Australia | Jun 30 2014
-Earnings upside from Qld deal
-Commitment to marketing, network
-Victorian court win delivers compensation
By Eva Brocklehurst
Tatts ((TTS)) has won big. In two consecutive days the company has had a victory in the Supreme Court of Victoria and also framed a deal with the Queensland government whereby its ascendancy in racing and wagering is affirmed.
Brokers were very positive about the news and two – Macquarie and UBS – upgraded recommendations as a result. The announcement of the deal removes an uncertainty cloud over the expiring licence in Queensland, while the victory in the Victorian Supreme Court means the compensation payment is ultimately worth 26c per share, on Macquarie's estimates.
Macquarie had expected a less favourable result from the negotiations in Queensland. Under the new agreement the improved terms on taxes paid to the state should increase TattsBet earnings by around $12.3m, despite being partially offset by the introduction of new fixed fees and marketing costs. To secure the deal and extend wagering licences, Tatts has committed to spend $150m over nine years. Macquarie thinks the earnings upside outweighs the fee paid for extending wagering licences. There could be peripheral benefits as well. Macquarie notes the formalisation of a joint venture structure between TattsBet and the industry makes concessions for new products such as Trackside more likely in the future. The broker upgrades to Outperform.
The issue over the Queensland licences was a drag on the share price and UBS thinks together the two wins deserve an upgrade to Buy. Tatts is envisaged as better off under the new Queensland framework and the outcome was better than UBS feared. Tatts will extend retail exclusivity for 30 years as well as the sports betting licence for 61 years. A new $15m annual fixed product fee and 2.5% of fixed odds retail sports bets, capped at $5m, are payable.
Tatts will only be liable for race field fees if there is a net cost to Queensland, and even then it is shared 60% Tatts/40% racing industry. Tatts will pay $150m as a licence fee in four instalments and the tax on tote betting is reduced to 14% from 20% and for fixed odds to 10% from 20%. UBS thinks the stock is a high quality, defensive business with strong underlying cash flow and long-term monopolistic licences with stable earnings and low capex requirements. The stock's premium is justified, in the broker's view, despite a relatively low growth profile.
Citi views the Queensland deal as highly favourable because of the associated cost saving and the extension to retail exclusivity. Lower tax rates more than offset an additional $15-20m in contributions to Racing Queensland. Citi calculates the deal creates a net $114m or 8c per share in value for shareholders. Tatts has also made commitments to invest in marketing and network initiatives to improve the competitiveness of its operations. Tatts is expecting a cash payment on June 30 of $540m from the Victorian government following the court ruling in its favour. From that Citi estimates gross value creation to be 28c per share, after accounting for a likely appeals process which will delay a final outcome. Still, the broker retains a Neutral rating as the stock is trading near estimates of fair value.
JP Morgan expects a significant re-branding exercise in wagering in the next few months. The broker considers the outcome in Queensland was "excellent" given the risks surrounding potential competition, and the erosion of earnings that would have occurred if the race field offset was reversed. The broker has incorporated the new fee arrangements and increased marketing spending estimates by $10m per annum and considers there is potential for further upgrades amid signs the cost initiatives are working. Until then the broker retains a Neutral rating.
BA-Merrill Lynch was quite stunned, not expecting to upgrade forecasts, being more upbeat than the rest of the market ahead of the announcements. The broker had believed the market was too negative on the stock but the deal was even better than it expected. The broker thinks management deserves credit for achieving the long-term licences and an attractive tax structure, as well as maintaining the race fields offset function. Critically, the legal action between Racing Queensland and Tatts over unpaid offset fees has been terminated. This had represented a potential liability of over $100m. The broker has raised profit forecasts for FY15 by 1% as a result of the negotiations. The company's lotteries also remain the core supporting pillar of Merrills' Buy case.
On the FNArena database Tatts has three Buy ratings, three Hold and one Sell (CIMB ahead of the announcements). The consensus target is $3.32, suggesting 1.5% upside to the last share price and comparing with $3.11 ahead of the two announcements. The dividend yield on FY14 and FY15 consensus forecasts is 4.6% and 5.0% respectively.
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