odds on them returning at least to 2012 earnings (very likely), squeezing a bit more money out of online second half of 2014 (also pretty likely). So not factoring in regulation risks here, it seems likely this idea has nice upside in the very near future.

 

But I find it hard to figure out how likely regulation is exactly. THe market seems to think it is a serious risk. Is it very likely? Highly unlikely? Their tax rate is ridicilously low. Seems to be a serious risk that one way or another the government will do something here. Since these companies really increase problem gambling with their in your face shops and advertising. 

 

ANd if regulation is a serious risk, that kills almost all the upside really.

[cr6196]

Earnings were down due to bad luck with their sports book. And double charges in their online business:

Ladbrokes also hinted that sports results hadn’t been going their way either, not helping with picking up forward momentum. Another factor which has stifled summer profits has been for example, Match Day One of the Champions League, where 15 of the 16 favourites won and in the Premier League the number of draws which has happened (a result which is generally favourable for the bookmaker) is down 35% from last year.

 

Both one time events really. And the market is really being shortsighted and results oriented here.  So even if online doesnt materially improve, and they return to their old 2012 levels (which seems very likely) and would get a 10x multiple on that, there is about ~30% upside at the very least this year.  If online starts showing signs of succes, and they can even get maybe 190-200 million in earnings this year, then it would yield more like a conservative 12x multiple. Which would imply a ~65% upside this year.

 

If online turns out to be wildly succesfull, it might even go higher to 100-150% upside this year and next year. Because online yields a higher multiple?

 

So I guess it all comes down to how much regulation will mess this up, and that seems to be the only risk here really. William hill is getting a 11x multiple, but half their earnings come from online. Their retail has a pretty similar size (in revenue at least). So they are almost as depressed as ladbrokes really.

 

It is pretty easy to put odds on them returning at least to 2012 earnings (very likely), squeezing a bit more money out of online second half of 2014 (also pretty likely). So not factoring in regulation risks here, it seems likely this idea has nice upside in the very near future.

 

But I find it hard to figure out how likely regulation is exactly. THe market seems to think it is a serious risk. Is it very likely? Highly unlikely? Their tax rate is ridicilously low. Seems to be a serious risk that one way or another the government will do something here. Since these companies really increase problem gambling with their in your face shops and advertising. 

 

ANd if regulation is a serious risk, that kills almost all the upside really.

 

On taxes...http://news.sky.com/story/1129538/online-gambling-firms-to-pay-15-percent-tax-in-uk

 

I have already said a bit on this so I won't go on about it but I just thought I could add something about marketing. Marketing is obviously a huge expense for these companies (often more than operating costs) and as gambling is tolerated culturally here marketing is really very in your face. It started with live odds being shown before/in the middle football (soccer) matches and now Bet365 are actually advertising during the start of the match (when the teams line up and shake hands). This was probably partly because the new entrant to sports broadcasting needed advertising but anyone who watches sports now notices how much advertising these companies are doing. Again, regulation seems unlikely but this really heavy marketing is a new development and draws attention to the industry in a negative way.

[yadayada]

what happened? Why did it drop so much? a 5% tax increase causes a 15% drop?