Flutter Entertainment PLC [FLTR: LON] – Market Cap as of 08/10/2019: £6.32bn

Stars Group Inc [TSGI: TSE] – Market Cap as of 08/10/2019: C$7.89bn

Introduction

On Wednesday October 1st 2019, news broke of the all-share takeover of the The Stars Group (TSG), a Canadian owner of online gambling platform PokerStars, by Flutter Entertainment, an Irish bookmaking holding company. The transaction will create the worlds’ biggest online betting operator in terms of revenues with annual revenues of £3.8bn, 13m customers across 100 markets and valuation north of £10bn. The combined group will have its head-quarters in Dublin and will be listed on the London Stock Exchange as well as on Euronext Dublin.

About Flutter Entertainment

Flutter Entertainment, previously Paddy Power Betfair (PPB), was created through a merger of the Irish Paddy Power and its British rival Betfair, completed on the 2nd of February 2016. In May of 2016, PPB acquired daily fantasy sports operator Draft, a deal which started the companies’ expansion into the prominent market of fantasy sports games. In May 2018 PPB announced its intent to acquire FanDuel, one of the two leading daily fantasy sports operators in the United States. The move followed the overturning of a federal ban on sports betting, which gave PPB leeway to expands its assets in the US. The company paid $158m in order to merge its existing US operations into FanDuel group, where it holds a 61% controlling stake. In October 2018, PPB faced regulatory scrutiny which resulted in a £2.2m fine for failing to protect customers showing signs of gambling addiction and for failing to implement adequate anti money-laundering measures. On the 6th of March 2019, PPB announced it would change its name to Flutter Entertainment in order to reflect the growing number of consumer brands in its portfolio. The Flutter group has a clear, four-pillar strategy to support global growth: maximizing profitable growth in core markets, growing Betfair in the rest of the world, attaining podium positions in additional regulated markets, and pursuing the US opportunity rigorously.

Flutter operates across four divisions: Online, Retail, Australia and the United States. The Online division consists of the Paddy Power, Betfair and Adjarabet online sites which offer sportsbook, exchange and gaming services across the UK and Ireland, Europe and International territories. The division has leading positions in key regulated markets and is targeting many more in the wake of rising popularity of online gambling. The Online business of Flutters accounted for £948m in revenues and £316m in EBITDA of the group in 2018, making it Flutters primary source of profit. The Retail division is comprised of 626 Paddy Power betting shops across the UK and Ireland which brought £331m in EBITDA in 2018. The Australian division oversees Sportsbet, the leading corporate bookmaker in the Australian online market which currently has a market share of about 26% and had £403m in revenues in 2018. The US division, the FanDuel Group, is the number one operator in the developing US market, with online and retail operations across the country. The FanDuel Group recorded £236m in pro forma revenues last year and is looking to increase this number substantially following the acquisition of TSG.

Flutter Entertainment recorded £451m of EBITDA (24.1% margin) and £1.87bn in revenues in 2018, a 7% increase since 2017. The Flutter group had above 7.5 thousand employees in 2018 and is led by Peter Jackson as CEO, who will remain as such in the newly formed company with TSG.

About The Stars Group

In 2014, the company led by David Baazov agreed to buy the parent company of PokerStars and Full Tilt Poker from the Scheinberg brothers for $4.9bn. The take-over made TSG, then called Amaya, the world’s biggest publicly listed online gambling company. In August 2016 David Baazov resigned as Amaya CEO following multiple securities and fraud charges by Canadian regulators. In August 2017, under the newly appointed CEO Rafi Ashkenazi, the company changed its name to The Stars Group in order to distance itself from it’s the marred legacy of its predecessor Amaya. In April 2018 TSG acquired UK-focused Sky Betting & Gambling for cash and stock worth $4.7bn. In May 2019 Fox sports announced a partnership with TSG to develop sports betting platforms for the US market under the Fox bet banner. The deal involved the Fox Corporation purchasing a 4.99% stake in TSG for $236m and thus becoming the first major US sports broadcaster to introduce a co-branded sports betting platform.

TSG offers a wide range of online gaming products and services including poker, casino and sportsbook through its online gaming division, Stars Interactive. The online brands include PokerStars, PokerStars Casino, Full Tilt Poker and BetStars. The online division, Stars Interactive, has licenses or related approvals to operate from 17 jurisdictions and offers its products and services in Europe, North America and elsewhere. The group also owns a number of live poker tournament brands, such as PokerStars Live held in gambling hubs such as London, Macau and Manila.

The group is traded on Nasdaq and the Toronto Stock Exchange and is headquartered in Toronto, Canada. TSG recorded $2bn in revenues in 2018, a staggering increase of roughly 50% compared to 2017. However, operating income was halved from 2017 to 2018, much due to the acquisition of Sky Betting & Gambling and thus expansion into the UK market which increased costs related to marketing and R&D. The group has around 4.5 thousand employees and its current CEO Rafi Ashkenazi will be appointed COO of the newly formed company following the acquisition.

Industry Overview

The merger between Flutter and TSG is the latest in a flurry of deals in the gambling industry, which seeks to adapt to changing regulatory environments and to benefit from the growing demand for online gambling.

Betting companies operating in the UK and Ireland have come to face increasingly stringent regulation and higher taxes. Policymakers worried about the damages of gambling have introduced measures which have increased costs for betting companies and cooled demand from their customers. For instance, regulators slashed the maximum stake permitted in fixed-odds betting terminals from £100 to £2. This had drastic consequences for bookmakers, whose income from these machines can make up to a third of total profit.

