Placing a bet on history

Even allowing for the fact that about half the fall reflected that the deadline for qualifying for Tatts' 10? interim dividend expired on Friday, it was a thumbs-down for the deal, and the price Tatts has paid in an auction skilfully orchestrated by the NSW government and its adviser, Goldman Sachs JBWere, is the bone of contention.

Tatts was always considered the most likely buyer: it was looking for something to fill the hole created by the loss of its pub poker-machine licence duopoly with Tabcorp in Victoria, and, adding Queensland's Golden Casket lottery business to its Victorian lotteries franchise for $542 million in 2007, was able to factor in savings and other synergies other potential buyers could not access.

Those synergies are the key. Investors flogging Tatts shares yesterday will be proved right if Tatts fails to crystallise them. The synergies are so large in prospect they can halve the effective acquisition price.

NSW Lotteries reported earnings before interest, tax, depreciation and amortisation (EBITDA) of $67.5 million in the year to June 2009. Tatts estimates about $5 million of that was a windfall that flowed from increased ticket purchases leading up to the once-in-a-generation $106 million Oz Lotto jackpot that went off on June 30 last year (and ignoring that it is paying 13.6 times EBITDA for a 40-year lottery licence). That's the sort of multiple that was being paid at the height of the asset bubble madness ahead of the global financial crisis.

Tatts says, however, that it expects the NSW acquisition to be generating $120 million of EBITDA a year for the group by 2014. On that basis, NSW Lotteries is valued at just over seven times expected 2014 gross earnings, at a purchase price of $850 million. (The NSW government's total receipts were just over $1 billion, but that included $160 million of genuine surplus cash inside NSW Lotteries that the government, not surprisingly, raked off ahead of the sale.)

History says Tatts will go close to getting the synergies it says are available. Its lotteries division boosted EBITDA from $35 million in 2006-2007 to $119 million in 2008-2009 after the Golden Casket purchase, as Tatts extracted a similar group of synergies from the Queensland and Victorian businesses, and NSW is a bigger market, booking about $1.4 billion of revenue compared with $1.2 billion in Victoria and about $1 billion in Queensland.

Tatts is rolling out an in-house lottery information technology platform to replace one it licences from US gaming group GTECH (a rumoured underbidder for NSW Lotteries, along with Tabcorp, Intralot of Greece and the Ontario Teachers Pension Plan) and will extend it to NSW at minimal extra cost.

Marketing and other administrative tasks will be absorbed into the existing Tatts budget, and overlapping staff will go (the NSW government has guaranteed jobs at NSW Lotteries for three years, but a similar guarantee in Queensland was overcome with voluntary redundancies). Investors who like a punt will buy during the sticker-shock sell-off.

A MONTH ago the Reserve Bank went close to raising its cash rate, but didn't. Yesterday was also a toss-up, but the central bank took the cash rate up by quarter of a percentage point, to 4 per cent. What changed? Not all that much, but enough to give the Reserve new confidence that a baton pass from government subsidies growth to more sustainable private-sector demand is under way.

Big slabs of the announcement yesterday were cut and pasted from its February statement, including its descriptions of a global economy recovering with Asian economies at the vanguard but still facing challenges, including big sovereign debt overhangs in the northern hemisphere.

But although it says, again, that banks have added their own rate rises to the three-quarters of a percentage point increases in the cash rate that the Reserve announced in the final months of last year to take the total increase to about 1 percentage point it no longer says, as it did in February, that information about the impact of the earlier rate rises is limited, and it cites clearer evidence that the local economy is able to withstand higher rates.

In February, it said that credit for housing was still expanding strongly, but that business lending was weak and the strangled supply of loans "difficult" for small businesses. This time, it says loan funds are beginning to flow more easily, and adds that recent positive data (including, no doubt, the NAB's influential business survey) suggest the local economy may have been growing at or close to its long-term trend "for a few months".

If the Reserve had believed that in February, it would have taken rates higher then: and if the evidence that makes it believe it now continues to flow, the cash rate will be at 5 per cent and policy equilibrium by the third quarter.

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Peter Martin

Elizabeth Knight

Norman O'Bryan

Pages 14 & 15

mmaiden@theage.com.au