By Gustaf Baavhammar and Chris Leung (University of Warwick), Adam Butlin and Ilya Korzinkin (UCL) - Date: 20/10/2019
Overview of the deal
Acquirer: Flutter Entertainment (LSE: FLTR)
Target: The Stars Group (NASDAQ: TSG)
Estimated value: $6 billion
Announcement date: 2/10/2019
Acquirer Advisors: Goldman Sachs, PJT Partners
Target Advisors: Barclays, Moelis & Company, BMO Capital Markets
Where traditional gambling landmarks like Macau or Las Vegas have struggled for organic growth, M&A activity has picked up significant traction over the recent years as a result. Regulation also continues to be an overbearing incentive for takeovers as key players seek to reduce customer acquisition cost and achieve economies of scale to protect profitability margins.
The global gaming industry is worth an approximate $450 billion with a long runway of growth still available. The deal unites two of the biggest brands in online betting, creating a global leader in sports betting and gambling as they gear up to dominate the fast growing sports gambling market in the US. Of the $450 billion in gross revenues generated in 2018, 11% originated from the online sector, having grown at an overall CAGR of 12% over the last 5 years. It is evident that both Flutter and TSG believe that the online sector continues to exhibit structurally attractive characteristics that warrant such a mega-merger and the migration of customers from retail to online platforms will remain a key driver.
Under the terms of the deal, Flutter will offer 0.2253 shares for each TSG share in a merger that will see Flutter shareholders take control of 54.64% of the NewCo, whilst TSG assuming the remaining 45.36% – valuing the NewCo at £9.8 billion or £14.2 including debt.
“We believe the combination of Flutter and TSG will deliver substantial value for shareholders. We will have an exceptional portfolio of leading recreational brands and best-in-class products on industry-leading technology platforms.” – Flutter CEO Peter Jackson
Company Details (Flutter Entertainment)
Flutter is a global sports betting and gaming operator that focuses on 4 primary divisions: Online (encompassing Paddy Power, Betfair and Adjarabet), Retail (over 620 Paddy Power betting shops across the UK and Ireland), Australia (Sportsbet) and U.S. (FanDuel Group).
- Founded in: 2016, following a merger between Paddy Power and Betfair
- CEO: Peter Jackson
- Number of employees: 7,503
- Market Cap: £5.91 billion - EV: £6.7 billion
- LTM Revenue: £2.03 billion - LTM EBITDA: £432 million
- LTM EV/Revenue: 3.30x . - LTM EV/EBITDA: 15.51x
Company Details (The Stars Group)
The Stars Group is a global leader in the gaming and online gambling industry operating poker, casino and sportsbook services through its Stars Interactive Platform. TSG also runs live poker tours and championship events such as the No Limit Hold’em Championship and the European Poker Tour.
- Founded in: 2001
- CEO: Rafael Ashkenazi
- Number of employees: 4,500
- Market Cap: $5.68 billion - EV: $10.6 billion
- LTM Revenue: $2.44 billion - LTM EBITDA: $604 million
- LTM EV/Revenue: 4.34x - LTM EV/EBITDA: 17.54 x
Projections and Assumptions
The deal is about delivering growth and presents strong strategic rationale by way of scale and diversification that is mutually complementary. The NewCo would have over 13 million customers (6 million from Flutter + 7 million from TSG) in 100 countries with combined revenues of £3.77 billion and £1.14 billion EBITDA – 50% higher than its closest rival Bet365 and twice of Ladbrokes Coral parent GVC. The composition of revenue streams will also significantly alter as highlighted in the table below. Most strikingly, 35% of TSG’s revenue is derived from PokerStars and likewise Flutter sees 18% of its revenue from retail betting – highlighting the mutually beneficial dynamic the transaction would provide most synergies to.
Fundamentally, there's a logic to the deal – Flutter benefits from much needed diversification, especially as its profits have taken a toll over the past 6 quarters amidst regulatory and tax changes in its UK and Australian businesses. Simultaneously, Flutter offers relief to TSG’s balance sheet struggles where its relatively clean balance sheet with net debt of 0.8x TTM EBITDA is capable of acquiring TSG’s $5.2 billion in gross debt. Where the current expected leverage ratio sits at approximately 3.5x (excluding synergies), this is expected to be eased down towards Flutter’s target ratio of 1-2x over the medium term, all whilst maintaining their existing 200p dividend per share. The NewCo is also anticipated to take advantage of pre-tax cost synergies of £140 million per annum coupled alongside cross-selling in international markets and reduced finance costs, ultimately boosting free cash flows that should accelerate its deleveraging plans.
