Stock to Watch: Sportingbet

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While the fears over eurozone/US debt issues mean tricky times for trading shares, this is becoming a boon period for corporate takeovers - offering acquirers the chance to build market share possibly at a discount to the long-term fair value of targets and without needing to pay much premium for control.

Sportingbet (SBT), a leading online sports betting and gaming provider in Europe and Australia, is one such example.

Its shares are listed in the FTSE Small Cap index, although this is quite a substantive company capitalised over £350 million, expected to grow normalised pre-tax profit from £31.4 million in the last financial year to end-July 2010, to over £37 million in the current year and over £45 million in 2011/12. If achieved, then the shares' forward price-earnings multiple is a modest 8.5 times and there is a prospective yield of about 3.4% covered nearly four times by earnings.

Sportingbet also enjoys firm support among City brokers, with Company REFS showing near-unanimous 'buy' advice in June.

For some time this company has been regarded as a bid candidate and is currently subject to an approach from FTSE 250-listed Ladbrokes (LAD), with analysts suggesting it would be a positive move to generate a wider online presence and immediate market-leading position in some new regions.

Negotiations have been on for at least a month and Ladbrokes initially stressed it has a clear organic strategy anyway; that the approach was "highly preliminary" and there was "no certainty of any offer".

All this tends to be standard legalese however, so speculators don't get carried away.

The modest P/E rating, which applies similarly to other betting shares, is part-explained by the industry's liability to adverse changes in gaming regulations and taxes.

For example, the sector has seen share price falls just recently as the coalition government said it will review taxation of offshore gambling, possibly to involve bring its taxation in line with the 15% gross profits tax for onshore operators. Some analysts have pointed out, however, that offshore operators just may not comply, thereby creating an uneven playing field for British companies.

Sports betting comprises about two-thirds of Sportingbet's revenue, the rest being poker, casino and other games. Websites are tailored to particular regions to maximise potential, and before the Ladbrokes approach it was proposed to acquire Centrebet, an Australian-based bookmaker, to expand in the fast-growing Antipodean market.

Broker Cazenove has estimated that Ladbrokes has about £700 million financial headroom for an acquisition, ie nearly twice Sportingbet's current market value. Perceived risks to consummating a deal include diluting the quality of Ladbroke's online customer base, since it enjoys a 70% exposure to the regulated UK market while Sportingbet is 70% exposed to unregulated markets.

More positively, while Ladbrokes is currently realigning its divisions, now would be a sensible time to execute a transformational deal before the new structure is consolidated.

Evolution Securities has entertained a take-out valuation of 80p to 90p a share, although an analyst at Daniel Stewart thinks Sportingbet should wait for a higher offer, hence his 130p target price. Indeed, there is scope for counter bidders such as William Hill (WMH), Unibet and others.

If talks with Ladbroke fail, Evolution has estimated a fair value of 75p a share after completion of the Centrebet deal, which is interesting although I would not rely on it as a short-term market price when this expectation is already in the air together with a possible takeover.

Balancing act

Bookmakers' balance sheets may help explain the shares' modest P/E ratings; for example Ladbroke has negative net tangible assets. Of Sportingbet's £112.7 million net assets - or just 17p a share - at end-April, £41.7 million represented goodwill and £26.8 million other intangible assets; although there was consistent £57.5 million cash versus only £6.1 million debt.

The first half results to end-January showed some encouraging operating statistics, such as like-for-like amounts wagered in Europe up 19% in the second quarter, one of the busiest periods for sports betting, helped by European football programmes and Australian horseracing. There was a remarkably strong 73% growth rate in net gaming revenue in Australia also 67% in emerging markets, more than offset weaknesses in Spain and especially Greece. Dependence on Europe has been reduced to 77% of net gaming revenue and it is hoped that a recent Russian joint venture will reduce this further.

The overall impact on first-half revenue saw a 7% rise to £107.9 million while pre-tax profit rose 20% to £19.6 million and interim earnings per share rose 12% to 3.6p, with a 0.6p a share payout up from 0.5p - so pretty good overall performance.

"The long-term growth prospects of the industry combined with our constantly expanding product offering give us confidence as to the group's future growth and the board remains confident for the remainder of the year."

Third-quarter results to end-April then saw like for like net revenue slip from £55.7 million to £54.7 million although pre-tax profit rose from £10.7 million to £12.1 million and earnings per share from 1.7p to 2.3p. The outlook statement (26 May) remained firm.

So despite pressures on consumer spending it appears that online gaming is able to attract sufficient business by way of innovation and possibly the escapism gambling offers in hard times. In this regard, some investors may regard it as an unethical industry when it risks people who have family obligations, for example, becoming addicted during a recession. You have to decide where to draw the line.

Chart-wise, the current market price does not look demanding - especially in terms of downside, should bid talks end. With the autumn 2008 financial crisis, Sportingbet fell to 23p then recovered to 77p and spent last year in an 80p to 54p range. The price drifted from 61p to 40p this year before the bid approach.

So while speculation is involved, it is an interesting time to be watching Sportingbet.

For more information, see sportingbet.com.