Analysis: Paddy Power Betfair and the tough road back

The management team of Paddy Power Betfair seemed full of confidence and positivity at the H1 results. “Paddy Power has got its mojo back,” they proudly proclaimed. The original recreational sports betting brand, we were told, was back to fighting fitness and once more punching its weight during a “busy and successful” few months. But the markets did not agree. PPB’s share price dropped from £8.12 to £7.54 that day and has continued to slide to around £7 at the time of writing. Perhaps those lucky pants aren’t quite as foolproof as we’ve been led to believe.

So what went wrong? As always with the financial markets it’s hard to be sure, but the overall message of a return to the good old days was not entirely convincing. There were problems at the exchange, which remains a major source of revenues for the combined group, the US uptick still seems a long way off and while Australia continued to power on, the increasing competition and imposition of taxes doesn’t suggest plain sailing ahead. While for the core online segment it was a positive set of results but not the great revival some were maybe hoping for.

Expectations perhaps were higher in the City than they were at PPB towers. Gaming growth was deemed miraculous by the firm despite being just 15% in the quarter, adding only £7m in revenue in real terms over the six-month period. And sportsbook growth of 23% in Q2 and 15% pre-World Cup is tough to sell as a big market share gain against a really weak comparative period in Q2 2017 and similar-looking growth numbers from the likes of Sky Bet (as reported by The Stars Group) and William Hill. In short, while PPB appears to have started to find its way, it’s not really out of the woods yet.

Breaking down the numbers

PPB don’t split out the two brands, but online revenue increased by 5% to £462m, and the 2% decrease in Q1 was boosted by 13% growth in Q2. Growth in Q2 against a poor comparative period last year and in a World Cup year was to be expected, but PPB execs said the improvement was “most evident in gaming, where Q2 revenues were up 14% in Q2 and 5% for the six months to £127m”. This they put down to improvements on the Paddy Power user experience where a vastly improved app had contributed to higher cross sell rates.

Sports was the more interesting vertical in the period however, and revenues were once again up 5% to £355m for the period with a 12% increase in sportsbook and a 4% decline in exchange and B2B revenues. The decline in exchange was particularly concerning, and management said that based on the current market they had reassessed long-term growth expectations downwards from its 2-3% growth rate target previously. This doesn’t suggest a business in rude health and has worried analysts. The exchange is a material revenue contributor to the group, although management talk was of positivity and building closer links between the exchange and the sportsbook product as it looks to build for the future.

And the executive team also played down talk of competition from the likes of Smarkets and Matchbook eating into its market share, suggesting, slightly less plausibly, it was more an issue of recreational players having access to equally tight pricing on sites like bet365. They said they had made moves to address this, however, and noted advertising on Betfair was focused on the exchange over the World Cup. The ethos seems to be driving towards more interoperability between the exchange and fixed-odds Betfair Sportsbook as it looks to put more blue water between the two brands in the market.

This is slightly at odds with Betfair’s pre-merger growth strategy – its sportsbook is by some distance the fastest-growing product pre- and post-merger. It’s arguable that some of that market share was taken directly from Paddy Power in its earlier incarnation, but since the merger there has been a clear attempt to position Betfair Sportsbook as the value option in the market aimed at smart punters, or perhaps punters who perceive themselves as smart. Driving this, using the benefits of the exchange and giving customers access to a more complex product seems logical although it does risk driving them to a lower-margin product.

Equally losing the effective monopoly on exchange betting doesn’t seem like something PPB can afford to do, and it places the group in a tricky position trying to navigate the choppy waters of the sports betting vertical in 2018. One analyst noted the exchange had lost a number of “international” customers and would be making changes to the product to “get back that appeal” to the non-UK market. And this speaks to another issue in terms of the group’s relatively weak international revenue base. Previous management at Paddy Power were very reluctant to enter any market that didn’t look whiter than white.

