The results presented by gaming and wagering giant Tabcorp on Thursday underline why the competition regulator should reverse its 10-year-old decision to block a merger with Tatts.
While these two companies would dominate the traditional TAB businesses, these retail betting outlets have been the victim of massive disruption from digital operators. The results, which were below expectations, demonstrate more clearly than ever the size of the growing wave of competition
Tabcorp has its own digital business that is growing strongly but, unlike the physical outlets, there is increasing competition from numerous operators.
Retaining a legacy business is still important for Tabcorp but it comes with retaining a cost base that the new punting businesses don't have.
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Tabcorp recognised years ago that it needed to innovate – an exercise that is costly.
New products and plenty of marketing are part of the plan to, for example, boost the flagging revenues from its Trackside betting venues.
Capital expenditure and operational expenditure are on the rise. It also needs to acquire new businesses.
Buying Tatts, which has a very successful lottery business, is a sensible way to diversify earnings. And getting its hands on Tatts – which owns TABs in Queensland, NT, South Australia and Tasmania – will give Tabcorp an almost complete box set across the nation and around $130 million of cost-cutting gains.
Tabcorp sounds pretty upbeat about its chances of getting competition regulatory approval from the Australian Competition and Consumer Commission. But it's rare to find a corporate predator that isn't.
There is also the additional risk that another party could make a bid for Tatts. Tabcorp has already seen one competing consortium led by Macquarie Group. There is talk that another is swirling around but realistically it is hard to see how another group could better the offer for Tatts from Tabcorp.
(The Macquarie consortium has yet to concede defeat and is said to be waiting on the results from Tatts and Tabcorp before making a final decision.)
It has also been busy acquiring businesses that add to its gaming services division and only a few months ago set up a online gaming business in Britain.
As a start-up operation, Britain's Sun Bets was quite the corporate punt. It is a big market but crowded with competition and (not surprisingly) loss making.
And Tabcorp suggests this will continue in the second half of the financial year – thus continuing to be a drag on the group results.
It appears that the analysts had not factored in losses of this magnitude from Sun Bets.
The group's largest division, wagering and media, didn't perform particularly well in the first half to December 31. After backing out positive contributions from lower amortisation and depreciation costs, its profits fell slightly due to poor trackside and Luxbet performances.
Other parts of the business are growing but they are smaller and many operate with slimmer margins.
It was a result that clearly disappointed analysts and investors, who had sold the stock off more than 4.3 per cent by lunch on Thursday.
They would have been additionally frustrated by the meagre outlook statement on the full-year performance, however, it did not change its previous guidance. On Thursday Tabcorp said only that it expected to see the returns on invested capital come in at 14 per cent in 2017.
Investors have been generally supportive of the Tabcorp merger with Tatts and would be concerned if the ACCC took the view that it would significantly lessen competition.
CLSA analyst Sacha Krien reportedly said the result was "messy" and missed his forecasts. He said Tabcorp had disappointing growth in wagering and higher than expected significant items.
Citi noted that the first-half result "excluded a $21.3m/$22.8m EBITDA/EBIT loss from SunBets, which has been treated as a significant item and is much higher than we had anticipated (we had assumed a -$2m EBIT impact above the line, hence we clearly underestimated the impact of start-up costs etc)".
The costs already spent on the Tatts merger and last year's acquisition of INTECQ added up to $13.2 million, and when the Sun Bets losses and regulator legal proceedings are thrown in, the total "significant items" for the half were more than $43 million.
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