too pricey??

2 Mar 2010| More Stephen Bartholomeusz

Tatts' pricey jackpot

The one thing that everyone who was involved or interested in the process for the sale of NSW Lotteries agrees is that Dick McIlwain has paid a very big price.

The $850 million price-tag at least $150 million more than the market had anticipated will delight the cash-strapped NSW government, which will also pulled out $160 million in cash and other assets ahead of the sale.

Depending on who one talks to, Tatts Group has paid a multiple of a bit over seven times NSW Lotteries earnings before interest, tax, depreciation and amortisation (EBITDA) and 17 times! How one calculates the number depends on how the business earnings are normalised for an unusually high incidence of jackpots last year (jackpots drive revenue) and marketing spend that was funded from unclaimed winnings.

In reality the multiple is probably somewhere between the extremes but is also ultimately irrelevant because (a) McIlwain had to win the bidding for the business and (b) Tatts was easily the best placed to not just win it but to make sense of a big price.

Tatts shares fell as the market digested the steep price it has paid, but McIlwain does have a lot of credibility with investors for his track record on acquisitions and costs.

Tatts had to win the contest for NSW Lotteries and there were a number of serious bidders because the loss of its Victorian gaming licence in 2012 will remove more than 40 per cent from its earnings base. It needed to replace that earnings stream and bulk or it would be a relatively small lotteries and wagering business.

Its Victorian rival, Tabcorp, which will also lose its gaming licence in 2012, has its big casino business into which it is injecting a lot of capital to maintain a critical mass and generate growth. Tabcorp, depending on what the Victorian government decides in relation to its wagering licence, also has the Victorian and NSW TABs.

Tatts was best placed to win the bidding for the NSW business because it already has a meaningful lotteries division, with Queensland Golden Casket and its traditional Victorian operations. It has more expertise in lotteries and more available synergies than any of the rivals that it blew out of the water.

While the acquisition may look expensive, McIlwain has a long and impressive history of delivering on acquisitions. Tatts bought Golden Casket in 2007 on, it says, similar multiples and increased the EBITDA of its lotteries business from $35 million to $119 million.

With the deal expected to close in March, it wont take long to determine whether the acquisition is going to add or subtract from Tatts near-term performance.

NSW Lotteries was always going to sell for a decent price, despite some restrictions on the buyers ability to expand its distribution channels over the next five years or significantly reduce its employee numbers over the next three years.

Employees have been guaranteed their jobs, with the option of switching to the NSW public service while the conditions that enable Tatts to expand the number of distribution outlets but not the channels are designed to placate the newsagents and convenience store operators who currently retail the products.

The reason NSW Lotteries value was maximised is that the government and its advisors at Goldman Sachs set out to do exactly that, while minimising the political obstacles and risks. Even the structure of the tender "best bid, final bid" with no subsequent discussion on value was designed to force bidders to put their best offer on the table. It worked.

When Victoria introduced competition in lotteries, it offered only a 10-year licence. Intralot paid $12 million for it. Queensland sold Golden Casket for $542 million with a 65-year licence and a 10-year exclusivity period, although it can issue more licences if it pays compensation to Tatts.

NSW offered a 40-year licence and absolute exclusivity for that period. The duration and exclusivity provide long-term certainty, which Tatts self-evidently valued highly and capitalised into its bid.

Given Tatts experience in owning, managing and expanding its lotteries businesses, the length of licence and exclusivity periods is like acquiring an annuity income stream with significant growth potential. It expects the acquisition will help it to double the EBITDA generated by its lotteries division by 2014.

The NSW business is regarded as poorly managed relative to the privately-managed licences elsewhere and as underdeveloped there are a lot of products Tatts offers in its other lotteries businesses that could be added to the NSW offering.

In the medium term, once it has some flexibility as to its workforce and distribution, Tatts should be able to improve the performance of the business significantly. In the near term it should gain operating efficiencies from putting all its lotteries operations on one platform, injecting its management into the NSW business, and updating its product range.

Given the price it has paid, it will need to deliver substantial improvements in NSW Lotteries performance over both time horizons to satisfy the market that it hasnt over-paid.

Long Term veiw IMHO - We needed this!

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