Tabcorp has extended its digital lottery relationship with Jumbo Interactive to 2030 on a more favourable basis, emphasising its significant market weight.
-Economics of the deal shift in favour of Tabcorp via services fees
-Australian digital lottery turnover rapidly increasing
-Race wagering solid, offsetting sport cancellations
Tabcorp Holdings ((TAH)) has wielded market power, renegotiating a more favourable digital lottery relationship with Jumbo Interactive ((JIN)). Jumbo Interactive accounts for around 20% of total digital lottery sales in Australia ex Western Australia while Tabcorp has the other 80%.
Tabcorp has extended the relationship to 2030 and effectively reduced the net commission it pays. Tabcorp will receive a fixed extension fee of $15m and ongoing services fees based on the ticket subscription price which moves up annually to 4.65% by FY24.
Citi asserts renegotiating the deal is less risky than an exit from the current agreement. The prospect of Tabcorp being the sole online lotteries option outside of Western Australia would have required a successful customer migration from one platform to another that may have proved challenging.
The economics have shifted in favour of Tabcorp via the services fee. Morgan Stanley calculates, when fully implemented in FY24, this will result in a -3.75 percentage point reduction in revenue and transaction value for Jumbo Interactive.
The broker also believes the one-off extension fee is strange, given this is a long-term deal. Importantly, while the upfront fee is a marginal benefit, this limits Jumbo Interactive from bypassing Tabcorp as a reseller until 2030.
Mitigation of the lost revenue is likely to be the focus for Jumbo Interactive, Citi suspects and using the price lever is an option for improving its revenue in the short term. The broker upgrades Tabcorp to Neutral from Sell, believing some of the short-term headwinds are being countered by extracting value from the lotteries chain.
While on balance the new deal is positive for Tabcorp, Goldman Sachs believes the announcement may have disappointed those who were expecting even more favourable terms, in light of Tabcorp's strong bargaining position.
The broker, not one of the seven stockbrokers monitored daily on the FNArena database, retains a Sell rating and increases the target to $2.80. The main upside risk envisaged for Tabcorp includes acquisitions, reduced wagering competition and better-than-expected lottery revenue growth.
Digital Lottery Turnover
Macquarie calculates the new deal could generate around $20m in operating earnings after FY24, noting Australian digital lotteries account for around 27% of turnover and this is rapidly increasing.
The broker envisages challenges and benefits, with a an expected increase in digital at the expense of retail. Tabcorp is likely to have generated free cash flow throughout the pandemic restrictions, given online capability. Overall, volumes have been better than the broker had expected since retail outlets were closed.
Credit Suisse calculates lottery revenue is down around -10% in the June half year. Considering the circumstances, this is assessed to be "pretty good". A number of agencies did close during the pandemic and jackpot sizes are generally smaller.
Meanwhile, the broker assumes a -19% drop in revenue for wagering in the June half. Around half of revenue is sourced from retail betting locations which were shut in April and May. However industry turnover has been solid as race wagering has offset cancellations in sport.
Macquarie forecasts Tabcorp's wagering & media revenue will still fall -15% in FY 20, with a -29% decline in the second half, and remains concerned around heightened competition because of the step-change in digital and the integration of BetEasy/Sportsbet.
Still, the broker considers the valuation attractive and a re-rating possible if lottery jackpots surprise or wagering stabilises. Macquarie expects dividends may resume in FY22 and assumes an 80% pay-out ratio.
The new Tabcorp transaction does not cover Western Australia and this could be the next material change as Morgan Stanley considers Jumbo Interactive's WA business is unresolved.
Scenarios could range from Jumbo Interactive losing the ability to resell tickets to retaining that ability and securing a software agreement that would power Lotterywest's operations. Incumbent Intralot has a market cap of EUR23m but, as far as Morgan Stanley can tell, the contract expired in 2019.
FNArena's database has two Buy ratings, four Hold and one Sell (Ord Minnett, yet to comment on the deal). The consensus target is $3.30, signalling -2.2% downside to the last share price.
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