Company Reports

The abrupt resignation of Tabcorp CEO Adam Rytenskild has no impact on our outlook. The resignation, effective immediately, comes amid a probe into an allegation of inappropriate and offensive language used in the workplace. But we think the company’s fundamentals remain intact. The departure is due to personal behavior, rather than mismanagement. We make no changes to our AUD 1.05 per share fair value estimate. Shares screen as undervalued. We think the market is overly concerned about the abrupt departure, which is unrelated to business performance, and the near-term cyclical weakness facing the wagering industry.

Australian wagering volume is still coming off the boil after spiking during the pandemic. Tabcorp’s first-half fiscal 2024 EBIT fell 32% on the previous corresponding period, with operating deleverage magnifying the 5% slide in revenue. Wagering has historically proved resilient through the economic cycle, but this slowdown is shaping up to be more severe than originally anticipated. Accordingly, we lower our fiscal 2024 revenue forecast by 5% to AUD 2.3 billion, which brings down our underlying EBIT forecast 9% to AUD 105 million, a 30% fall from fiscal 2023.

We expect Tabcorp will remain unparalleled in physical wagering—stringent regulatory licensing requirements create barriers to entry to compete with Tabcorp's retail locations, such as racing venues, pubs, and TAB agencies. However, the pari-mutuel model is in decline as punters increasingly choose fixed-odds betting, and technological change means geographic exclusivity no longer translates to a monopoly.

Tabcorp has penned a new exclusive wagering license with the Victorian government. We had already expected Tabcorp to retain the Victorian license, but the terms are better than anticipated. We lift our fair value estimate by 5% to AUD 1.15 per share. The deal is a win for Tabcorp, with no joint venture partner, 20 years of exclusivity, and no industry funding obligations. Previously, the license involved a joint venture with the Victorian Racing Industry. The increase to the point of consumption tax, to 15% from 10%, will apply to all bookmakers, providing an equal footing between Tabcorp and online bookmakers such as Sportsbet.

We expect Tabcorp will remain unparalleled in physical wagering—stringent regulatory licensing requirements create barriers to entry to compete with Tabcorp's retail locations, such as racing venues, pubs, and TAB agencies. However, the pari-mutuel model is in decline as punters increasingly choose fixed-odds betting, and technological change means geographic exclusivity no longer translates to a monopoly.

With softer wagering activity, competition is heating up for Tabcorp. Revenue was down about 6% in the first quarter of fiscal 2024, with revenue declines across all segments. We expect weaker wagering activity to have an outsize impact on earnings as Tabcorp is forced to increase promotional spending to retain share. Punters show little loyalty to bookmakers and increasingly compare odds online before placing bets. We lower our fiscal 2024 EBIT forecast by 20% to AUD 129 million—a 14% decline on fiscal 2023.

We raise our fair value estimate for no-moat Tabcorp by 5% to AUD 1.10 per share following fiscal 2023 results. Underlying EBIT more than doubled from pro forma fiscal 2022 (excluding the now-demerged Lottery Corp) to AUD 151 million, about 1% ahead of our forecast. Tabcorp rebounded strongly from COVID-19 closures in fiscal 2022, which weighed on TAB wagering and revenue linked to electronic gaming machines. The valuation uptick reflects increased confidence in the company's cost-out program and the time value of money.

In a Nov. 18 submission to a parliamentary inquiry on online gambling, Tabcorp noted the efficacy of consumer protection initiatives is limited "without addressing the fact there is too much gambling advertising." This echoes the firm's view over several earnings calls that there should be further restrictions on gambling advertising, including when and where advertisements can be aired or shown. For the purposes of the inquiry, Tabcorp's submission makes sense: there is a strong link between advertising and an increase in gambling activity. While this approach may appear odd for a gambling company, we don't think it is a purely selfless endeavour: more advertising merely equates to more competition. We think tighter restrictions on advertising would favour the most recognisable brands: Sportsbet and TAB. We estimate Sportsbet and Tabcorp together represent more than 80% of the betting market, with Sportsbet leading share in online betting, and Tabcorp a close second after including retail venues.

The upcoming demerger of The Lottery Company, or Lottery Co, from Tabcorp allows shareholders to invest directly in the latter's crown jewel. We raise our fair value estimate for shares in the combined Tabcorp entity to AUD 5.00, from AUD 3.80 previously, following a fresh look at the competitive positions for the two separate entities. The raise is based principally on a lower cost of capital assumption and assigned moat rating for The Lottery Company, which we expect to thrive once liberated from the beleaguered wagering and gaming services businesses—more than offsetting additional one-off and ongoing costs following the demerger.

We maintain our AUD 3.70 fair value estimate for shares in no-moat Tabcorp following a trading update for the first quarter of fiscal 2022. Both the wagering and gaming services divisions waned as venues remained closed for much of the period--particularly in New South Wales and Victoria--dragging first quarter group revenue down 7% on the prior corresponding period, or PCP. By contrast, the lotteries and keno business (which generate the majority of earnings) remained broadly flat, with 1% revenue growth in lotteries--not materially impacted by shutdowns--offset by a 19% decline in keno. We lower our group fiscal 2022 EBITDA forecasts by 5% to AUD 1.1 billion. But with restrictions easing and the country gradually reopening, we see these as short-term headwinds, and our longer-term forecasts are broadly intact.

