Gambling behemoth Tatts Group has won a tender for the Victorian Public Lottery Licence, which gives the company exclusive rights to operate lotteries – including Powerball, Oz Lotto and scratchies – in the state through to 2028.
Though the terms of the deal were largely the same as the previous 10-year contract, Tatts still had its arm twisted at the negotiating table. Tatts will make a single payment of $120m to the Victorian Government on 1 July 2018, up from just $19m for the previous licence.
However, this is only around three times earnings before interest, tax, depreciation and amortisation (EBITDA), which is well below the roughly ten times EBITDA paid for the NSW and Queensland lottery licences in 2010 and 2007. Most of that difference, though, is due to these licences being much longer concessions, extending 40 years and 65 years, respectively.
Because the Victorian government takes a big slice of revenue, the Victorian licence is also the lowest margin lottery in Australia, contributing around a third of revenue for Tatts’ Lottery division but only around 20% of operating profits. Perhaps counterintuitively, that actually gave Tatts a slight advantage when bidding for the new licence: as the incumbent, with existing infrastructure integrated across several states, Tatts is the lowest cost operator, meaning it can take the lowest margin work and still turn a profit.
The need to keep renewing the Victorian licence every 10 years does add an element of risk to an otherwise low-risk business model for the Lotteries division, and the huge jump in renewal cost this round is a reminder of that.
Tatts generated revenue of $2.8bn in the year to December and consensus estimates are for earnings per share of 16 cents in the 2017 financial year, with underlying free cash flow being roughly the same. That puts the stock on a forward price-earnings ratio of around 26 and the stock sports a fully franked dividend yield of 4.2%. With several competitive advantages and the Victorian licence renewal now out of the way, we’re sticking with HOLD.