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Winning Post 20 – 05 -16

UK LBOs – Party Like its 1999?

Today the UK CMA gave its provisional findings and remedies for the proposed Ladbrokes-Coral merger (see our summary below). Based upon the phraseology of the reports and press release, it appears as though the CMA is minded to allow the merger on a local divestment basis (c. 350-400 shops). However, the merger is not a ‘done deal’ yet by any means, with further submissions requested and a potentially tricky issue which could involve the (naturally apolitical) approval of the Secretary of State for Business – due to undertakings made in at the last attempt in 1999.  However, while focus is naturally on ‘will it and if so how’, the process has also thrown up a wealth of data, analysis and opinion on the state of the UK betting market. We will be examining this data in some depth over the coming weeks in blog form, but here are a few early thoughts.

Channel shift is not yet immediately disruptive

The CMA report recognized that (betting) channel shift from LBOs to online has been material over time, but it estimated that direct channel-shift due to lessening of competition (or ‘diversion’) was likely to be only 10% out of a range of 6-14%. This reinforced the CMA’s analysis that the LBO market is still a different one to online. This may surprise some, but it should not: LBOs still have an appeal which is different to online, in terms of cash, atmosphere and ‘escape’. Product usage is also different (eg, football in-play vs. coupon; greyhound mix; horseracing quality mix). This speaks to the long-term resilience of the core retail customer base (as distinct from the LBO business model).

Innovation is lacking

The CMA’s comments on innovation could not be more damning – highlighting a total lack in the sector. This should be a call to arms for operators and suppliers alike: the retail customer base might be resilient but that does not mean they can be taken for granted. Channel shift might not result from a merger, but it is still happening – even 5% annual shift represents a c. £70m transfer of value. Complacency around retail resilience has caused a fragile eco-system, given the high fixed cost base and (near total) lack of differentiation or development in the offer: resilience and decline are not mutually exclusive, and the LBO sector does not have long to realize it is not still 1999 (ex FOBTs) before structural issues become immediate problems.

The sector is still opinion-led

One of the most interesting issues to come out of the many submissions to the CMA during this process is the extent to which the evidence can support quite significantly conflicting opinions. Naturally, that is often the nature of evidence, especially when being used to support a position. However, it also highlights a wider sectoral problem: many operators and commentators still start with a strongly held opinion and then find the evidence to fit. This is a key reason for the structural issues alluded to above. The UK LBO sector needs to become more cognizant of the value of its offer within a wider marketplace, more innovative, and more data-driven, if it is to drag itself into the 21st Century. If it succeeds in doing that, it will continue to be a successful market for many years to come.

UK: In Parliament: All Quiet on the FOBT front?

Parliamentary process and larger affairs of state meant that it was a relatively quiet week for gambling in Westminster. Perhaps the most notable development was a salvo fired off from the newly-formed All Party Parliamentary Group for Fixed-odds Betting Terminals.

The group, which appears to have attracted a healthy (or perhaps unhealthy – depending upon one’s perspective) number of MPs, petitioned the Government on: the timing of the Triennial Review; the need to apply the ‘precautionary principle’ to harm from machines by reducing B2 stakes to a maximum of £2 per spin; to implement whatever other harm prevention measures are considered necessary, and; to effect suitable anti-money laundering controls.

Details of changes to anti-money laundering regulations in relation to gambling are expected from HM Treasury next month, while material progress on the Triennial Review now appears unlikely until after the EU referendum and summer recess – by which time Tracey Crouch is expected to have resumed her ministerial responsibilities for the sector (pending any post referendum reshuffles).

Meanwhile in the Lords, the Liberal Democrat peers, Lord Foster and Lord Clement-Jones lamented the absence from the Queen’s Speech of any plans to tackle FOBTs. Lord Foster – a persistent critic of machines in betting shops during his Commons career – also invited the Government to comment on the timing of the Triennial Review.

The Bishop of St Albans has become the latest peer to submit a Private Members’ Bill to give local authorities greater power to refuse licensing permission for FOBTs. The bill will begin its uncertain passage on 13 June.

UK: Gaming: Reality Checks

William Hill has this week taken the decision to temporarily remove a number of remote casino games, due to the games not yet offering the “reality check” functionality that is expected in the Gambling Commission’s most recent Remote Gambling & Software Technical Standards update. The provision in question, RTS requirement 13B, which took effect from 30 April 2016, requires:

“The gambling system must provide easily accessible facilities that make it possible for customers to set a frequency at which they will receive and see on the screen a reality check within a gaming session. A ‘reality check’ means a display of the time elapsed since the session began. The customer must acknowledge the reality check for it to be removed from the screen.”

