UK betting: is there a future for LBOs? – Part I

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UK betting: is there a future for LBOs? – Part I

There’s a feeling that strength is determined by the size of a union. That clearly is nonsense.” Arthur Scargill

The latest delay of the UK government review of machines and TV advertising, through which the LBO sector has by far the most to lose, could be considered a potential boon for GB’s retail betting sector (see our blog: is the snap election a break for betting shops?). However, most industry participants would rather simply know the decision, however painful that may be, in order that they can move on.  Uncertainty over the future of ‘FOBTs’ has existed since before their existence was even enshrined in law and they have been on (at least) a ‘watching brief’ since. However, the recent crescendo and Review is putting a potentially highly destructive break on potential investment, corporate development and M&A in the LBO sector and all companies materially exposed to it (directly or indirectly).

Regardless of the detailed outcome of the Review, and its underlying logic (where apparent), we can state with facile confidence that it is likely to fall within three broad bands, possibly in combination depending on the nature of the change and the positioning of the operator:

  • Material but manageable: less than 5% revenue impact, c. 15% profit reduction or less
  • Significant: 5-15% revenue impact, c. 35% profit reduction
  • ‘Seismic’: 15-25% revenue impact, c. 70% profit reduction
We will not discuss the likelihood or components of each band here, suffice it to say that even a relatively mild intervention would have a material impact on sector earnings, and therefore both existing supply and future investment.

Perhaps of greater long-term importance, change is not being felt in a steady state environment. Traditional OTC is declining by c. 3% pa; SSBTs are not (yet?) a proven net growth driver (Ladbrokes has underperformed William Hill despite aggressive rollout) and machine growth appears to be stalling. Notwithstanding topline pressure, costs continue to rise.

A key cause of this is channel shift: over the last decade, OTC betting has lost c. £450m of revenue, while online has gained c. £1.3bn. However, focus on these ‘big changes’ misses a perhaps more significant point: net GB betting growth over this period is only c. 3% – roughly inflation. In other words, despite the explosion of online betting, British consumers have not materially increased the net amount spent on betting, they have simply aggressively switched channel. Given the (relatively) gradual nature of this change, the amount of short-term ‘noise’ in the data, the extent to which FOBTs have plugged the gap and the different operators who have benefited vs. lost out, the nature of this shift is often lost on both operators and commentators. Nevertheless, the shift is real and profound: in the last decade, retail betting has lost 35ppts of market share in a market growing only by inflation.

Before we appear to be beating up too much on retail bookmakers (see Tim’s companion blog for the light – this is the tunnel), it is worth flagging that this trend has been mirrored (albeit less aggressively so far) in other sectors. To provide remote mix by way of comparative example:

  • Online betting is 55% of the ‘omnichannel’ total, growing at c. 15-20% (GC data, RP estimates)
  • Consumer banking logins are already over double branch visits, exacerbating closures (FT)
  • Online general retail is 16% of total retail spend, growing at 20% (ONS)
This is therefore a consumer-wide phenomenon and it the ubiquity of mobile would suggests we have not yet found the bottom for retail, including betting.

This matters – a great deal – for betting operators for three reasons:

  • The status quo business model is probably broken regardless of regulatory intervention
  • Even with (nascent at best) omnichannel strategies, preserving ‘traditional’ market share in the structurally more profitable online sector is very tough (in fact arithmetically impossible)
  • Most betting shops are now dependent on machine revenue for profitability, with betting either a tired anachronism or (which would make founders spin in graves) provided by a third-party bookmaker in cabinet form (imagine inviting a rail bookmaker to set up in the corner)
Worse, the level of market and regulatory change probable in the short-to-medium term is likely to force a reinvention of the model far away from existing supply, and the capabilities of existing operators. On the one hand, there will be a need to aggressively cut cost: with traditional content the loser and SSBTs / B3 content the winner: this is bad for the ‘Big Three’ and also racing (on the current model), but a potential opportunity for new entrants (depending on whether the tested definition of ‘Primary Purpose’ gets tightened).  On the other hand, there will be a need to shift retail venues from transactional profit centres to customer engagement and entertainment venues. However, most retailers are struggling with this and they have typically had a far more competitive framework to cope with in the first place.

So where does this leave the sector? From a demand-side perspective, we believe there will be a need for well run and attractive LBOs for as long as we can predict. However, these LBOs will need to be materially different to the current offer and there are likely to be (far) fewer of them. In this context, it will never be ‘too late’ to adapt the model. From a supply-side perspective, a combination of channel shift and regulatory change could (stress, could) make the next 24 months an ‘extinction event’ for many GB LBOs (if not immediately, at least with clear predictability). Therefore, stakeholders should not be thinking about the potential reduction in LBOs in net terms: many (many) more may close to be replaced by new models operated by more flexible businesses.

There is no point complaining about this, or clinging to an already bygone era: failure to adapt will cause multiple micro-business failures and very possibly a few (potentially spectacular) large ones. Indeed, to be in this current state of precipitate failure given how long the writing has been on the wall for, already begs a number of difficult (or simple, depending on view) management questions. Businesses which fail to adapt will be replaced and few will mourn them – the only way to prevent them being object lessons on how not to engage with government and how not to adapt is to start radically changing thinking now.