Moving Tatts to a Hold

As we noted in March, Tatts was ultimately unsuccessful in obtaining compensation from the State of Victoria after it and competitor Tabcorp were stripped of their Victorian pokies operator licences in 2012.

Tatts used the compensation awarded to it by lower courts to repay debt and so it will use existing debt facilities to repay the $550m or so in compensation and interest to Victoria.

All things equal, the resulting higher interest costs reduce future earnings and cash flows. However, the High Court's decision had no impact on Tatts' underlying businesses and with its strong cash flows (particularly from its Lotteries division), the company's debt burden remains manageable.

O'Farrell review

Recent announcements from the Federal Government that it will accept 18 of the 19 recommendations made by the O'Farrell Review into Illegal Offshore Wagering are also positive for Tatts.

Before smart phone apps provided access to online betting, placing a bet meant venturing to your closest TAB outlet. This gave the owners of the various TABs – originally the relevant state governments but now, except in Western Australia, Tatts and Tabcorp – cosy and highly profitable monopolies.

Now punters can use their smart phones to bet online, not only with Tatts and Tabcorp but also with a number of local and international competitors that have sprung up to cater to Australians' penchant for gambling. The likes of CrownBet, Bet365 and Paddy Power Betfair are competing fiercely with Tatts and Tabcorp and are advertising heavily to acquire customers.

Many Australians now have betting accounts with multiple companies, allowing them to choose the operator which is offering the best odds. As a number of international competitors are illegal and don't pay Australian taxes, licence fees or product fees, such as those paid to the various racing bodies, this helps them offer better odds than their licenced competitors.

More choice of course benefits consumers at the expense of former monopolists like Tatts and Tabcorp. However, increased choice and the ability to gamble 24 hours a day means those with gambling problems now have even more ways to lose their hard-earned cash. We're investment analysts and so we'll leave the arguments over the morality of all this to others.

Regulatory changes

Tatts will potentially benefit in two ways if the government's proposed responses to the O'Farrell Review become law.

Firstly, the government will try to remove loopholes that allow “in-play” betting (being able to bet after a game or race has started). Neither Tatts nor Tabcorp currently offer this service but competitors do.

It will also amend the law to clarify that it is indeed illegal for unlicensed offshore operators to offer gambling services to Australians (apparently current law is ambiguous on this point). Further, the government will also follow the lead of other countries such as France and the US and work with ISPs to block illegal overseas operators while also working with the banks to block payments to these sites.

Foreign jurisdictions have successfully reduced illegal offshore gambling using these measures and so, assuming these changes do become law, it's likely that Australia will be successful in this regard too.

Tatts will likely benefit as Australians direct more of their gambling dollars away from illegal offshore operators to their legal competitors as a result of these changes. Nevertheless, the monopoly enjoyed by its Wagering businesses is long gone and increased competition is here to stay.

WA TAB

The Western Australian government plans to privatise the WA TAB, the last remaining TAB in public ownership. Although companies ranging from Seven West Media to CrownBet may be interested in purchasing the WA TAB, Tatts and Tabcorp remain the frontrunners.  

The two companies discussed a “merger of equals” last year but ultimately couldn't come to terms. Nevertheless, we think it's likely that they'll recommence merger discussions at some stage, perhaps once the WA TAB sale process is complete.

The increased scale and resulting cost savings would help a combined Tatts/Tabcorp compete with global competitors such as the recently merged Paddy Power Betfair and the potential tie-up between Ladbrokes and Gala Coral.

Downgrading to hold

Tatts shares have risen 13 per cent since our last review and at the time of writing are now trading around our projected price of $4 – at $3.96 today. As such, we're downgrading to Hold.