Lottery and wagering operator Tatts Group has received a revised bid from a group of private equity investors. The ‘Pacific Consortium’ – which includes First State, Morgan Stanley, Kohlberg Kravis Roberts and Macquarie Group – had previously proposed a two-step purchase of the company: separate the wagering and lotto divisions, then give shareholders $3.40 in cash for the lotto business and one share in the newly independent wagering division (in effect, buying the lotto division for $3.40 per share). Tatts' board rejected the offer in favour of Tabcorp's earlier bid (see Tatts and Tabcorp set to join forces).
Now, the consortium is proposing a 100% cash purchase of the whole company for $4.21 per share.
As we explained in The lottery that always pays, Tatts' lottery division is a regulated monopoly and offers a stable, growing income, while earning extremely high returns on tangible capital. It’s by far the best side of the business, so we were disappointed with both the original Tabcorp offer and the consortium offer, both of which would leave shareholders with the stumbling wagering business.
This all-cash bid is a step in the right direction, but it comes with a huge dose of irony. The consortium’s own original offer said a standalone wagering business would be worth $1.00 to $1.60 on the open market. The new offer of $4.21 – less the consortium’s $3.40 previous bid for the lottery division – implies the wagering division is only worth 81 cents per share. If you really want to know what someone thinks a business is worth, ask what they will pay for it in cash. Bankers aren’t fools.
The new consortium offer of $4.21 is in line with Tabcorp’s offer of 0.80 Tabcorp shares and 42.5 cents in cash for each Tatts share held, which implies a value of $4.20 given Tabcorp’s current share price of $4.72.
Tatts’ board hasn’t yet formed a view on how the new bid stacks up against the proposed Tabcorp merger and, for the time being, continues to back the Tabcorp bid.
Though we believe both bids undervalue Tatts, this new consortium offer is the best currently on the table and gives shareholders more pricing certainty thanks to its all-cash nature. It also still leaves open the prospect for Tabcorp and Tatts’ wagering businesses to merge and cut out duplicate costs – we doubt the consortium will want to hold onto it for long.
The two proposals could take some time to play out – and, who knows, maybe Tabcorp will up its bid. The Australian Competition and Consumer Commission (ACCC) will announce early next month whether it approves the Tabcorp merger and we’ll keep you up to date as things develop. For both Tabcorp and Tatts, we continue to recommend you HOLD.