Finding growth from outside the UK

Whereas over at William Hill, the talk was about entering grey markets to generate short-term cash flow to reinvest in the more tricky but long-term stable regulated markets, at PPB it was a little more vague. CEO Peter Jackson talked of being focused on “podium positions” in regulated markets and didn’t rule out M&A to get there, but it seemed the hope was more of driving that growth organically. “In time we will get to a podium position,” was the message, but based on its previous experience in Italy and the fiercely competitive nature of most of these emerging regulated markets, that doesn’t by itself inspire confidence in the short term.

Of course the one obvious market for PPB is the US, where it was one of the first operators to launch in New Jersey through a deal with the Meadowlands Racetrack. But Jackson was wisely keen to downplay the short-term potential of the US sports betting market. The near-term opportunity, he appeared to suggest, was more in growing the existing FanDuel fantasy sports and TVG horseracing businesses. Although the group is well-placed to capitalise on any developments, this can also be said of a number of its rivals, who are being equally aggressive in the space.

But if the US is for the future, then online is where the growth must come in the present. Online, representing 53% of group revenue, was up 5% year-on-year in revenue terms, but down 4% in EBITDA terms. Taxes were up, marketing costs were up and the market became more competitive in the period in its sports and gaming verticals. In revenue terms, things were positive and both sportsbooks brands apparently showed “good revenue momentum”, with 3% total sportsbook growth in Q1, and 23% growth in Q2 with 15% underlying growth prior to the World Cup.

Perhaps the most interesting number was that in a World Cup year, turnover was down 8%, although this was put at the door of reduced recycling from Q1 and a focus on “profitable revenue growth rather than volume”, which sounded dangerously similar to the “volume to value” pledge from a rather less successful major merger predecessor. And Jackson said Paddy Power has been regaining share from its competitors after major upgrades to its product and marketing in both the gaming and sportsbook verticals.

Speeding up the recovery?

“Paddy Power customers have… enjoyed a significantly improved gaming product following the migration to the new integrated platform at the end of January. This has driven a three-percentage point increase in the proportion of Paddy Power sports customers who also used gaming products, contributing to good growth in gaming revenues in the first half,” the firm said in a statement. Gaming’s performance in the second quarter was a highlight for the group and the vertical still retains a lot of headroom for growth, which must surely be an area of focus for the remainder of the year.

And PPB should continue to get some uplift from the work it has done on product. Certainly the Paddy Power apps have improved markedly from this time last year and now compare favourably with its peer group. The operator said this change had been “most material for the Paddy Power brand due to its relatively weaker starting point” and much was made of a 50% faster load time and a significant but relatively modest 12% increase in customer satisfaction with the app’s speed. But it was clear nobody thought this was the finished article and far more work was required to regain the brand’s “product leadership”.

It also stressed the need to back this up with marketing spend for acquisition and retention, which although sounding obvious, is not always the case for product launches in the sector. Marketing spend jumped 13% to £128m in the first half, as you would expect in a World Cup year, with the growth exceeding the rise in revenue and comprising 28% of net revenue in the period.

But this is not a time to be cautious, as the executive team have realised, and Paddy Power in particular needs to find its voice again and a large above-the-line spend realistically has to be a part of this. If it wants to regain the glory days of the Paddy Power brand then this large segment of the online gambling market must once more begin to see Paddy Power as their natural home.

The noticeable rise in promotional offers has remained post-World Cup and we’d expect to see more product innovation as the year progresses. But driving this while also getting the exchange product back on track, repositioning the Betfair brand, building out the US business, defending Australia from aggressive competition and taxes, and dealing with the FOBT fallout in retail, looks an incredibly complex and demanding task.

After the platform upheaval of last year it felt like 2018 might be the year for PPB to get back on track and reassert its authority as the premium online gambling operator in the market. But it feels like it still has a number of battles left to fight before it can begin winning that war again. There are, however, signs it is getting back to fighting strength, despite what the markets may be telling you.