Other unfavorable measures include restrictions on advertising during sports games and tougher anti-money laundering rules. While these changes have impacted big players such as Ladbrokes, William Hill and Betfair, smaller companies were also hit. As such, the betting industry has become a major playground for consolidation, with recent examples being JPJ, the Rank Group and Sportech. Indeed, betting companies which struggle to remain afloat pursue M&A strategies as a means to improve their digital offerings and expand their geographic reach. A larger geographic presence is a key enabler for betting companies as the situation across the Atlantic Ocean is much milder. Last year, the US Supreme Court lifted a ban on individual states which prohibited betting on sports such as football, baseball and basketball. This opened a new market estimated at $150bn, which betting companies are eager to tap into.

Deal Structure

The all-share combination will see Flutter pay 0.2253 new Flutter shares per TSG Share, which represents an implicit 36% premium. As a result, Flutter will own the majority of the combined group, with its shareholders holding approximately 54.6% of the new company and TSG Shareholders owning the remainder. The newly formed company will be headquartered in Dublin and listed on the London Stock Exchange as well as on the Euronext Dublin. As part of the merger, Flutter has entered an agreement with FOX Sports, one of TSG’s partners, in order to align the two companies’ economic interests. If the merger goes to completion, the sports broadcasting network FOX Sports will have a 10-year option giving it the right to acquire up to 18.5% of Flutter’s FanDuel business, its U.S.-based sports bookmaker. The deal is still subject to regulatory approval, which may prove difficult given the companies’ large market share in the UK and Australia. Flutter and TSG hope to obtain their shareholders’ backing around March 2020.

Deal Rationale

The transaction is perfectly aligned with Flutter’s strategy, both in terms of presence in its core markets and of further international growth. First of all, the combination will strengthen Flutter’s positioning in the core markets of UK, Ireland and Australia, where the group is expected to benefit from the combined offering of Sky Bet, Paddy Power and Betfair, while also developing cost synergies from integrated technology and marketing investments.

Secondly, the combination is expected to have significant effects on the international growth prospect for the entity: TSG currently has an active customer base of around 4m people in its international segment, and the transaction would, as a result, boost the international presence of the combined group. More specifically, a notable revenue growth in international markets is expected to be achieved through a cross-selling strategy to TSG’s poker customer base, potentially bringing sports betting to entirely new markets. Furthermore, the transaction will also increase to 8 the number of countries in which Flutter enjoys a market-leading position: UK, Ireland, Australia, US, Georgia, Spain, Italy and Germany, with the final three being added by the combination with TSG. Finally, TSG’s platform capabilities will aid the internationalization process through the increased offering of around 30 languages, 25 currencies and more than 55 payment options. It is evident that overall, the product and geographical diversification brought by the combination of Flutter and TSG will better position the resulting entity to successfully manage future tax and regulatory change in the industry.

Another key strategic factor behind the deal is represented by the excellent brand recognition that will be achieved across the Unites States, through the combined offer of FanDuel, FOX Bet and PokerStars. The combined group will offer free-to-play games, sports betting, horse racing and poker amongst many others; such a wide product offering will drive down the cost of acquiring new customers, while increasing customer lifetime value.

Furthermore, the two companies have highlighted the deep understanding they have developed of each other’s businesses and the management of the combined group will focus on maintaining momentum in the most successful businesses of the respective companies.

From a financial perspective, the merging companies expect that the combination will lead to material pre-tax cost synergies of around £140m per annum, which will be achieved by eliminating redundancies in corporate functions, programming interface integration across platforms and economies of scale for advertisement and marketing. The combined entity is also expected to generate a strong cash flow that would result in rapid deleveraging, maintaining a 1x-2x Net Debt to EBITDA. The combination will be value accretive for Flutter’s shareholders and will be 50% accretive to its EPS in the first year after completion.

Market Reaction

On October 2nd, the day of the announcement of the transaction, Flutter Entertainment (FLTR) listed on the London stock exchange was up 17% in morning trading, closing at £81.64 per share, corresponding to a 6.94% increase on the day before. On the same day, The Stars Group Inc (TSGI) was up almost 30% at the opening in Toronto, reaching peaks of C$20.38 per share and closing at C$20.06.

Over the two subsequent days, The Stars Group share price kept on rising, closing at C$20.92 per share on October 4th, which seems reasonable when considering the 36% implicit premium received by The Stars Group shareholders in the transaction. On the other hand, over the same time period, Flutter share price behaved very differently, closing at £80.90 on October 4th, down from £81.64 on October 2nd. The drop may be explained by rising concerns on the size of the implicit premium recognized to TSG, which stands at about £200m more than the value of savings. Other major concerns are represented by the level of net debts, that will soar to 3.5 times combined forward EBITDA, and by uncertainty in terms of tax and regulation for the entire gambling industry.

Financial & Legal Advisors

Barclays, BMO Capital Markets and Moelis & Company LLC served as financial advisers to the Stars Group board. A&L Goodbody and Blake, Cassels & Graydon LLP served as Stars Group’s legal counsel.

Goldman Sachs and PJT Partners served as financial advisers to the Flutter Entertainment board, while Artur Cox and Blank Rome LLP acted as Flutter’s legal counsel.


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