Good reasons for Tabcorp to sell its Wagering & Media division

Australian gaming giant, Tabcorp Holdings (ASX:TAH) has received unsolicited, confidential, non-binding and highly conditional proposals to buy its Wagering & Media division. I think a demerger makes sense for Tabcorp, and its investors, as it would leave the company as a leaner, almost pure play lotteries business.

One of the potential buyers is Entain Group, owner of Ladbrokes, Neds and other overseas wagering brands, which has confirmed it had put a non-binding indicative offer to Tabcorp for its Wagering & Media division. Two press reports also named private equity firms Tanarra Capital and Blackstone as also having put proposals to Tabcorp. Tanarra later released a statement that the report in which it was named was false and misleading and had no basis in truth.

This is not the first time a breakup of Tabcorp has been proposed. In 2017, there was a push to demerge the Lotteries business that was acquired by Tabcorp as part of the merger with Tatts Group. Additionally, in November 2020, press articles suggested Matthew Tripp had been approached by private equity firms to launch a bid for the Wagering business.

A demerger makes sense given that there is little operational, systems or product overlap between the Wagering & Media business and the Lotteries & Keno operations. Additionally, the competitive dynamics in the respective markets are completely different with Lotteries & Keno essentially monopoly operations, while the Wagering business is under ongoing competitive pressure from international operators that enjoy a variable cost advantage. While the introduction of race fields fees and point of consumption taxes have reduced the variable cost advantage of the international challengers like Flutter (Sportsbet), Entain (Ladbrokes, Neds) and bet365, Tabcorp has not been able to halt the decline in its market share as consumers move from the traditional retail channel to online account betting.

The acquisition of the Wagering & Media division offers the opportunity for Entain or one of the other smaller operators in Australia to step change their scale in the Australian market. This provides scale benefits in terms of overhead and technology/product development costs. The division had $454 million of operating costs in FY20 in addition to the direct costs of taxes, racing industry payments, broadcast rights, venue commissions, depreciation and lease costs. This represents a large pool of costs from which the acquirer can generate synergies and improve business efficiencies.

The other opportunity sits in the Media part of the division. This is essentially Sky Racing, which owns most of the broadcast rights for Australian racing product. The ability to leverage these rights into the acquirer’s wagering operations in other countries could provide some upside to both the overseas wagering operations and Sky Racing itself.

The wagering operation is a capital light business and, as such, highly cash flow generative. The strong cash generation of the business would be attractive to private equity funds, particularly if the performance of the business could be improved such that revenue growth accelerates and the negative working capital, resulting from the payment of racing fees, taxes and commissions in arrears, releases capital from the balance sheet at an accelerated rate.

Of course, there would be some considerable hurdles for a bidder to overcome, with approval from various state governments and racing bodies required. Given that Tabcorp pays a higher rate of tax and racing fees per dollar of wagering revenue, both of these stakeholders should be positively disposed toward a new owner that could turn around its downward market share trajectory and therefore improve the outlook for their future funding payments. But the politics of the various racing codes, clubs and bodies are never simple to navigate.

If Tabcorp were to negotiate a sale of its Wagering & Media division at an attractive price, it would leave the company as an almost pure play lotteries business, offering a near monopoly on both live and periodic lotteries in most parts of Australia. The Lotteries and Keno businesses are highly cash generative businesses, with strong scale advantages and long licences (excluding VIC).

The company also operates its small TGS gaming machine services business, but it is likely that once Wagering & Media is separated from Tabcorp, the company will also look to divest TGS.

The remaining high quality and relatively a-cyclical revenue stream of the Lotteries business would be highly attractive to those looking for annuity style income streams, and could be expected to be positively re-rated once it becomes a pure play asset.

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