The reality check should appear at selected time intervals, should allow the player to exit the game, and should link to the player’s account history.

The implementation of such a system isn’t trivial, especially given that a number of major operators use multiple gaming suppliers, meaning that a session could be played out across games from different suppliers, so the session will have to be tracked separately, likely by the operator. We would therefore expect to see other operators following a similar path to William Hill over the coming weeks.

This case highlights the importance for all suppliers to be aware of upcoming regulatory requirements in every jurisdiction that their customers operate. Whilst any individual operator can partially cover the revenue gap with an alternative product, the supplier may lose all of its revenue until the products meet the required standards.

UK: Horseracing: following Best practice?

The BHA has received considerable negative media this week, after a potential conflict of interest within its disciplinary panel was uncovered. In practical terms, this could result in numerous unsafe outcomes of disciplinary procedures, and may raise the prospect of numerous appeals and litigation, going back at least two years.

Solicitor, Matthew Lohn, who chairs the BHA’s disciplinary panel, had previously advised the sport’s governing body and was allegedly asked to complete a large review of the rules of the sport – leading to the accusation of potential for bias within his job as Panel Chair. According to the Professional Jockey’s Association, this issue was uncovered over a year ago, and was brought to the attention of the BHA, who allegedly ignored the warning.

The matter was brought to the attention of the BHA again following the hearing of trainer Jim Best, who was initially banned for four years for breaches of rules concerning ‘conduct prejudicial to horseracing in Great Britain’, and ‘not running a horse on its merits.’ Mr Best’s conviction has since been quashed, with the prospect of a re-trial doubtful since it could not be considered fair after being so publicly scrutinized.

The story is important not just because of the publicity it raises but also because it is crucial that a betting sport such as horseracing must be seen not just to be strong on integrity, but to be a leader in integrity. Once the media circus is over, the incident will hopefully be used to ensure that the BHA has the ‘best’ people, the ‘best’ processes and the ‘best’ governance to oversee the ‘best’ betting sport in the world.

US: remote regulation: regulator responds to commercial pressures in Nevada…

“Gamblers make viewers, and viewers make gamblers,” the man from Station Casinos tells the regulator.

Having last month panned the DFS industry’s attempts to justify non-regulation, the Nevada Governor’s Gaming Policy Committee provides an enlightening insight into constructive regulation in its recent analysis of eSports. The committee met last week with the express purpose of debating in public whether the activity was licensable; and commenced with the state governor, in the chair, confessing his lack of knowledge about eSports to a room full of regulators, operators, and the public. Speakers from across this range of interests then identified the activity, the opportunities and the issues. Broadly these were identified as:

Activity – competition and betting based principally on four specific on-line games, each a proprietary product and arguably each a separate sport.

Opportunities – eSports attracts big, young audiences -the 10th Intel Extreme Masters event in Poland last March attracted 113,000 supporters with 36 million watching online. This resonates in Las Vegas, with an industry based on slot machines facing declining “snake person” interest.

Issues – is this in fact a sport, or a number of sports, at all (Nevada regulations define sports as “athletic events”)? Does it even need regulation? Is it clean – when bet volumes exceed prize money, as recently in S. Korea? Why no trade association? How can betting operators identify unusual betting patterns? Can players enhance performance – i.e. drugs?

Operators were able to point to the recent developments in eSports infrastructure involving, variously, eSports Integrity Coalition, which aims to establish a code of practice at the earliest opportunity; a single governing body in the new World eSports Association (WESA); and the relationship that ESL had built with Sportradar’s anti-fraud package which can indicate where match fixing might take place. They cleverly dealt with the “athletic event” challenge by fielding a square-jawed jock player rather than a pallid geek to advertise the importance of eSports players’ speed of reaction. They didn’t get onto the remote gambling issues of system integrity; nor of propriety; nor have they touched on the regulatory challenges that would arise in (non-cash-based) DFS skin betting.

The committee will return to these issues in October, after further consideration by the regulator; but the governor clearly and publicly indicated his enthusiasm for progress. It will be interesting to see if the substance of this emerging sector’s infrastructure, as represented to him, has filled out in the interim and has withstood a bit of regulatory probing.

