A Bet on Betting Itself

By David Dittman • May 17, 2012

What to Buy: Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF, ADR: TACBY)

Why Now: Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF, ADR: TACBY) is an Australian wagering, gaming and Keno operator with a media unit attached to it. It’s one of the biggest publicly trading companies in the world. Based in Melbourne, Tabcorp was formed in 1994 from the privatization of the Victorian Totalizator Agency Board (TAB).

The stock has been in a long downtrend, falling from an May 4, 2007, all-time closing high of AUD8.08 on the Australian Securities Exchange (ASX) to an all-time closing low of AUD2.48 on Oct. 4, 2011.

The downside has been particularly steep since April 2008, when the government of the Australian state of Victoria changed the way it awarded gaming licenses, shifting from an effective duopoly where Tabcorp and competitor Tatts Group Ltd (ASX: TTS, OTC: TTSLF) held exclusive rights to own operate poker machines to a system based on awarding licenses to venues.

The event Australians refer to as the “Great Financial Crisis” impacted gaming and wagering activity Down Under, and the company’s announcement of a structural separation created additional uncertainty. Always looming is the threat of government in what is a highly regulated segment of the Australian economy.

But after splitting casino and hotel operations from the core gaming, wagering and keno operations Tabcorp has posted solid if unspectacular results. Management has down-shifted its target dividend payout ratio from 70 percent to 80 percent to 50 percent to 60 percent of normalized net profit after tax, but at the same time it’s been able to focus on growing its businesses through investment and to maintain a decent balance sheet.

At these levels–it closed at AUD3.01 per share in May 17 trading on the ASX–Tabcorp is priced to yield 10.6 percent. The dividend rate does vary based on operating results and is not fixed in the manner of North American dividend-paying companies.

But revenue continues to grow and underlying earnings are healthy, even in this difficult environment. And management recently refinanced the company’s fiscal 2013 maturing debt. Tabcorp has also secured important long-term licenses over the past year, removing some of the ever-present uncertainty that comes with this territory.

The market is beginning to recognize Tabcorp’s potential. But we can still pick it up at bargain levels and lock in what’s likely to be a dividend yield well in the neighborhood of double digits while we wait. And a favorable court ruling over recovery of license fees paid to Victoria in respect of the license that was abrogated by the April 2008 decision could push the stock to AUD3.50 by year’s end. Buy under USD3.15

The Story

Big Yield Hunting is all about taking informed risks–in other words, making bets based on imperfect information. Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF, ADR: TACBY) is one of the biggest gaming and gambling operations in the world, and the stock has also been beaten down to the point where it yields double digits.

With a demonstrated ability to generate cash flow to support the dividend and reasonable prospects for solid upside–and Co-Editor Roger Conrad appearing at the Las Vegas Money Show this week–this might be the apotheosis of the BIG concept.

Roger: OK, this is almost too much irony. But I can already see your headline: “Gambling on Gamblers” or “This Month’s Game IS Gaming.”

David: I went with “A Bet on Betting Itself.” I like your style, though.

Speaking of gambling, how’s the Las Vegas Money Show going?

Roger: Hey, what happens in Vegas stays in Vegas, remember?

Actually, it’s always a great experience to meet with and talk to investors, particularly those who read and follow our stuff.

So Tabcorp certainly provides an interesting story.

David: Yeah, it listed on the Australian Securities Exchange (ASX) in 1994 as part of the first major public offering by the Victorian government of a state-owned entity. Tabcorp acquired the businesses formerly conducted by the TAB for a total of AUD77.8 million and acquired licenses to conduct wagering and gaming in Victoria for AUD597.2 million.

This latter license will be the subject of litigation between Tabcorp and the state government, which feels it doesn’t have to compensate for basically breaking a contract, once it becomes ripe in August 2012.

In December 1999 Tabcorp acquired Star City Holdings Ltd, the owner of the Star City hotel and casino complex in Sydney. In April 2000 Tabcorp bought Structured Data Systems Pty Ltd, which developed networked wagering systems, Keno systems and animated games. And in November 2003 Tabcorp merged with Jupiters Ltd, which owned three Queensland-based casinos and other gaming operations in Queensland and New South Wales.

Finally, in September 2004, Tabcorp gobbled up Tab Ltd, a New South Wales-based wagering and media company.

Roger: It sounds like the Victorian government can’t keep its hands off its old business.

David: Tabcorp shares sold off hard on the government announcement and then again later in 2008 when it announced fiscal 2008 results, which included a one-off writedown of AUD487 million as well as AUD26.5 million to be amortized from that fiscal year over each of the ensuing four. The total charge related to government changes to its license amounted to AUD593 million.

