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A Merger Between Paddy Power Plc And Betfair Group Ltd Is A Win-Win Proposition

The boards of Paddy Power (LSE: PAP) and Betfair (LSE: BET) have agreed to a merger that would create the world’s biggest online gambling company. In an all-stock merger, Paddy Power shareholders will own 52% of the combined company, leaving Betfair shareholders with the remaining 48%.

Although regarded as a “merger of equals”, Paddy Power shareholders will receive an 11% premium to its share price, based on yesterday’s closing price. This is mostly down to the special dividend of €80 million that Paddy Power shareholders would receive immediately prior to completion.

Following today’s announcement, shares in Paddy Power and Betfair rose by 17.2% and 17.5%, respectively. The double-digit percentage gains recorded by the share prices of both stocks reflect that the market views the merger as a win-win proposition for the shareholders of both companies.

Paddy Power and Betfair are two of the fastest growing gaming companies in the industry, and the combination of the two companies would create an even more powerful competitor in the gambling industry. The combined company would generate revenues of £1.1 billion and will become a market leader in many markets, including the US, UK, Ireland, Australia, and much of Continental Europe.

Betfair has a strong online betting franchise and unparalleled popularity with its betting exchange, whilst Paddy Power has a retail, mass market business and a strong presence in Australia. The two companies have highly complementary assets, and the merger of the two should create significant revenue and cost synergies. Management intends to retain both brands, but there is still significant scope to eliminate duplication, given the overlaps in online operations and geographies.

One area this could have a significant effect is with product development costs. The gambling market is evolving quickly, and companies face costly investments to develop new products and features to attract customers to their online and mobile betting platforms.

With increasing regulatory pressure and higher taxes in many markets, the need to expand is increasingly important. Scale has become a byword in the corporate board rooms, and acquisitions is the quickest way to grow. M&A activity in the gambling industry has picked up recently, with Ladbrokes and Coral agreeing a merger in June, and Bwin.party in talks with potential suitors.

Both companies also released their trading updates today. Despite the pressures affecting the industry, both Betfair and Paddy Power are showing robust growth in revenues and earnings. Betfair saw revenues in the three months leading up to 31 July rise 15% to £135.4, despite a tough comparable period last year, which included the 2014 World Cup.

In the first six months of 2015, Paddy Power’s underlying operating profits grew 68%, whilst net revenue increased 25%. Its latest results also showed the importance of the mobile channel, as mobile net revenue accounted for 67% of online revenue, with 78% of active customers transacting via mobile.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.