Amid increasing uncertainty around the future of the beleaguered wagering and media business, shares in no-moat Tabcorp remain overvalued. Entain's increased offer of AUD 3.5 billion (from AUD 3 billion previously) for the wagering and media division appears to more fairly value the segment, marginally ahead of our preliminary valuation of around AUD 3.2 billion, but not enough for Tabcorp to halt its strategic review. Indeed, there are hurdles--the board is yet to assess the proposal, which is highly conditional, and we anticipate regulatory obstacles. Given current uncertainty around ownership structure with the ongoing strategic review, we continue to value Tabcorp on a standalone basis and maintain our AUD 3.40 fair value estimate.

With significant barriers to new competitors, we expect Tabcorp will continue to dominate the Australian lotteries landscape. Tabcorp's lotteries are underpinned by long-dated, state-based licences throughout Australia (with the exception of Western Australia)--an enormous scale which adds a degree of earnings certainty. Even when Tabcorp's state licenced exclusivities end, we expect the scale of the business is such that new entrants will find it extremely hard to compete against Tabcorp's distribution network and national jackpot pool size. We also expect the firm will remain unparalleled in physical wagering--stringent regulatory licensing requirements create barriers to entry to compete with Tabcorp's retail locations, such as racing venues, hotels, and TAB agencies. However, the pari-mutuel model is in decline as punters increasingly choose fixed-odds betting, and technological change means geographic exclusivity no longer translates to a monopoly.

We maintain our AUD 3.40 fair value estimate for shares in no-moat Tabcorp following release of interim fiscal 2021 results. Underlying NPAT slipped 3% compared with the previous corresponding period, or pcp, to AUD 207 million. Retail closures weighed heavily on the gaming services and physical wagering businesses, only partly offset by strong digital growth in wagering and continued lottery performance. We lift our fiscal 2021 NPAT forecast by 2% to AUD 336 million, principally due to improved lotteries outlook. But our long-term forecasts remain broadly intact and we forecast an EPS CAGR of 14% over the five years to fiscal 2025.

With significant barriers to new competitors, we expect Tabcorp will continue to dominate the Australian lotteries landscape. Tabcorp's lotteries are underpinned by long-dated, state-based licences throughout Australia (with the exception of Western Australia)--an enormous scale which adds a degree of earnings certainty. Even when Tabcorp's state licenced exclusivities end, we expect the scale of the business is such that new entrants will find it extremely hard to compete against Tabcorp's distribution network and national jackpot pool size. We also expect the firm will remain unparalleled in physical wagering--stringent regulatory licensing requirements create barriers to entry to compete with Tabcorp's retail locations, such as racing venues, hotels, and TAB agencies. However, the pari-mutuel model is in decline as punters increasingly choose fixed-odds betting, and technological change means geographic exclusivity no longer translates to a monopoly.

Tabcorp operates three segments. The ostensible spread belies the fact that the wagering (providing betting services) and media (providing racing pictures to complement betting services) division generates more than a third of the group's earnings. The wagering business consists of state-based, licensed monopolies to offer off-course totalisator and fixed-odds wagering in a retail environment in Victoria and New South Wales on thoroughbred and greyhound racing, as well as live sporting events. The merger with Tatts during 2017 has seen Queensland, South Australia, Tasmania, and the Northern Territory added to the list, and we believe the combined entity will be substantially better placed to meet the growing competition that traditional brick-and-mortar wagering is facing from digital-only competitors. This certainly justifies our narrow moat rating on Tabcorp.

Tabcorp released a positive third-quarter fiscal 2014 trading update, reporting growth in total wagering revenue of 2.7% relative to the prior corresponding period, or pcp. This follows a 0.7% decline in the first half and a 4.8% decline in fiscal 2013. Positively, Tabcorp also saw a slowdown in the rate of turnover decline at retail outlets, down 0.6% albeit against a very weak pcp. Revenue through digital channels accelerated in the quarter from the first half, and up 20% against the pcp. Quarter fixed-odds revenue was also stronger, up 21.4% from against pcp, though, as expected, momentum is beginning to slow.

Narrow moat-rated Tabcorp Holdings reported first half-fiscal 2014 results broadly in line with consensus expectations. Underlying earnings before interest tax depreciation and amortisation, or EBITDA, rose 5% to AUD 244 million. Underlying net profit after tax was up 4%, to AUD 75 million. The results highlight the slightly lower short-term earnings risk of Tabcorp's wagering business relative to other gaming segments, such as casinos. This is not to ignore the longer term structural challenges facing Tabcorp's wagering operations, in particular customer preferences shifting from retail to digital distribution channels. Digital platforms, including Mobile and Online, reduce barriers to entry and have encouraged large offshore competitors to enter the market.

Narrow moat-rated Tabcorp provided a first quarter update largely in line with our expectations. Slower consumer spending continues to hamper keno revenue while changes in the revenue share structure with Victorian Racing lowered wagering revenue. Excluding the change to the Victorian Racing revenue stream, wagering revenue increased 5.4%. While group revenue growth of 3% is slightly below our forecast of 5%, we leave our full-year forecasts unchanged, as we expect stronger growth in the key racing periods in the second and third quarters to offset the slower first quarter.

Tabcorp's fiscal 2013 results were in line with our expectations. Net profit was AUD 137 million, compared to our AUD 144 forecast. There is no change in our long-term view on the stock and we expect the wagering and Keno operations to generate low but steady growth. Our narrow economic moat rating is also intact.