RP iGaming Index: A Rolls Royce ride, or more British Leyland?

Despite the intrinsic uncertainty and risk posed by yet another UK general election, the Index kept pace with the NASDAQ in the period, with stocks in focus Stars and Flutter the biggest gainers ahead of their proposed merger. By Regulus Partners

As we write this, the UK braces itself for another General Election—the third in four years and the first in which all major parties offer a review of gambling policy.

While this is ‘only’ likely to affect the UK directly (though its indirect effects will be felt much more broadly, it is worth reflecting that 71% of the index’s constituents derive revenue from the UK and it is the biggest single revenue market for 34% of them.

As the world’s biggest single domestically licensed market, UK policy is therefore a very big deal. At the moment, markets (both betting and stock) are expecting a Conservative victory and a relatively light follow-up commitment to regulatory reform. If either of these assumptions prove wrong, then we will be in for a very volatile (read bruising) time.

The election outcome is also likely to affect gambling companies in three other ways.

First, the economic and cross-border impacts of Brexit are likely to be tested in the event of a Conservative victory and gambling has a lot riding on both of these.

Second, while the lack of a Corbyn victory might defuse the risk of harder Brexit scenarios, it also potentially brings in sweeping economic reforms and devolution. It is hard to say which might be more disruptive or could create more lasting damage (or opportunity).

The election and subsequent political direction of travel will also affect the value of sterling—with a very real possibility of a much weaker pound either from Brexit or balance sheet fears. UK companies could therefore become prey to their international rivals regardless of gambling policy (assuming the problems in Britain are worse than the problems in the predator’s markets, which is by no means a given in the current climate).

With all of this uncertainty and systemic risk about to crash upon us, we might be expecting jittery markets and an underperforming RP iGaming Index. But instead, the NASDAQ (far less concerned about Britain or gambling) advanced 5.0% over November to YTD highs (up 28% from January) while the index almost kept pace at +4.5% (similarly up 25% from January lows).

Perhaps surprisingly therefore, the market appears to see less risk at the end of the year than at the beginning of it, both for wider stocks and for the online gambling sector specifically.

Certainly the world hasn’t fallen apart despite simmering trade wars, but perhaps we should thank the resumption of quantitative easing in the short term, without looking too closely to what that might mean for the longer term if we want to keep our sanity.

The biggest gainers on a market capitalisation adjusted basis (and therefore the biggest movers of the index) were The Stars Group (+21%) and Flutter (+12%), with the market warming to the likelihood and benefits of a deal and especially the relative positioning of Stars.

Since this has been the biggest sector news of the quarter and creates a group which would rank c. 35th in the FTSE 100 (£14bn market cap, bigger than all the other UK listed gambling companies put together), these companies are our stocks in focus.

Stocks in focus: Stars and Flutter
Stars and Flutter, if given the approval of competition authorities (which we believe likely on close examination given the structurally highly competitive nature of the products and markets which overlap), will create a business the same size as Rolls-Royce in market cap terms.

That is a huge leap forward in terms of online gambling’s entry into the mainstream: it can no longer be ignored by any investors of any stripe without an active reason to do so (e.g. running an ethical fund which prohibits ‘sin’ stocks).

However, gambling historically performs badly in the public gaze (with the possibly short-term exception of US sports betting) and so the ‘mega-merger’ is setting a significant bar on two levels.

First, it can’t afford to mess up the synergies. Historically, putting lots of brands under one roof has had mixed results in a number of sectors—and sustainable innovation around the customer is vital for both resilience and growth.

The combination certainly has the resources to do it, but without very careful management of a business of that scale the risk is innovation by committee and the emergence of the gambling version of the Austin Allegro.

If innovation splutters (from a relatively low base), then the new-found scale will rapidly become illusory and the combination will not be hobnobbing with Rolls-Royce for long.

Another stock the combination will be close to is Smith and Nephew, an advanced wound management specialist. This may be apt, because the online gambling industry’s ability to hurt itself through sharp practice, failure to think through the consumer impact of operational decisions, and poorly considered PR has been proven time and again.

Midcap investors expect a bit of madcap—it is part of the high-risk/high-reward trade-off that comes from choosing to own low liquidity stocks. In many ways gambling is made for this world (they have a thing or two in common).

Not so the dizzying heights of the FTSE 100 mid-table. Here companies are expected to behave like grown-ups (sharp practice tends to involve entire countries, not just a few VIPs) and no (online-led) constituents of the sector have yet demonstrated they are fully ready for the big league of scrutiny.

To be fair, Stars and Flutter are two of the closest to these high standards and companies can grow into a role just as people can. However, in a heavily regulating universe, companies are only as strong as their weakest links, and the online gambling sector sometimes looks like a chain of chocolate.

The mega-group must therefore not only raise its own game a bit, but also show the leadership necessary to get the wider sector to raise its game a lot, which is where the combination may stutter…

Disclaimer: the narrative provided represents the opinions of the authors. Any assessment of trends or change is necessarily subjective. The information and opinions provided are not intended to provide legal, accounting, investment or policy advice, nor should they be used as a forecast. Regulus Partners may act, or has acted, for any of the companies and other stakeholders mentioned in this article.