During the company’s fiscal 2008 earnings conference call then CEO Elmer Funke Kupper estimated the refund due Tabcorp from the Victorian government as a result of the latter’s action to be AUD687 million.

Tabcorp also took a AUD194 million goodwill charge that year on its wagering business, also related to the Victorian government.

In the aftermath of the Victorian government’s announcement and Tabcorp’s related writedowns the company faced the deterioration of the global economy, and it later had to issue AUD300 million of stock at a 15 percent discount to the publicly quoted price of its shares.

Well, the government that made that move is no longer in power. What was an Australian Labor Party government, led by John Brumby, was defeated by the center-right Liberal/National Coalition opposition, with Liberal Ted Baillieu at the top of the ticket and now serving as premier, in November 2010.

So Brumby, et al., paid for their sin. And Victoria may have to pay again, once the issue becomes ripe in August 2012, when the new, restructured license takes effect.

Roger: It is a good thing that Tabcorp retained at least a part–a substantial part–of its Victoria monopoly. The state government awarded a license to run wagering and betting operations for 12 years commencing in August 2012.

David: Yes, it is a good thing; the only thing it doesn’t have anymore is the almost exclusive right to run basically poker and other electronic gaming machines (EGM), licenses for which now must be held by venues such as hotels and bars.

And Tabcorp beat out Australian rival Tatts Group Ltd (ASX: TTS, OTC: TTSLF) as well as UK-based giant Ladbrokes Plc (London: LAD, OTC: LDBKF) to keep what remains a big foothold in Victoria.

It did pay a AUD410 upfront premium for the license, which according to the Victorian government, “allows the licensee to conduct pari-mutuel and fixed odds betting, operate the only off-course retail network in Victoria, establish and operate a Betting Exchange in Victoria to support account-based betting and conduct approved simulated racing events.”

Roger: At AUD410 million that’s about AUD34 million for each year of the new license, cheaper than the AUD53 million per year paid for the expiring license but no longer inclusive of poker machines and revenue from other “gaming” interests.

David: About the AUD687 million in refunds Tabcorp believes to be due because of the cancellation of the old, as yet unexpired licenses: Litigation won’t start until after the April 2008 ruling comes into effect later this year, but based on what I’ve read the odds are about 50-50 it will make some kind of recovery.

There’s the possibility of modest to substantial upside based on this issue.

Roger: Judging from what’s happened in the recent past it’s fair to say government is an unpredictable yet ever-present potential threat.

David: Right, so there is a form of “certainty” there. But the current, seemingly more favorable government will be in place until at least November 2014, when the next state election is scheduled to take place.

But that’s not the only source of skepticism about the stock.

Roger: Last June it de-merged its casinos operations and spun them off as Echo Entertainment Group Ltd (ASX: EGP, OTC: EHGRF). That caused a little upset in the market.

David: And now Echo is the subject of a pretty hot potential takeover battle between casino/gaming company Crown Ltd (ASX: CWN, OTC: CWLDF, ADR: CWLDY), controlled by billionaire James Packer, and Perpetual Ltd (ASX: PPT, OTC: None), an investment management company.

Roger: The separation was announced in October 2010, at which time the company also said it would reduce its target dividend payout ratio from 70 percent to 80 percent to 50 percent to 60 percent of normalized profits.

David: And when the de-merger was approved by shareholders on Jun. 6, 2011, Tabcorp shares slid more than 50 percent to AUD3.63 on the ASX. This was all about re-pricing the stock based on the casino operations no longer being apart of it.

At the same time David Attenborough replaced Elmer Funke Kupper as CEO.

The new Tabcorp includes four operating segments. Wagering, which includes “totalizator,” or “tote board,” and fixed odds wagering in Victoria and New South Wales, fixed odds betting in the Northern Territories under the Luxbet brand, and Trackside, a simulated racing product in Victoria and New South Wales, accounted for an estimated 43.3 percent of revenue in fiscal 2011. It operates through about 2,800 outlets and has 300,000 individuals with accounts.

Fiscal 2011 revenue for the unit was AUD1.569 billion, while earnings before interest, taxation, depreciation and amortization (EBITDA) was AUD288 million. Next license expirations are as follows: New South Wales in 2097, the Northern Territories in 2015, and Victoria in 2024. The latter is the new license.

Roger: Gaming is the segment where the new 12-year Victoria “wagering and betting” license is relevant, yes?

David: Yes.

Gaming operates EGMs under the Tabaret brand in Victoria until mid-August 2012.