Of course Nevada’s position in this is most unusual anyway – the State has an exemption from the federal PASPA ban on legal sports betting; and its economy is very much focused on gambling revenues, encouraging this exemplary open and constructive approach which is made fertile by the general conjunction of participant interest.  The same committee took a leading position last year on the introduction of skill gaming on slots, and is now also contemplating licensing remote casino games.

Elsewhere Nevada’s initiative in developing a pro forma inter-state remote gambling treaty “MSIGT” – intended to develop poker liquidity but unkindly nick-named Midget due to the initial counter-party, Delaware, being quite small – may pay off as exploratory discussions are proposed between Nevada and New Jersey. The two major US gambling states have (at best) failed to acknowledge each other’s prominence in the past but IF an alliance is developing it is likely due to the impending arrival of Pennsylvania Michigan and Massachusetts into the remote gambling community. Their proximity to NJ, and specifically Massachusetts proposed acceptance of out-of-state players, present a reason to combine each of NJ’s marginal on-line activity and NV’s small population in an enlarged liquidity pool.

Nevada’s confident position on DFS regulation is relevant elsewhere, with FanDuel’s reported annual losses and audit qualification on its “going concern” status due to the marginalising of their US business prospects (in spite of $250m marketing spend), as various states close them down. This may be further threatened by rumours of a federal DOJ investigation into the legitimacy of the activity more generally. What a train smash that could turn into, with two dozen states having already legitimised or conversely blocked the activity and with temporarily deferred threats of nine -digit law suits in each of Kansas and NY.

US: remote regulation: …but State by State challenged in Washington

Is it more surprising that readers of the Online Poker Review should read the whole way through the 141 page Departments of Commerce and Justice, Science, and Related Agencies Appropriations Bill, 2017 – concerned with $50bn of state funding approvals – and currently before the US Senate Appropriations Committee? Or that they should find in there one short and completely irrelevant clause intended to breathe some life back into RAWA?

They might have been tipped off but “Bitter Experience” provides the answer to both questions. The insertion is positively attributed to failed republican presidential candidate Lindsey Graham, who’s brief 2016 campaign was financed by Sheldon Adelson. Adelson has also failed a bit, five times in 2015 and counting – to introduce legislation for the restoration of the Wire Act’s effective prohibition of internet gaming.

All parties have remembered the successful implementation of UIGEA through the same Trojan Horse strategy of attachment of unsupported legislative change to undeniable but unrelated and separate draft legislation. That attempt was successful, this one still might be; but thanks to the publicity that OPR readers have given it, it seems unlikely that the “Graham” clause will survive this time, and possibly there is some collateral damage to its author’s perceived integrity and to a system that permits the statute book to be influenced by sleight of hand.

Financial updates: Ladbrokes – Coral merger: CMA provisional ruling – deal likely, on balance
The CMA has reported its provisional findings and remedies in its investigation into the proposed merger between Ladbrokes and Coral. Here is a summary of the findings, remedies and timing for next steps.

Timing

Given the need to gather further views (on findings by 13 June, on remedies by 8 June), as well as a requirement for the CMA to consider whether the Secretary of State for Business needs to give his approval to the merger (!…due to an undertaking from last time round), the CMA has extended its deadline by 8 weeks; this takes the official deadline to 19 August, but CMA hopes to publish its final report by the end of July.

Findings

The CMA’s findings on the LBO – remote market are somewhat double edged.

While it recognises some level of channel shift (migration), it estimates it to be only c. 10% of LBO customers, based upon surveys and submissions providing figures between 6 and 14%. Therefore, while online is recognised as a constraint on retail pricing (especially in terms of best odds), the CMA has provisionally ruled that online and LBOs are separate markets. Interesting, this has been arrived at entirely with reference to betting, with gaming machines not mentioned.

The CMA has also found that distance is a far bigger driver of local competition than brand (although recognising a difference national brands vs. independents; this could also be product-driven, in our view). A distance of up to 400m between LBOs still seems to be the magic figure from a local competition standpoint, with a WSS model calculating the competitive threshold in local markets to be 35% or more. Following some adjustments, this leads to 659 local markets where a Significant Lessening of Competition (SLC) is likely to take place.

However, contrary to some expectations, the CMA has raised concerns that the cumulative impact of local competition could raise SLC issues at national level. While it recognises that online is a mitigator of this, the CMA does not seem to see it as a solution in itself.

