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Monday, 7 September 2015

Achtung Paddyfair!

By Paul Leyland, Founding Partner

“Actions speak louder than words. In the days to come the Goddess of Victory will bestow her laurels only on those who are prepared to act with daring.” Heinz Guderian

It is axiomatic that most armies prepare to fight the last war, just with more resources. Those armies tend to lose. For nearly a decade, scale and operational efficiency (alongside regulatory risk) has tended to decide the winners and losers in remote gambling: the game has got bigger, but (outside the regulatory landscape) it hasn’t really changed. However, it may be about to…

The potential merger announced between Betfair and Paddy Power initially surprised everyone. 

However, it only takes a few seconds of reflection to see this as one of the most ‘obvious’ and compelling deals available in gambling. The positives were already well rehearsed within minutes of the announcement, and at least partly reflected in the share price reactions: highly complementary product and brands (sophistication through to entertainment); complementary culture (bright, tough, hard-working and data-driven); stronger technology and trading capabilities; significant revenue and cost synergy potential. If there is a defensive element to the deal it is that double-digit growth is becoming increasingly hard to come by in maturing markets: but that is what M&A is for.
Over and above the (very important) points listed above, there are three further reasons why I believe this deal is so compelling.

First, the genuine ubiquity of product and customer reach. Pretty much all sports betting customers sit somewhere on an axis of price-sensitive sophistication to offer / fun-driven entertainment. Betfair owns one end of the spectrum, Paddy Power is the strongest player seeking to dominate the other (with increasing competition from Sky Bet). It was always going to be difficult to turn Betfair into a mass-market brand without diluting it: that was a strategic growth problem for Betfair that has been brilliantly solved. Equally, Paddy Power’s opportunities for genuine differentiation were always going to be constrained by sitting on the same ubiquitous technology stack as everybody else: that problem may too be solved. 

Moreover, since most customers move about within the price-entertainment spectrum according to product etc, the opportunities for cross-sell and highly sophisticated insights-driven marketing are huge. So the combination of Paddy Power and Betfair dominates the sports product and brand spectrum while also increasing flexibility to adapt. For a sector with a relatively rigid structure that struggles with containing CPA and struggles even more with retaining customers, this new flexibility from a major competitor could be a huge headache.

Second, the merger creates the scale to really innovate. Pre-synergies, combined revenue will be c. £1bn, EBITDA c. £320m and a technology spend of over £100m. Moreover, this scale is combined with a culture of low regulatory risk, strong work ethic and data-driven brain-power. That is a recipe for productivity-driven growth, rather than the sector default strategy of buying market share with marketing money or bolt-ons. In other words, the combination has the scale and skills not just to be a leader of the pack, but to redefine the pack; as Apple did to Nokia/Microsoft/RIM or Google did to Yahoo! The competitive problem with this is while the leader is focussed on growing the segment (as industry leaders should but so rarely do in gambling), it takes market share directly as well as relatively, almost effortlessly.  The requirements to turn this potential into reality should not be under-estimated. However, nor should the ramifications for the sector if the combination gets it right.
Third, timing, they say, is everything. 

We have seen the Ladbrokes – Coral merger maths work because Coral is on its way up about as fast as Ladbrokes is on its way down. The danger here is that this is the sort of ‘convergence criteria’ that might have put Britain in the Euro where it not for wiser heads. Similarly, the run-rate EBITDA of both Betfair and Paddy Power is now very similar (c. £160m), while so is the market-cap. A year ago, before Betfair CEO Breon Corcoran’s textbook operational turnaround, market valuations were very different; three years ago profitability was even more starkly different. Only six months ago, the impact of POCT was still relatively uncertain. Now, and really only now, the stars have aligned to allow this deal to happen in such a compelling way. It is a sign of superlative leadership to strike with full force as soon as the opportunity presents itself.

Veterans of Paddy Power will remember with amusement that a certain senior industry exec once said of his company’s move into Ireland: “Watch out Paddy Power, we’ve parked a tank on your lawn”. That company has since ignominiously retreated from the republic faster than a Char B on the Meuse. Similarly, Betfair’s coffin-wielding reports of the demise of the bookmaker was very much exaggerated: this now really is a case of if you can’t beat them… In contrast to previous empty sabre rattling, I think the Paddy Power – Betfair combination really will be a game changer for the sector.

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