Long Term Upsides
Based on the pro-forma merger model, the combined company should trade on +32.57% upside based on the current Flutter share price, and +45% upside on the Stars Group, based on the assumption that the firm will be valued on the average of the standalone pre-deal multiples. EV/EBITDA multiples pre-deal being 8.7x for The Stars Group, and 14.3x for Flutter, the NewCo is expected to trade at 14x pro forma EV/EBITDA.
Apart from cost synergies, in the long run, both firms are reasonably well positioned to benefit each other from regulation discrepancies across markets where the NewCo will operate. The Stars Group has more unregulated exposure, (i.e. Italian gaming market and other locally taxed areas) thus if the firm can keep its SkyBet Poker top line from shrinking in the face of player liquidity drying up, both firms can continue benefiting from the firm’s ability to continue offering more lucrative, higher ROI deals to customers in its less regulated markets. In the US, with the Supreme Court giving the green light to legalize sports betting, Flutter, that has acquired the US-based FanDuel last year, partnering with The Stars Group’s FoxBet is thus better positioned to capitalise on the new regulatory environment, having greater brand power and geographical presence post-acquisition, than the next two competitors, namely bet365 and DraftKings. Fox Bet will have the right to acquire 18.5% of FanDuel in a reciprocal ownership scheme, creating a powerful branding combination, where FanDuel will essentially have a free advertising channel to approximately 100 million users according to management, through Fox Bet, as Fox Sports commences advertising betting and gaming content in its coverage. Fox Bet in turn can access over 8 million customers across 41 states through the FanDuel’s customer base.
Risks and Uncertainties
Most immediate risks to the NewCo are that previously unregulated markets can require TSG to pay back taxes, and that the Italian gaming advertising ban will come into effect, as well as that additional countries will adopt or strengthen online gaming regulation, all of which can potentially negatively impact the the top-line growth profile of both firms.
The biggest hurdle that the merger faces however, is from the regulatory standpoint. There are considerable regional overlaps, in the UK, where Flutter operates PaddyPower and Betfair brands, and Stars Group operates Sky Bet, and in Australia, where Flutter operates Sportsbet and Stars Group operates BetEasy. Market shares will be assessed via a Herfindahl-Hirschman Index (HHI), which is the sum of the squared values of the combined market shares. Markets where HHI is <1000 are seen as not concentrated, where the HHI is 1000-2000 they are seen as concentrated and an increase in HHI of <250 is not seen as a concern. In the UK, online betting and online gaming are considered to be two separate markets by the CMA. Online betting is considered to be a concentrated market, with an average post-merger HHI of 1568. The NewCo is projected to have a post-merger HHI delta increase of 696, and the HHI of 2264, resulting in an almost certain CMA Phase 2 review. The NewCo will have a post-merger market share of 37.6%, almost double of Bet365, which comes in at 24.9%. The Online Betting market however, has a pre merger HHI of 457, post the merger will have 570, with a delta increase of only 113, there is no concern for CMA, as the market will remain largely fragmented, although the NewCo will be the largest company by market share with 15.5% against 13.6% of GVC, its closest competitor.
In Australia, competition authorities (i.e. the ACCC), are not concerned with markets that have an HHI of <2000, or >2000 with a delta of less than 100. Pre-merger, the online betting HHI is 1780, however a post-merger delta of 924 is well above the 100 allowance, and the post-merger HHI of 2704 will almost certainly be an issue for the ACCC, and will attract an ACCC extensive review into the NewCo.
The firm will most likely dispute the authorities’ claims, on the basis of the fact that there will still be competitive pressures from other firms in all of the aforementioned markets, and consumers can still choose between the other large competitors, which have more that 10% share in each market. In case remedies are required, the group will have to sell the smaller betting overlap, for example the sale of TSG BetEasy Australian business or UK’s SkyBet could be on the table, however the transaction faces the biggest risk from if both assets will have to be sold simultaneously, resulting in the StarGroup losing 20% of its revenues, therefore almost definitely preventing the merger from completion.
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