M&A watch: Regulated vs. grey

In his first monthly column for IGaming Business, RB Capital’s Ben Robinson digs into the data to identify how the transition to regulated markets is driving sector M&A strategies

It’s the age-old question that the industry has always grappled with. White or grey, which one is going to give us the best (risk-adjusted) return?

More countries, particularly across Europe, are now closing their borders to offshore operators and introducing licensing and tax frameworks. Consequently, the industry is being gradually coaxed into abandoning its ‘darker’ market activities in favour of expanding white market portfolios which drive more visible and investor-friendly regulated revenues.

With more markets choosing to follow the likes of Italy, Spain and Denmark, this regulated land grab has come at a price. Regulation is an expensive activity, from the additional funds and resources needed – and topped up on an annual basis – to pay for new licences, local partnership agreements and suppliers, tax bills and staff, to the endless, eyewatering legal and consultancy fees used to smooth the processes.

But has this put companies off from investing in regulated businesses and pushed them towards arguably riskier opportunities?

As we know, the industry’s appetite for risk isn’t restricted to the products it develops for players. Many successful operators and their founders have been richly rewarded for treading a fine regulatory line over the years.

But even the more prominent exponents in the space – namely GVC, a listed business which for many years built its business in grey markets, and PokerStars, which emerged relatively unscathed from the Black Friday Department of Justice indictments in 2011 – have fallen for the lure of regulatory earnings in recent times.

Numbers speak for themselves
According to RB Capital’s M&A Monitor, over the last three and half years a staggering £10bn has been spent on regulated market acquisitions (classified as those conducting a minimum 50% of their business in regulated territories),with the two largest transactions (GVC– Ladbrokes-Coral and PokerStars–Sky Bet) both announced and completed in 2018 (see below).

These two deals may have skewed the trend somewhat, but even when these two transactions are excluded a whopping £1.3bn was still spent buying up businesses mainly focused in regulated markets in just 40 months.

On the flipside, unregulated company M&A (classified as that focused on companies with less than 50% of their business regulated at the point-of-consumption) has also continued at a steady pace, but with deal flow and deal value diminishing over the assessment period, with just over £700m in ‘grey’ transactions taking place between 2015 and today.

The anomaly here has been the affiliate sector – with two significant trends emerging.

Firstly, through rapid-fire acquisition, affiliates such as Better Collective and Catena Media have developed into global super affiliates by acquiring hundreds of leading brands and the power to pull in huge player numbers – a potentially massive headstart for operators entering any newly regulated or regulated market.

Secondly, changes in regulation, both positive (US sports betting) and negative (additional cost pressures in regulated markets), shifts in Google’s search engine policies and the challenges of facing more scale players in the space have forced many affiliates to sell up, a process set to continue.

RB Capital’s data shows that 85 regulated business transactions took place from 2015 to June 2018 compared to 35 ‘unregulated’ acquisitions in the same period with – multi-billion agreements aside – the number of regulated deals increasing annually.

While unregulated dealflow has lagged behind in recent years, this segment has been the most buoyant for the affiliate sector.

2018: The tipping point
This year has by far been the biggest year for regulated market deals in the history of the industry, with more done in the first half of this year than the whole of 2017.

The opening of new markets has been clearly forcing the hand of operators and suppliers to switch lanes and grow by acquisition as opposed to organically.

Look under the hood of the deals of the last 12 to 18 months, however, and some interesting patterns begin to emerge.

While there may be more deals in regulated markets than ever before, they are becoming increasingly structured and complex, with sellers not making as much upfront cash as they would have done a few years ago.

On the flipside, earn-out proportions and time periods are also widening.

This is due to several factors. Predominantly, savvier buyers and investors have carefully studied the highs and lows of the market over many years and can now tailor their offers by product and territory.

Furthermore, there is less liquidity flowing through the system, with major buyers able to leverage the use of raised capital and shares or share swap arrangements to buy their prized assets.

We expect transaction activity among operators to continue to intensify in the second half of 2018, with the regulated acquisition trajectory following similar, if not higher, levels for the next 18 to 24 months, whilst existing capital remains liquid or under invested.

The markets will look to public company buyer share prices to gauge how healthy the M&A market is, while private buyers will focus on unregulated markets and (safer) US assets.

Merging or taking over a business with local nous, talent and rapidly growing present and projected regulated earnings has clearly been too tempting a proposition for many to resist.

But there remains another factor driving whiter market growth, namely the saturation and gradual slowdown of large, well-established regulated markets.

The UK online gaming market, for instance, was worth approximately £5bn in the 12 months to November 2017, but growth is dropping off.

According to British Gambling Commission figures, annualised revenue growth has fallen to around 9%, compared to 20% between 2014 and 2016.

This will only increase the rate of consolidation, as several brands and suppliers will be unable to keep up.

Conversely the leaner, more agile players will be incentivised to drastically improve efficiencies and push for better products and a faster product release cycle.

In such a fiercely competitive and increasingly regulated global market, the appetite for growth has never been higher. Correspondingly the fight for prized assets will only intensify in the coming years. It’s going to be fascinating to watch.

Ben Robinson is co-founder of boutique advisory firm RB Capital, focused on the igaming, fintech and media sectors; working with start-ups and scale-ups looking to raise capital, but also established businesses looking to take their business to the next level or initiate a liquidity event.