Following the August 2012 implementation of the new regime this unit will take on EGM management services, which doesn’t promise the same kind of returns its previous monopoly did, under the Tabcorp Gaming Solutions (TGS) brand. But Tabcorp should be able to recoup some of what it’s losing, together with whatever it recovers via the Australian legal system.

This is important because Gaming accounted for a 53.7 percent share of revenue in fiscal 2011. But TGS has already signed up 8,500 EGMs. Management has forecast EBITDA from TGS of AUD55 million for the 12 months commencing Aug. 16, 2012. Fiscal 2011 revenue for the entire unit was AUD1.077 billion; EBITDA was AUD280 million.

Keno operations, with 3,300 outlets in New South Wales, Queensland and Victoria, generated fiscal 2011 revenue of AUD170 million and EBITDA of AUD61 million. This unit just secured a new 10-year license to operate as a monopoly in Victoria. There are no license expiration issues in New South Wales (2022), Queensland (2022) or Victoria (2022) for a decade.

The Media & International segment broadcasts racing on three channels plus digital media and operates Sky Sports Radio. It also rrovides wagering and pooling services in the Isle of Man via the Premier Gateway International incorporated joint venture. Fiscal 2011 revenue was AUD179 million, with EBITDA of AUD60 million.

Roger: I think it’s fair to say the market has had time to digest the coming August 2012 Victoria license/structure issue as well as the de-merger and related announcements.

David: One would hope, particularly as the company itself includes in presentations such as one made May 3 to the Macquarie Australia Conference the statement, “Post mid-August 2012, the business structure, financial profile and financial position of the Tabcorp Group will change due to, among other things, the expiry of the current Victorian Wagering Licence, the commencement of the Victorian Wagering and Betting Licence, the expiry of the Victorian Gaming Licence and a change in the regulatory regime in relation to the operation of EGMs in Victoria.”

Roger: That’s a pretty clear statement. But things on the ground, now that the company’s had a chance to settle into a more streamlined structure, appear to be working well. The fiscal 2012 third-quarter (ended Mar. 31, 2012) “trading update” was positive, and the company also refinanced its fiscal 2013 debt in recent weeks.

David: Tracking back to fiscal 2012 first-half results, net profit after tax (NPAT) for continuing operations–excluding the casino assets–was AUD189.3 million. NPAT for the prior corresponding period was AUD265.5 million, but this included AUD99.6 million from the demerged casino business.

On a comparable basis NPAT was up 14.1 percent from AUD165.9 million. And the prior year numbers include the full weight of the Tabcorp Echo debt, factored into the interest numbers, which was substantial. Getting rid of this burden will help going forward.

Management’s preferred metric for growth measurement of the underlying business is earnings before interest and taxation (EBIT) from continuing operations, and this was up 5.6 percent to AUD316.9 million. Earnings per share on a continuing operations basis of AUD0.2609 was up 3.5 percent, and Tabcorp declared an interim dividend of AUD0.13 per share.

Roger: That’s right in line–but on the low side–with the policy laid out with the original de-merger announcement.

David: I think it’s important too that positive revenue trends that emerged in the first half of fiscal 2012 continued into the third quarter, despite the apparent deterioration of global economic conditions. Total revenue from Jan. 1 to Mar. 31, 2012, was AUD724 million, up 2.7 percent on the prior corresponding period. And total revenue for the year to March 2012 was AUD2.297 billion, up 2.8 percent.

Roger: Net debt is hefty at AUD1.233 billion. But interest coverage of 4.2 times for fiscal 2011 was solid. And there are now no maturities until fiscal 2014, which begins Jul. 1, 2013, and runs to Jun. 30, 2014.

Any qualms about recommending a company that stands to benefit from vice?

David: Well, we’re all adults here. And in 2010 Tabcorp was recognized through the Dow Jones Sustainability Index as a global leader in promotion of responsible gambling. That was actually a requirement of the Victorian government as part of the bidding process for the new, restructured license.

More important, the stock is cheap relative to other publicly traded companies in the Australian and the global gaming and gambling industry.

Roger: Sounds like pretty good bet to me.

David: Exactly. Tabcorp Holdings is a buy under USD3.15 on the ASX or using the US over-the-counter (OTC) symbol TABCF for riverboat gamblers with plenty of risk capital to put at work on a high-risk play subject to several potential variables. The US OTC-traded American Depositary Receipt (ADR), which is worth two ordinary, ASX-listed shares, is a buy under USD6.30.

Open Positions Closed Positions

Stock Talk

Comments Guidelines

Add New Comments

You must be logged in to post to Stock Talk OR create an account