The CMA did not see entrants or market dynamics impacting these findings. Further, and somewhat damningly on innovation: “competitive interaction between the Parties was not regarded as driving innovation and the Parties themselves were not particularly innovative.”

The findings are therefore perhaps more nuanced than the headlines.
Remedies
In order to remedy these findings, the CMA has proposed two solutions, with the text and press release suggesting it is minded to favour the latter, if possible (and pending further submissions).
a) Prohibition
which the CMA described as “a comprehensive solution with very few risks in terms of effectiveness”
b) local divestiture (c. 350-400 shops – as expected in a local competition environment)
which the CMA added a number of very sensible caveats
– any disposal must be substantially completed prior to the merger taking place
– any buyer must be ‘qualified’, specifically to have some LBO experience and critical mass
– CMA would like to know whether Ladbrokes-Coral should be allowed to choose the shops or not

Financial updates: Amaya: Q1 – growth getting harder

Amaya reported a solid Q1, with revenue up 6.0% to US$288.7m and EBITDA up 8.7% to US$123.4m; key points:

– revenue growth was 14% on a constant currency basis, optically impressive but driven by mix
– mix moved materially away from poker (89% to 75%) in favour of casino and sportsbook (6% to 21%); implying poker decline of 11%, casino and sportsbook growth of 267%
– in other words this YoY Q1 growth is optically strong since increasing casino product maturity is being lapped – medium-term growth of this magnitude is likely to be much more challenging
– Growth in actives was a more muted 1.7%, to 2.5m (ie, revenue growth is yield-driven through cross-sell), with 469,000 playing casino (97% of actives played poker, suggesting c. 85% of casino players were cross-sold vs. stand-alone; or 19% of the poker base)
– Amaya estimates that its casino player base is now one of the largest in the sector, reinforcing a view that cross-sell led growth from here will be much tougher than 2015 – Q116, given the product’s rapidly gained scale (creditable, but momentum hard to sustain)
– Sports actives were an impressive 169,000, though data is not given on yield by product
– Long-term debt closed at US$2.57bn, implying an EBITDA interest cover of 3.8x and debt / EBITDA run-rate of 5.2x (punchy for a remote business, especially if external factors such as regulatory change/enforcement constrict cash flow)
– Current trading is a strong +11% (14% cc), with continued YoY casino growth on flat poker performance; the key questions for operational performance going forward are whether flat poker is sustainable, and the extent to which Amaya can penetrate the stand-alone casino and sports markets in share of wallet terms (much tougher than cross-sell)
– The company is still looking at ‘strategic alternatives’ (including an MBO from Baazov, the former Chairman and CEO who is on leave of absence while he fights insider trading charges) and is therefore not giving guidance for 2016

Financial updates: Genting UK: FY15 filings – Chinese take away

Genting UK (the holding company for Genting’s 43 UK casinos, including 4 London, and a Mayfair hotel) filed its FY 2015 results at Companies House.

Key revenue and profit figures have already been published by the parent:
– Annual revenue was down 26.5% to £228.2m (though improving in Q4)
– EBITDA losses were £27.6m vs. £47.9m profit in 2014
– pre exceptional EBIT loss of £63.2m, vs a 2014 pre ex EBIT of £29.8m
Subsidiary accounts flag the reason for the revenue drop:
– London (International) revenue fell 64% to £58.3m,
– Provincial (Home) revenue increased 12% to £163.5
Further, in an already well known development (in both senses):
– Resorts World in Birmingham opened in October, the UK’s first integrated resort casino
Genting is clearly strengthening its UK provincial presence, both organically and through major investment. Provincial revenue per casino is now £4.2m – on a par with Rank’s Grosvenor (£4.3m) – a considerable achievement given the state of the assets acquired from Stanley in 2006, demonstrating the benefit of deep pockets and a long-term view.

The results also show the (usually short-term) risks as well as the rewards of operating in the International VIP market, with London revenue per casino falling from £41m to just £15m (by comparison Rank’s more mid-market London estate grew revenue per casino by 6% to £16.7m). More specifically, Genting has always been clear that it has sought to leverage its Asian connections to bring Chinese VIPs to London, this has been disrupted by the Chinese government junket crackdown and the tightening AML procedures in the UK, but the strategy is likely to pay off over time.

