Where’s The Value Post Tabcorp De-Merger?

This story features TABCORP HOLDINGS LIMITED. For more info SHARE ANALYSIS: TAH

– Tabcorp completes de-merger of Echo Entertainment
– Brokers question value in both entities
– Assuming no M&A activity both stocks appear fully priced

By Chris Shaw

Tabcorp ((TAH)) has completed its de-merger, with the gaming and casino assets commencing trading as separate entities yesterday, as Tabcorp and Echo Entertainment Group ((EGP)) respectively. Following the de-merger a number of brokers have been quick to update their models and views.

For Tabcorp, there has been one associated downgrade in rating, RBS Australia cutting its recommendation to Hold from Buy. RBS now sees Tabcorp as a play on the outcome of the Victorian wagering and betting licence awarding process, as well as the longer-term outlook for wagering in general.

The Victorian wagering licence is expected to be awarded soon and Tabcorp is a strong favourite, but as RBS points out, the general wagering outlook is somewhat problematic given strong competitive pressures.

Macquarie agrees, expecting wagering will continue to face challenges from the growth in online-led corporate bookmakers. As wagering represents two-thirds of the new Tabcorp, such issues are likely to play on share price performance in Macquarie's view.

As well, Macquarie notes a number of Tabcorp's licences are short-dated in nature, which introduces some valuation concerns. This is particularly the case given the Tabcorp share price is well above Macquarie's $2.80 per share valuation.

On the positive side RBS suggests the current environment could drive consolidation in the sector, with one possibility in the broker's view being a joining of the operations of Tabcorp and Tattersalls ((TTS)).

But Deutsche Bank is less positive on the potential for such corporate activity involving Tabcorp, largely due to valuation issues. On Deutsche's numbers, the de-merger has left Tabcorp a smaller, more highly geared entity, meaning at current levels the stock is trading at an 18% premium to the broker's valuation of $2.85. This suggests Tabcorp is not a highly attractive shorter-term target.

For both Deutsche Bank and Macquarie the valuation issue means Tabcorp is rated as a Sell, which compares to Hold ratings for RBS, JP Morgan and Goldman Sachs. The latter sees some value starting to emerge at current share price levels, but would prefer to wait for the Victorian Wagering Licence decision before making any adjustment in rating given the importance of the decision to Tabcorp's earnings.

JP Morgan adds the cost of the licence assuming Tabcorp wins will have a major impact on valuation for the company. On a de-merged basis, share price targets for Tabcorp range from $2.80 to $3.50, which suggests the stock is fully priced at current levels. Tabcorp today is trading down 19c at $3.16 as at 11.30am.

Turning to Echo Entertainment, Goldman Sachs suggests the key issue shorter-term will be driving earnings growth from the current $1.6 billion casino capex program. While management has made good progress to date and significant earnings growth is expected at Star City through FY13, Echo still looks expensive at current levels.

In the view of Goldman Sachs, the share price is factoring in not only successful execution of capex spending but a reasonable chance of Echo being involved in some merger and acquisition activity in the sector.

Echo is not a likely shorter-term target in Goldman Sachs's view as Star City will soon be ex-capex, so limiting any turnaround potential. As well, Echo will have some gearing and any potential buyer would need be prepared for what would be a large transaction. This limits the number of potential buyers.

Macquarie agrees, arguing its valuation for Echo Entertainment factors in good execution of the current capex program by management. This implies less potential for M&A upside. The other issue for Macquarie is there is better value elsewhere in the sector, as Crown ((CWN)) is trading at a more attractive medium-term earnings multiple at current levels.

The argument from Deutsche Bank is similar, with Crown being the preferred exposure given a more attractive valuation and little likelihood of corporate activity to boost the Echo Entertainment share price shorter-term.

Deutsche goes a step further than Macquarie and rates Echo as a Sell compared to Macquarie's Hold, while Goldman Sachs has also initiated coverage with a Sell rating. Goldman Sachs has a price target of $4.30, which compares to Macquarie at $4.70 and Deutsche Bank at $3.80.

Shares in Echo Entertainment today are slightly higher and as at 11.30am the stock was up 1.5c at $4.375. 

 

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