The merger between Australia’s betting company Tabcorp and lottery Tatts faced immense scrutiny from both shareholders and competitors, and took one year to finally complete in 2017. Now, activist investor Sandon Capital believes it should be undone because lotteries and wagering do not belong together.

“These are fundamentally different businesses, with different capital allocation profiles. Lotteries is a good high-yield stock, whereas the wagering business is more akin to an app business, where you need to keep reinventing it,” Sandon’s Managing Director Gabriel Radzyminksy told Activist Insight Online in an interview.

Sandon’s idea is not new. The activist initially opposed Tabcorp’s acquisition of Tatts, but at the time was not able to muster the necessary shareholder support. In 2019, large institutional investor Perpetual, which owns 5.9% of the stock, floated the demerger idea, but CEO David Attenborough described it as “total nonsense.”

New era

Times have changed. Attenborough is on his way out as shareholders have expressed dissatisfaction with his tenure, with a new CEO yet to be named.

The company has a new chairman in Steven Gregg, who might look at the demerger idea with a fresh set of eyes honed for more than 30 years in the investment banking and management consulting sectors in Australia and the U.K., with stints at ABN Amro and McKinsey. “Everyone we’ve contacted has spoken very highly of him,” Radzyminksy said, referring to Gregg.

Radzyminksy said he has discussed his thesis with the company and expects a public response shortly. He will also start discussions with other shareholders soon in order to hear their thoughts on a public presentation making the case for a demerger.

Perpetual, the second-largest shareholder with more than 5% of the shares, is likely to agree with Sandon. Perpetual voted against all directors up for re-election and executive pay in 2019, according to Proxy Insight Online. Perpetual and Martin Currie Investment Management were the only institutional investors to cast such big protest votes from the ones tracked by Proxy Insight. The largest shareholder, pension fund AustralianSuper, backed all the company’s proposals in 2019. In 2020, shareholder sentiment improved, but approval levels were still below Australian averages, Proxy Insight Online data show.

Poor fit

Three years have proven that keeping lotteries with wagering under the same corporate roof does not work. The lottery business has seen strong improvements in recent years and has grown strongly even during the coronavirus pandemic. The business has a strong moat given its monopolistic nature stemming from its 35-year exclusive license and needs little capital to operate. At the same time, wagering and media have been experiencing declining revenues and profitability, are more capital-intensive, and face strong competition.

Lotteries’ revenues have grown from around AU$2.5 billion in 2018 to AU$2.9 billion in 2020, while Ebit margins jumped from around 13% to 15%. Meanwhile, wagering revenues declined from AU$2.4 billion to AU$2.1 billion, with the Ebit margin improving to around 8%.

The weak strategic fit between the two businesses has been reflected in the stock price performance. Since the deal closed in December 2017, Tabcorp shares have lost 17%, while the S&P/ASX 200 Index rose 13%.

Consolidation time

Across the world, lotteries are largely in private hands and rarely make up half of the business as at Tabcorp. In the U.K., Camelot Group, which runs the National Lottery, is a pure-play owned by the Ontario Teachers’ Pension Plan. France’s Francaise des Jeaux is controlled by the French government and in 2019 listed a 20% stake, which has since appreciated more than 62%. Francaise des Jeaux has a small wagering business.

It is not surprising that Tabcorp itself received a takeover bid, which partly prompted Sandon to come out with its alternative thesis. Rumors surfaced in November that Tabcorp is being courted by private equity firms and online wagering pioneer Matthew Tripp. Radzyminsky believes there is more value to be created by demerging the businesses than getting a premium right now.

“The lottery business of Tabcorp is globally unique, it owns the rights of its entire value chain, and it’s a monopoly,” Radzyminsky said. “We would argue the Australian lottery business is the best anywhere in the world.”

A separate wagering business could become a takeover target, given the ongoing industry consolidation. U.S. entertainment companies are out shopping across the Atlantic. Caesars Entertainment acquired U.K.-based William Hill in November, while MGM Resorts offered to take over U.K.-based Entain Group but withdrew its entreaties after opposition from the board. Entain itself is seeking to acquire Swedish online betting house Enlabs but faces opposition from activist investor Alta Fox.