Gala Coral clears debt hurdle: a refinancing at Gala Coral will leave the group free to explore expansion, while it keeps one eye on a deal to buy the Tote

Leisure Report, May, 2008 by Dominic Walsh

John Kelly and Neil Goulden, respectively chairman and chief executive of Gala Coral, have been around the gambling industry too long to be surprised by the sudden change in the company's fortunes over the past year. Every time they spun the Gala roulette wheel with a new set of private equity masters, they would have known that, by the law of averages, they couldn't keep picking the right number.

But even these two hardened industry veterans must have been taken aback by the remarkable run of bad luck the group has suffered, what with the smoking ban, the scrapping of Section 21 machines, the hike in gaming duty, the Treasury's failure to scrap VAT on bingo in Budget and, last but not least, a global credit crunch and worsening economic outlook. Could it get any worse?

Well, it could have been worse. At least, unlike poor old Ian Burke at Rank Group, Kelly and Goulden have a relatively resilient and cash-generative bookmaking business in the shape of Coral. Burke only has the much smaller Blue Square sports betting business to mitigate the debilitating impact of all the woes that have afflicted the casino and bingo industry. The irony, of course, is that, almost six years ago, Rank was leading the field in the race to buy Coral when it was pipped at the post by Charterhouse, which in turn ended up selling out to Gala at a handsome profit.

The decline in trading, and the resultant rail in the stock market value of Rank and rival bookmakers Ladbrokes and William Hill has had a knock-on effect on the value of Gala Coral, even though it is privately owned. Its private equity owners have written down the value of their holdings by about 50%, implying a fall in the company's equity value from 1.35bn [pounds sterling] to about 675m [pounds sterling]. The result is that some of its banking covenants had become a little too tight for comfort, giving the business very little room for manoeuvre in terms of future investment and continued development both in Britain and overseas. Hence the need for a refinancing.

Goulden, who succeeded Kelly as chief executive in 2004, insisted to me that there was "no risk we'll go bust because the value of the debt is way lower than the value of the business". He was also adamant that, if necessary, he and his team could have kept plugging away under the previous capital structure by slashing costs and capex and "micro-managing" the business. But that would, he argued, have meant abandoning Gala's well-defined growth strategy.

As a result, the group's three private equity backers, Candover, Cinven and Permira, have agreed to make a cash injection of 125m [pounds sterling]. The three firms have put forward a proposal to Gala's banking syndicate to underwrite a so-called payment-in-kind (PIK) note, of which 85m [pounds sterling] would be used to reduce its 2.8bn [pounds sterling] debt burden and release the pressure valve on its covenants. True, it will end up paying a slightly higher interest rate, but the additional headroom will allow it to press ahead with the new five-year business plan it has drawn up. At time of writing, the refinancing was due to be considered by the banking syndicate, although with the top 20 banks already "onside" with the plan, Goulden was confident it would be waved through.

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Its new business plan, like the old one, includes an ambitious international expansion programme. It recently acquired its first bingo club in Italy, in Genoa, mainly as a means of easing the development of its internet bingo business in the country. It also secured a licence to open China's first bingo club in order to tap into the Chinese love of numbers games, although again the move was taken with one eye on the country's internet opportunities.

Gala al ready has 219 betting shops in Italy and is targeting Spain, Greece, the Balkans, India and South America for future international expansion. Goulden said recently he believed that, over the next three to four years, its overseas operations could grow to account for about 10% of group operating profits.

But Gala also sees plenty of opportunities in the UK. It recently investigated a possible tie-up with Harrah's Entertainment that could have seen the Las Vegas casino giant inject its London Clubs International business into Gala in return for a significant minority stake in the enlarged company. However, Gala's balance sheet problems are believed to have put paid to the discussions, at least for the time being.

The group is also still hoping to acquire the Tote, although its recent financial travails mean it would have to acquire the Government-owned betting group through a separately funded standalone vehicle. Goulden revealed that Gala's three backers had agreed to stump up 50m [pounds sterling] of new equity each, with the balance of the expected 400m [pounds sterling] asking price to be funded with about 180m [pounds sterling] of debt and 70m [pounds sterling] of mezzanine or PIK finance.

Although Gala is seen as the frontrunner in the auction, which is being handled by Goldman Sachs, there are still plenty of hurdles to jump before it can enter the winner's enclosure. Not least of these is the impact of the current financial climate on the price. Throughout its abortive negotiations over a sale to the racing industry, the Government made it clear that 400m [pounds sterling] was the asking price, a figure that remains the target. But Goulden opined that, in current markets, that might be optimistic, throwing something of a cloud over the process. There is also the issue of the Tote's pool-betting monopoly. The Gala boss has been clear about the fact that he does not want this part of the Tote, arguing that "emotionally it belongs to racing".