Is the market overreacting to Paddy Power Betfair’s Q4 results?

Paddy Power Betfair (PPB) was the worst performer on the FTSE 100 yesterday, dropping 4.4% on the back of a trading update that reported a 3% fall in Q4 Online revenues.

The decline continued Tuesday morning, with the operator’s stock at 8,115p after closing at 8,675p last Friday.

However, some analysts were quick to point out that core metrics showed a business growing as rapidly as ever, with customer-friendly football results overshadowing the fact that sports betting stakes grew 15%.

All sports betting firms reporting Q4 figures so far have seen some impact from the football results, with William Hill saying they sliced around £20m profit from its bottom line. Ladbrokes Coral reported profits in line with expectations despite the results, but both firms are coming for a much lower base, with Ladbrokes continuing to spend more than 30% of GGR on marketing.

One industry trading chief said sportsbook results in Q4 were going to be “exclusively shit, and if not, then you probably have bigger problems”.

When assuming “normal” sports results for Q4, analysts at Davy suggested PPB would have beaten its top-of-the-range EBITDA forecasts for the year by circa 4%, at more than £420m.

“It is easy to get caught up in the minutiae of a quarterly statement and to lose sight of the overall performance of the group for the year,” Davy said in a note. “This statement reinforces our upgrade thesis on the stock and, as such, we retain our ‘Outperform’ rating.”

Aside from sports betting, gaming caused some concern, with PPB mentioning “some weakness”, but offering no further details. EGR Intel understands the vertical suffered from weak cross-sell, a decline in VIP activity and a slowdown in gaming acquisition at Paddy Power, due in part to a lack of television advertising for gaming.

But gaming numbers could get a boost in Q1, as those football punters who took the firm for £40m in Q4 splash their cash in the online casino. Kames Capital UK equity manager Audrey Ryan said: “Having followed these stocks for some time, you do get periods like this wherein the punters are winning more than the bookmakers. But the individuals who win that cash typically have a propensity to spend it so those winnings are generally recycled.”

Short-term pain, long-term gain

Longer term, choosing to invest more in the vertical could be the key to PPB’s future growth and market-leading position, according to Regulus Partners.

“A key strategic question for the group is to decide whether it can maintain momentum in the longer term with nearly all its focus on betting, given that gaming is a bigger sector in nearly all regulated markets,” Regulus said in a note.

In the short-term, the Q4 revenue drop also overshadowed other positive notes in the trading update, including the group’s “lower than expected marketing and staff costs” and limited exposure to UK retail.

UBS for instance downgraded its rating on William Hill on Tuesday, saying the market was not accounting for the threat of changes to FOBT regulation. Hills shares were down 5% on Tuesday, while Ladbrokes was down 2.6%.

However PPB is significantly less exposed to this risk than its rivals, with just 6% of group revenues coming from FOBTs.

“Unlike Ladbrokes Coral or William Hill, PPB’s exposure to UK retail is limited,” said Numis analyst Richard Stuber. “Near-term we expect solid trading (gross win margins normalising) and continued EBITDA progression (operating leverage)”.

With this in mind, perhaps the biggest factor in the market’s antipathy on Monday was the lofty expectations associated with PPB’s brands and its 21x multiple.

“In short, that multiple needs outperformance,” an analyst speaking on the condition of anonymity told EGR Intel. “Historically PPB beats consensus and raises guidance – not this time.”

Regulus Partners point out that PPB needs to prove it can grow the sports betting market rather than simply tracking market growth to justify its lofty price tag.

“PPB is the combination of two former disruptors, still learning (and often struggling) to become leaders – the combination is an extremely powerful one, but it also sets the bar very high in terms of delivering sustainable growth.”

But variance in sporting results aside, the core numbers suggest PPB is indeed capable of delivering major growth year on year.

Peel Hunt were reflective of analysts’ comments on Monday: “With “normal” sporting margins we believe Paddy Power Betfair would have pulled a useful forecast upgrade rabbit out of its hat today.

“Looking through the volatility of sporting results we believe the company has multi-year growth potential and an underexploited balance sheet. We believe it will continue to turn its scale to its advantage. We reiterate our Buy recommendation and 11,000p target price.”