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Questor: a punt on Paddy Power could net big winnings – but there’s a lot that could go wrong too
Questor share tip: gambling is going global and Paddy Power Betfair has £1bn in firepower. But watch the execution risk
The triumvirate of sin stocks – drinking, smoking and gambling – used to offer comfort to investors in times of economic weakness or high anxiety.
But sin is not as profitable as it used to be. Cleaner living and tougher regulation mean the correlation between consumer temptation and shareholder reward is no longer a straight line.
Diageo, the gin-to-Guinness drinks giant, has continued to power ahead, with its stock trading at all-time highs. Life has been much harder for the tobacco firms, although shares in British American Tobacco are holding firm since Questor said in December that they were starting to look cheap.
The outlook for gambling is the most complicated of the three. Regulation, liberalisation, consolidation: it is the sort of accumulator with which a canny punter could scoop the jackpot.
That successful high roller is not so far Peter Jackson, who has watched shares in Paddy Power Betfair slide by a quarter since he arrived as chief executive in January last year. It is the same sorry tale across the sector, where curbs on advertising and fixed-odds betting terminals – stakes are to be cut from £100 to £2 from April – have dominated the narrative. And don’t mention the recent bout of equine flu, which played havoc with the racing card.
Demonstrating the scale of the challenge, Paddy Power said the cost of the regulatory and duty changes in Britain, Ireland and Australia would have been £115m if they had applied all year – slicing the best of a quarter from forecast earnings, as Peel Hunt, the broker, has pointed out. The risk of a Labour government here could make trading conditions harsher still.
- Questor archive: telegraph.co.uk/questor
Unperturbed, Jackson is a boss in perpetual motion, striking out in markets where betting opportunities are opening up. There was a small acquisition in Georgia but that pales into insignificance by comparison with FanDuel, the fantasy sports company that became the group’s leading brand in the US after assets were merged and Paddy Power contributed £120m of cash to take control.
It was a smart move soon after America’s Supreme Court ruled that individual states were free to legalise sports betting. New Jersey was quickly off to the races, and Paddy Power has reported strong offline and online growth.
Analysts at Barclays assume that 42 states will look to regulate sports betting, creating a market that could be worth $7bn to $19bn. What price a landgrab when every other betting firm will be eyeing the same market is open to question. And early progress will mean more investment committed, which could depress earnings.
But the 22pc pro forma US revenue growth was a high point of the third-quarter trading update in November and the reason full-year earnings guidance was nudged up. Overall, quarterly sales rose by 12pc on an underlying basis, boosted by £22m from last summer’s football World Cup.
Retail is having a tough time, but at least Paddy Power has fewer shops than most of its competitors and will be less distracted by the inevitable closure programmes.
The group was created by the merger of Betfair and Paddy Power in 2016 but has had little time to bed down. In fact, the Paddy Power brand lost market share in the run-up to its transfer to the Betfair technology platform at the start of last year. It has been regaining its position with loyalty bonuses for regular punters and said a year ago it would pump an extra £20m into marketing.
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This is a sector that has been rife with deals and there is no sense the pace is slowing. Having set out to target net borrowing of one-to-two times earnings, Paddy Power has perhaps another £1bn to spend, although some analysts expect a share buyback too.
Most intriguing of all are recent reports of a discontinued merger conversation with Stars Group, the Nasdaq-listed poker specialist that recently acquired SkyBet. Gambling is going global and scale could make all the difference, even if Britain’s competition authorities might impose some remedial measures as the cost of a tie-up.
Like a tempting wager, Paddy Power offers the chance of long-term gains with bags of execution risk. Trading at 17 times next year’s forecast earnings, it is best viewed as an each-way bet.
Questor says: hold
Ticker: PPB
Share price at close: £61.90