Refinancing pressures cast shadow over leading bookies

Leisure Report, Nov, 2008

The UK's leading bookmakers, Ladbrokes and William Hill, are over-geared and may be forced to issue equity to refinance debts in the next few years, according to Morgan Stanley.

The investment bank warned that William Hill (WMH) in particular is vulnerable, because debt levels, and refinancing requirements, are "acting as an overhang on the sector".

William Hill's main debt line of 1.2bn [pounds sterling] expires in March 2010, and Morgan Stanley estimates the firm will need to roll over at least 700m [pounds sterling] of new debt. "Given the nervous debt markets, and limited access to bank debt, we cannot rule out WMH requiring equity to refinance its debt. For this reason, we assume that the company will suspend dividends," it said.

Ladbrokes is in a slightly better position than WMH, as its debt maturities are more widely spread that its rival's, ranging from 2011 to 2013.

The firm will have to find at least 150m [pounds sterling] of the 350m [pounds sterling] due in 2011, Morgan Stanley estimates, which should be simple.

However, credit agency Moody's has put a negative watch on Ladbrokes' credit, owing to potential contingent liabilities from the Hilton disposal, with a potential magnitude of 106p a share, and this could affect the firm's ability to refinance at current levels.

The market is already adjusting to Morgan Stanley's bear case pricing, assuming reversion to 11x-15x P/E ratios, and a rights issue at one of the bookmakers.

The bank suggests that, in the wake of any rights issue, it "would take some time to revert to mean multiples, and our bear cases assume multiples of 8x-9x P/E on a post-rights basis."

The sector is also likely to come under increasing stress as a result of weak consumer spending trends.

While gaming has so far proved robust in comparison to retail, a like-for-like decline of c.3% in gross win for 2009 is predicted, which would be broadly in line with the pub sector.

This would imply a 20% peak to trough decline in the UK retail betting market, similar to the declines reported in the last recession in the early 1990s. With every 1% decline in like-for-likes equivalent to a 4%-5% fall in earnings per share for Ladbrokes and WMH, forecasts are expected to remain volatile.

"We expect 2009 to be a tough year for the bookmakers, and think that three key concerns (consumer confidence, refinancing, and regulatory risk) will mean that multiples remain low for the next 12 to 18 months. We do not see much chance of fundamental improvements in any of these areas in the foreseeable future, and this guides our more cautious stance on the UK bookmakers. With balance sheets that are starting to look more stretched, we expect bookmakers to remain under pressure, as visibility of cashflow deteriorates," the bank said in a research note: Bookies--Long Odds on 2009 being a Good Year.

Despite the cautionary words, UK retail gross win would have to tumble by more than 10% for WMH or Ladbrokes, for either to breach their banking covenants.

However, ongoing concerns over regulatory risk were highlighted last month with a surprise rise in gaming tax in Ireland. "The tax on betting will rise to 2% from 1%," according to Irish finance minister Brian Cowen.

Such an increase would raise Paddy Power's betting duty bill to about 20m [euro], leading to a "significant: impact on profitability, analyst Gavin Kelleher at stockbroker Merrion in Dublin said in a note before the budget was published.

William Hill and Ladbrokes also have stores in Ireland, so will see their tax bills increase.

Furthermore, the risk of a tax increase in England remains, with per-machine tax (AMLD) the most likely to rise, in order to part-fund further research into problem gambling.

Some hope does remain, however. During the last recession in 1991, gambling on horseracing or greyhounds accounted for 95% of betting turnover. This has now fallen to between 33% to 50% of total betting turnover, as products have diversified.

"The range of betting offers and continued product innovation should provide some insulation from a downturn", Morgan Stanley said.

Additionally, because market expectations are currently so low, any signs of trading strength could drive a significant rally, as proved by WMH's shares, which gained 10% after the firm's robust interim management statement in October, having previously lost 74% of their value over the last 12 months.

Any recovery in the debt markets will naturally reduce the refinancing risk for the bookmakers, as well as igniting M&A speculation, and the potential for organic growth in both overseas and online markets remains.

Indeed, the online sector has thus far proved to be ebullient, with positive trading statements coming from a number of key players, including Sportingbet, 888, and Leisure & Gaming, while Paddy Power, which according to Morgan Stanley has "the most attractive profit mix, with 70% of profits from the high-margin, high-growth internet" is rated as 'overweight'.

However, WMH received a boost from broker Numis Securities following its deal with Playtech to create a broad online service (see p3).