Genting can also probably be fairly relaxed about London volatility since the two groups (Malaysia and Singapore) form part of a global casino network spanning Singapore, the Philippines, Malaysia, New York City, UK, the Bahamas and gambling cruises in the South China Seas. Further, a footprint will soon to be in Las Vegas and Connecticut (with an option on Miami), and possibly also in Australia. With the exception of Macau, the Gentings’ casino reach is now truly global.

Financial updates: Genting Singapore: Q1 – No Relief for Genting as Bad Debts Mount

Genting Singapore’s Q1 results (released this week) revealed continuing pain for the operator of the Resorts World integrated resort on Sentosa. Bad debt provisions and currency movements caused net profits to collapse to SG$10.8m (US$7.8m) compared with SG$62.7m during the first quarter of 2015.

The bedrock of high value ‘rolling-chip’ baccarat play upon which Singapore’s two IRs were built has crumbled in recent times in response to the Chinese government’s crackdown on junkets (similar to issues also seen in London – above). In April, Las Vegas Sands announced a sharp fall in profits on the back of declining rolling-chip income as fewer VIPs played and those who did played less.

These are tough times for Singapore’s casino duopoly. Shortly after their opening in 2010, the two properties generated roughly as much gaming revenue as the 31 casinos on the Las Vegas Strip combined. Yet whereas Las Vegas has managed volatility by diversifying revenue, Singapore had been highly dependent on small numbers of highly valuable customers.

The relative resilience of mass market gaming in Singapore (LVS continues to report progress on slots income), and the growth in non-gaming, suggests that the current woes may simply be growing pains, especially if the path shown by Las Vegas diversification can be followed. On a brighter note, the company announced that it was on-track to open a second IR in Jeju, South Korea during the fourth quarter of next year.

Financial updates: Playtech: AGM Trading Statement – growth and scale

Playtech reported trading in line with previously reported trends (up over 12% YoY, 18% cc; 2% QoQ, 7% cc; with improved commercial terms and new customers in Asia), which implies a Q1 run-rate gaming revenue of €151m.

The company also flagged a strong licensee pipeline, improved trading in financials after a business overhaul further helped by high volatility, and a ‘healthy’ number of M&A opportunities (cash balances YE2015 €857.9m); if the right M&A cannot be found then cash will be returned to shareholders.

Playtech’s broad spread of geographies (including c. 35% Asia) and licensees (+10 in 2015), combined with continued M&A and R&D (inc €31m capitalised development), means that the company is achieving market growth despite a market leading position (especially in remote real-money gaming, ex poker). While there are several disruptive challenges to the sector on the horizon, Playtech has the scale and resources to exploit rather than suffer from them if effectively deployed.

Financial updates: Sportech: AGM Trading Statement – steady performance, transformation in sight

Sportech reported that trading is in line with expectations YTD, while it is still waiting to hear whether the Court of Appeal will allow HMRC to appeal its (unanimous) favourable ruling on the £97m Spot the Ball rebate up to the Supreme Court – a decision on whether an appeal is granted will be delivered within two weeks. Key points:

– Racing and Digital is benefiting from technology investment and sales in Asia, driven by its new Singapore office (eg, new sales in Macau, Malaysia, Vietnam)
– Venues are showing continued progress; Connecticut online is up 17% YoY; Netherlands up 10% (turning around decline)
– Football pools is also in-line (no figures) with an app now launched(!), retail distribution to be improved and a tech/ops modernisation programme to be shortly completed

Financial Updates: Intralot Q1 2016 Results – transition starting to bear fruit 

Intralot has been struggling to move the needle for some time, but finally it appears that all of the actions being taken by the new CEO are starting to bear fruit. Despite the decline in revenue of 3.6% for the quarter (to €335.2m without Italy, which is now reported as discontinued), EBITDA increased 5.6% (to €47.3m, again without Italy). This is a result of a focus by the business on cost reductions. which is reflected in the EBITDA margin increasing by 1.2%.

Numbers games remain the largest revenue contributor to the business, followed by sports betting. The company using it online partnership with Bit8 and knowledge of the lottery and sports retail space will allow it to focus on the development of a universal customer experience, which should become increasingly relevant to a multi-jurisdictional, omni-channel client base.

However, the lottery and sports betting market remains extremely competitive. One cannot cut oneself to greatness, and therefore business needs to make some significant moves to remain a strategic player in the global gambling supply chain. It will be interesting to see what the next moves of the business are going to be, especially given the constraints of high debt and low share price.