Key points
- Investors were very pessimistic on the stock in 2012 when it lost gaming licences.
- However at the same time, the company’s margin was expanding as business shifted from store based tote products to higher margin fixed odds products.
- CEO David Attenborough has led successful investment into new technology, marketing and product capabilities to hold share against aggressive new entrants.
Hamish Carlisle, Portfolio manager at Merlon Capital Partners
How long have you held the Tabcorp (TAH)?
We built a position in Tabcorp in 2012 when the stock was trading around $2.80 and hold Tabcorp stock in both our Australian Share Fund and Australian Share Income Fund.
What do you like about it?
Tabcorp is a diversified entertainment group encompassing several brands including tab.com.au, Luxbet, Sky Racing, Sky Sports Radio, Tabcorp Gaming Solutions (TGS) and Keno. Its four core businesses of Wagering, Media and International, Gaming Services and Keno employ more than 3,000 people. When we first built a position, the company had demerged from the more glamorous Casino business; was facing a significant reduction in earnings following the termination of its Victorian gaming operations; and was experiencing a decline in tote based betting, while online competitors ate away at the fixed odds market. Adding to this, the company had entered into new licensing arrangements in Victoria, which complicated the task of assessing its financial outlook. At the time, none of the Wall Street investment banks rated the stock a buy.
Tabcorp (TAH)
Source: Yahoo!7 Finance, 6 November 2014
Our process is focused on identifying instances where investors have become overly pessimistic about the outlook and back in 2012 Tabcorp certainly fitted the bill. One indication that investors are too pessimistic is that valuation metrics look attractive. Even taking into account some of the challenges Tabcorp was dealing with a few years back, we still thought the stock looked cheap.
How is it better than its competitors?
What struck us most upon our initial analysis, was that the prospective loss in earnings associated with the Victorian gaming licence was more than adequately built into market expectations and the company was actually holding its own against online competitors in the fixed odds market. In fact, the company’s margin was expanding as business shifted from store based tote products to higher margin fixed odds products. We also thought the company’s guidance about future capital expenditure looked conservative when benchmarked against its peers.
What do you like about its management?
Under the leadership of its chief executive officer, David Attenborough, Tabcorp has been one of the few examples of an incumbent player successfully investing in the technology, marketing and product capabilities to hold share against aggressive new entrants. The successful migration of the company’s business from retail stores to online, significantly reduces its dependence on licences issued by state governments and in doing so, the prospect of having to pay significant sums to extend such rights has greatly diminished.
What is your target price on TAH?
At Merlon, our investment philosophy focuses on fundamental valuations rather than target prices, which have speculative connotations. Our valuation of Tabcorp is currently around $5. The main differences between our valuation and many other commentators in the market are:
- We don’t believe the expiry of Tabcorp’s Victorian licence in 2024 will result in any meaningful reduction in earnings power or require a significant capital outlay to extend; and,
- We identify undervalued companies using “free-cash-flow” rather than accounting earnings. Tabcorp’s accounting earnings include significant non-cash charges associated with historic licence payments that are unlikely to be repeated.
At what point would you sell it?
If and when we don’t see relative valuation upside in one of our holdings, we would sell the stock. Instead of having a set sell date, the size of our portfolio holdings are directly linked to our valuations.
How much has it added (subtracted) to your overall portfolio over the last 12 months?
Our investment horizon is long term, we don’t get too caught up in short term performance. Over time, we think the market will come around to our way of thinking.
Is it a liquid stock?
Yes. All stocks held in our portfolio need to meet strict liquidity requirements and Tabcorp is no exception.
Where do you see the value?
As discussed earlier, our valuation of Tabcorp is currently around $5. Market timing is hard, if we think a stock has fundamental upside we’d rather buy than speculate as to whether it might get cheaper in the short term.
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