On Friday morning, high-street betting firm Ladbrokes (LSE: LAD) confirmed that it will merge with rival Gala Coral, to create a £2.3bn business that will control around 4,000 of the UK’s 9,000 betting shops.
The new firm will be called Ladbrokes Coral and will have indicative sales of £2.1bn and earnings before interest, tax, depreciation and amortisation (EBITDA) of £392m, according to Ladbrokes.
However, this deal isn’t enough to hide the cracks in Ladbrokes’ finances. Today’s deal was announced alongside a 66% cut to the 2015 dividend, which will fall to 3p, and a placing of 92.4m new shares, worth around £118m at today’s prices.
The reduced dividend payment means that despite trading close to a five-year low, Ladbrokes shares now offer a prospective yield of just 2.3%.
In my view, directly owning shares in Ladbrokes might not be the best way to profit from this deal. Instead, investors might want to consider investing in Ladbrokes’ technical partner, Playtech (LSE: PTEC).
The profit machine
Playtech provides much of the gaming software used by Ladbrokes’ betting shops and online operations. It’s a ‘pick and shovel’ business — by providing essential tools and services to Ladbrokes, Playtech makes a reliable profit, even when Ladbrokes isn’t doing so well.
If the Ladbrokes-Gala Coral merger goes ahead, Playtech will receive a £75m one-off payment from Ladbrokes. This will be made up of £35m cash and £40m in Ladbrokes shares.
Playtech has also agreed to buy 22.9% of the shares being offered in today’s placing of Ladbrokes shares. Assuming the new shares are placed at the current share price of 128p, that means Playtech has agreed to put £27m of its own cash into Ladbrokes shares.
If the merger goes ahead, this will leave Playtech with a stake in Ladbrokes worth around £67m at today’s prices. That’s a big vote of confidence, in my view.
Ladbrokes vs Playtech
Playtech’s expected shareholding in Ladbrokes suggests to me that the firm is keen to move beyond simply providing technology and wants to have a meaningful stake in branded betting businesses.
The group recently bought troubled financial trading firm Plus500, which it hopes to combine with its recently acquired TradeFX business.
In my view, Playtech’s online focus has a number of advantages over Ladbrokes’ large bricks-and-mortar estate.
|
Playtech |
Ladbrokes |
|
|
Operating margin |
27.9% |
5.5% |
|
2015 forecast P/E |
19.5 |
18.6 |
|
2015 prospective yield |
2.2% |
2.3% |
Ladbrokes and Playtech both have very similar valuations and yields, but Playtech’s 27.9% operating margin highlights a key advantage over Ladbrokes — cash generation.
Playtech’s earnings per share and dividend are expected to rise by around 20% in 2016.
The same is unlikely to be true of Ladbrokes, in my view. Today’s placing will have a dilutive effect on earnings per share, while the extra earnings arising from the Gala Coal merger will be cancelled out by the effect of the shares being issued to Gala’s current private equity owners, who will have a 48.25% stake in Ladbrokes Coral.
In my view the combination of Ladbrokes and Gala Coral is logical, but investing in Playtech could be the best way to profit from this deal.
