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Game on for private equity

The £2.2bn acquisition of betting shop chain Coral by private equity-owned bingo and casino operator Gala created Europe’s largest privately owned betting and gaming company. Meanwhile, in a much smaller deal HgCapital bought sports spread betting business Sporting Index from Duke Street Capital.

What both deals have in common is their anticipation that deregulation of the industry, following the Gambling Act 2005, will create attractive business opportunities. Aside from this deregulation, many in the industry also expect the rapid growth in online gambling and gaming to continue. For example, Party Gaming, which was launched on the stock market in June, predicts 22% annual growth in the market over the next five years and double that for online poker.

The Gambling Act was passed in April, but the government retreated on plans for numerous mega-casinos and capped the number of new casinos that can be built. Despite this, relaxations of the Gaming Act 1968 were brought in and there will be further reforms under secondary legislation until the Act is fully brought in over the next 18 months.

Candover and Cinven acquired Gala in 2003 and in August 2005 sold a £200m equity stake to Permira based on a valuation of £1.89bn for the business. Gala then went on to acquire Coral Eurobet in October 2005 for £2.18bn, taking its overall valuation to more than £4bn.

Gerard Conway, investment manager at Candover, said that Gala had already been benefiting from regulatory changes before the enactment of the Gambling Act. These included relaxations in the number of slot machines allowed in bingo halls, the size of prizes for bingo and casino opening hours.

Conway said it was still too early to ascertain how much additional business had resulted from the Gambling Act, which removed the 24-hour registration period for new casino customers. According to reports, however, the UK’s 138 casinos had received 100,000 extra visits by mid-November, which was likely to translate into 250,000 new casino-goers in a year.

“A lot of potential customers are not yet aware of the changes, such as removing the 24-hour registration, so any uplift is expected to evolve over time,” said Conway. He added that the gaming sector was a “very interesting space to be in at the moment” because of the changes.

Chris Collins, a partner at Electra Partners Europe, agreed with the sentiments. One of Electra’s investments is in amusement machine operator Danoptra. “The legal changes will be positive, though they are not as wide ranging as was first proposed,” Collins said.

Much will depend on the detail of how the new legislation will be put into practice over the coming months. Collins said: “For us, that means issues such as whether they will allow increases in the stakes and prizes for machines and whether they will allow fruit machine providers to share in the cash box rather than just charging a rent.”

Electra is exploring ways in which Danoptra can participate in the online market, where it sees growth opportunities.

Reasons for change

Conway noted that the new legislation was needed because the law in the UK had not kept pace with technological changes and social attitudes, which are more liberal than they were when the original Gaming Act was passed.

Deregulation and the increasingly common view that gambling is just another part of the leisure industry have been factors in the success of the Gala investment.

“Gala was always a growth story, in which we saw the potential uplift in profitability from driving spend per head and increasing the number of admissions. The attraction of putting Gala and Coral together is that there are potentially significant revenue synergies,” Conway said.

Although the UK Government disappointed many US gaming companies with its cap on new mega-casinos, existing operators such as Gala will be left with even more valuable assets.

“A lot of the excitement that surrounded the sector a year ago has subsided because of the watering down of the casino proposals,” said one buyout executive. “But what scared off the Americans made Gala’s position, as well as that of other big players like Rank and Stanley, more attractive, and so it was not a surprise to see Permira buying into Gala.”

The executive predicted heightened buyout house interest in Rank, which is rumoured to be in the sights of private equity investors such as Blackstone and BC Partners, and casino operator Stanley Leisure.

While there is clear growth potential in the land-based gaming market, many see the online sector as more lucrative. Peter Taylor, managing partner at Duke Street Capital said that there are basically only three or four major players in bookmaking and a similar number in casinos.

“That means there are limited opportunities for private equity in those sectors, whereas online markets are much more fragmented and immature, which means there are more chances to pick winners,” he said.

Sporting Index, which was sold by Duke Street, is the UK market leader in sports spread betting and has expanded customers and bet volumes by around 50% and 37%, respectively, in the past three years.

HgCapital aims to develop the company into a broader-based betting and gaming group, by rolling out the spread betting model into new jurisdictions and expanding the product range both in the UK and the international market.

Ben Hewetson, head of leisure investments at HgCapital, said that 70% of all Sporting Index bets were done via the internet and that the company continued to develop its distribution channels, such as recent deals with Sky TV and mobile phone channels.

Sporting Index will also be in the market for acquisitions. “There is still quite a bit of consolidation to come in both land-based and online markets and we intend to take advantages of such consolidation opportunities,” Hewetson said.

Online casino and poker rooms currently operate offshore, but the Gambling Act will enable them to operate from the UK for the first time, although that part of the legislation is not yet in place and the government has not yet announced the tax treatment of such companies.

Online challenges

When it comes to online gaming, one of the most serious issue is the question over the legality of such ventures in the US. Nearly 90% of Party Gaming’s players are based in the US, for example, but there have been concerns that its future potential is clouded by uncertainty over the attitude of US regulators.

This fear has already permeated the buyout community and it is believed that when Duke Street was seeking buyers for Sporting Index, which has plans to expand into the US market, a number of private equity houses were deterred because of regulation fears.

Peter Taylor of Duke Street said that the longer companies such as Party Gaming conducted their business without any problems from US authorities, the more the threat of legal action in North America would recede.

He added that, nevertheless, sporting bets companies were seen as riskier investments than games of chance. “There’s a growth area in online games of skill, but that sector has not got much publicity so far, and yet there is a lot of potential in areas like quiz-based games, backgammon and so on,” said Taylor.

Because of the uncertainty around US regulation, valuations of online companies can be volatile, according to John Campion, a partner at law firm DLA Piper. “Valuations on these online companies can change very quickly, depending on the market’s view of risks and uncertainty at any one time,” he said.

Valuations currently seem unrealistically high, according to some. “There are a lot of people placing high values on businesses that don’t have real legs. It reminds me of the buzz around online travel companies six years ago, but how many of them are still around?” said HgCapital’s Hewetson.

He added that the companies with credible business models and expertise would prevail but that, because of rising valuations, it was hard to find good opportunities at the moment. “There is unrealistic pricing and high prices are being sought for companies without much of a track record,” he said.

Nevertheless, the attractions of the industry are obvious – these are growing and highly cash-generative businesses that can potentially attract and hold on to loyal customers.

Another investment professional said that the addictive side of gambling and gaming was obviously a big attraction. “I’m not talking about gambling addicts who lose all their money in betting but rather the average customer who gets a buzz out of it and wants to return for more. One of the great strengths of these companies is that even when they pay out winnings there’s a strong probability all that money will be returned to the company in future bets,” said the professional.

The challenge for the gambling and gaming companies that are being formed through the current consolidation will be how to recruit a loyal customer base, added Hewetson. “It’s about making yourself attractive and holding on to customers, and that means ensuring customer satisfaction and loyalty, which is challenging given the big choice of gambling and gaming opportunities for people,” he said.

Duke Street’s Taylor said some of the online companies that had gone public would disappoint and become targets for public-to-privates, noting that companies such as Party Gaming and Empire Online were trading below their issue price.

“The bigger online companies have brought in professional management but the smaller ones are still being run by the founders and need to upgrade management and become more efficient, which is where private equity has an important role to play,” said Taylor.