Sandon Capital presentation on Tatts Group Limited (TTS). Tatts Group is an A$5.6bn diversified gambling conglomerate with an operational footprint in every state and territory of Australia and into the United Kingdom. The company has three related businesses that have significantly different operating models:
- Lotteries – 60% FY15 EBIT
- Wagering – 28% FY15 EBIT
- Gaming – 12% FY15 EBIT
In a nutshell, our thesis is:
- The sum of Tatts Group parts is worth significantly more than the current market price
- The Wagering businesses has strategic corporate appeal and should be separated from the Group
- The Lotteries business has attributes that are very similar to infrastructure assets and should be valued accordingly
- A free standing Lotteries business requires a refreshed Board and management to focus on growth opportunities
- The Balance Sheet provides scope for capital management
- We believe the company is worth >A$5.50/share today if separated. If growth opportunities in Lotteries are pursued and value creative capital management options are undertaken, it could be worth more
There’s a lot more detail in the attached 60-page presentation, which can be found below.
Tatts Group Limited (TTS) – Description
- Tatts Group (TTS) is a gaming conglomerate with an operational footprint in every state and territory of Australia and into the United Kingdom. The company has three related businesses that have significantly different operating models:
- Lotteries – 60% FY15 EBIT
- Wagering – 28% FY15 EBIT
- Gaming – 12% FY15 EBIT
- The company has a market capitalisation of ~A$5.6bn1
- The Balance Sheet is in good shape with net debt of ~A$656m2 and minimal other liabilities
Our Investment Thesis
- The sum of Tatts Group parts is worth significantly more than the current market price
- The Wagering businesses has strategic corporate appeal and should be separated from the Group
- The Lotteries business has attributes that are very similar to infrastructure assets and should be valued accordingly
- A free standing Lotteries business requires a refreshed Board and management to focus on growth opportunities
- The Balance Sheet provides scope for capital management
- We believe the company is worth >A$5.50/share today if separated. If growth opportunities in Lotteries are pursued and value creative capital management options are undertaken, it could be worth more
Our Investment Thesis – Sum-of-the-Parts
- Tatts Group individual parts are worth significantly more than the current market price
- The table below does not ascribe any value for TTS $197m (13cps) of franking credits
Wagering Demerger Superior to TAH Nil Premium Merger
- In November 2015, Tatts Group announced that confidential discussions had taken place between itself and Tabcorp (TAH) regarding a nil-premium merger of equals (NPM), however the two parties were unable to agree on key transaction terms
- Whilst we see the logic in putting the two wagering businesses together, we believe current TTS shareholders should retain the crown jewel – the Lotteries business – unless TAH is willing to pay an appropriate premium, and this certainly wasn’t implied in the NPM
- We believe a demerger of the Wagering business is a far superior outcome for Tatts Group shareholders than an NPM with TAH
- A demerger would also facilitate a competitive auction under the likely scenario that other parties have interest in owning TTS Wagering
- Based on comments following the disclosure of the NPM discussions, we believe TTS Board and Management had designs on creating a ‘national champion’ gambling conglomerate that would use its Balance Sheet to pursue opportunities in all forms of gaming in offshore markets
- “It would have positioned an Australian company at the forefront of the wagering space and it would have had the whole suite of products: wagering, gaming, lotteries. As the opportunities fell out around the globe, we would have been able to participate in a number at any one time. We would have been big enough to pursue multiple opportunities”
- We do not believe a combined TTS/TAH considering the acquisition of ‘a number’ of assets in offshore markets would be in the best interests of shareholders of either company
- We believe Tatts Group has a poor record of acquisitions outside of its core Lotteries competency:
- TTS outlaid >A$350m to acquire the Talarius slot machine business in the U.K. In FY15, Talarius generated A$6m in EBIT, with cumulative EBIT barely breakeven since it was acquired, an extremely poor return and in our view a waste of shareholder funds
- TTS outlaid >A$2.2bn in debt and equity to acquire UNiTAB in 2006 for a high EBIT multiple of 17.4x. We estimate the acquired businesses have grown at a paltry rate of 2% per annum1 and we expect this meager growth rate to decline further as Wagering continues to struggle and the NSW Gaming Monitoring license is renewed at lower profitability or lost to a competitor
- Given the track record of acquisitions, we question whether the current Board has the appropriate skill set
- The fact that the Board was willing to enter into discussions regarding a nil-premium merger with Tabcorp that substantially undervalues the crown jewel Lotteries business further erodes any confidence
- In contrast to its forays into Wagering in Australia and slot machines in the U.K., Tatts Group successful acquisitions have been in its core Lotteries business
- These acquired businesses were operating successfully prior to acquisition and with their monopoly position and good management of costs by TTS, profitability has improved
- The inherent strengths of the lotteries business model and the high regulatory barriers limiting competition ensure that it is difficult to diminish their profitability
- We believe that Wagering should be separated from TTS, and that TTS should then undertake Board and management renewal with a focus on the crown jewel Lotteries business
- Tatts has outlaid A$1.8bn to acquire Lotteries licences since 2007. By our estimates, these acquisitions now contribute >A$300m in EBITDA
- In contrast, TTS has outlaid A$2.6bn acquiring UNiTAB and slots assets in the U.K. By our estimates, these acquisitions now contribute <A$220m in EBITDA and these earnings look set to reduce further in the future
LOTTERIES – 60% FY15 EBIT
Tattslotto NSW Lotteries Golden Casket SA Lotteries
Lotteries Business Overview
- Tatts Group has operated regulated lotteries since 1897 and today is a licenced provider of lottery products in all Australian states except Western Australia
- The business sells products through >4,200 agents and online. In FY15, online sales comprised 10.4% of total sales
- Tatts Group is the only lottery operator that has a proprietary technology system
- 47% of the Australian adult population played a lotto game in the last 12 months. Average spend per transaction is ~A$12.50
- The business contributes >A$500m in lottery taxes to state & territory governments
Infrastructure Assets vs Lottery Assets
- Lottery concessions in Australia are state-based monopolies, very similar in structure to infrastructure concessions
- They have significant barriers to entry and provide a dominant market position for the owner
- They allow the owner to profitably operate a monopoly asset over a long duration (generally 40+ years) on behalf of a government
- The cash flows from lottery concessions have low economic sensitivity, are dependable and easily forecastable, and require very little capital investment to maintain
- An advantage of lottery concessions is that they are significantly less capital intensive to operate than infrastructure concessions
Long Dated Concessions to run a Monopoly
- Approximately 75% of Tatts Group Lotteries EBIT comes from licences that run for at least 35 years
See full slides below.
