Stars in their eyes: An in-depth look at the Flutter/Stars Group merger

When bwin merged with PartyGaming way back in 2011, co-CEOs Jim Ryan and Norbert Teufelberger hailed the deal as “a defining moment – not just for bwin.party but for the industry as a whole”. This was arguably the original industry mega-merger. Here were two giants of online gaming joining forces to create what was then the sector’s biggest publicly traded company with strong positions in poker, casino and sports betting, and which at the time offered a seemingly compelling rationale to be a leading industry force for years to come.

In the end, Ryan and Teufelberger were right to describe it as a “defining moment” for the sector – just not for the reasons they expected as the firm published poor results after poor results. In fact, bwin.party has since become synonymous for being a template for how not to do a merger, particularly when reflecting upon the complexity of its matrix organisation and how it stifled innovation.

“It was too complex and decision-making was too slow; there were inherent conflicts of interest in the way we organised ourselves across product lines,” Teufelberger commented four years ago. “The idea and intent at the beginning was correct, but the implementation and execution of the strategy failed.”

Major changes were made to breathe life into the beleaguered bwin.party but it never hit the heights expected and was later acquired by GVC Holdings for £1.1bn in 2017. The rest, as they say, is history, and since the bwin/PartyGaming deal eight years ago, the industry has seen a plethora of other multi-billion-pound transactions with a rather mixed record of success. However, few can hold a candle to the £10bn merger announced by Flutter Entertainment and The Stars Group in recent weeks.

In early October, it was revealed the two industry giants were to join forces in an all-paper transaction that will see Flutter shareholders own 54.6% of the new company and Stars shareholders own 45.4%, with the combined group to be headquartered and domiciled in Dublin. Upon completion, a new senior management team will be created that fuses talent from both organisations, with Flutter CEO Peter Jackson to become group CEO, Stars CEO Rafi Ashkenazi named COO, and Flutter chair Gary McGann the new group chair. In addition, nine non-executive directors will join the board, most notably former Sky Betting & Gaming CEO Richard Flint.

The deal sent shockwaves through the industry and is arguably the biggest M&A gamechanger since the aforementioned bwin/PartyGaming combination, and possibly ever. It also appears to tick all the right boxes, at least on paper. It will bring together some of online gaming’s most renowned brands like Paddy Power, Sky Bet and PokerStars, have a significant lead in the US sports betting market, as well as many other regulated markets, and boasts an experienced executive team tasked with a strong industry track record. That the merged entity would have boasted proforma online revenues higher than even bet365 last year is also a compelling statement, as is the fact that it will have an enterprise value larger than the rest of the London-listed gambling sector combined at £14.3bn.

We can work it out

The rationale behind such an ambitious deal is akin to what’s previously been espoused by other M&A wielding executives in recent years. Compared to the industry’s growth spurt at the height of the dotcom era, large scale M&A is now predominantly driven by a need for operators to build scale as margins are squeezed across Europe by increased taxes and additional AML and KYC requirements. The escalation of responsible gambling measures is continuing to have a significant impact to the bottom line too.

Like it or loathe it, this is now the new world order of online gaming – one which is unlikely to change for the foreseeable future. “There has been a lot of uncertainty as to which direction things go politically with increasing taxes and regulatory changes, which is why we saw a major correction of industry share prices over the last 18 months,” a source familiar with the Flutter/Stars deal tells EGR on the condition of anonymity. “However, industry share prices are starting to bounce back while management teams and boards are planning for the new world they’re living in and they are assessing options to come out of this and create value for shareholders. Further consolidation is highly likely to continue.”

Continued industry consolidation might have been an inevitability, but the timing of the Flutter/Stars deal was somewhat of a surprise after previous attempts to combine the two businesses failed in recent years. Both companies have also been preoccupied with their own integrations of late. Staffers at Flutter and Stars, the latter of which has already laid off numerous people in recent months, are no doubt also beginning to feel anxious once again about the security of their jobs.

Neither Flutter nor Stars have exactly been going great guns recently, with the PokerStars owner lowering its full-year profit and revenue guidance in August. Sky Bet in particular seems to have slowed down massively from the market-leading growth it was posting a year or two ago. “[The] track records of both have been mixed with both Paddy Power-Betfair and SBG slowing from double digit to mid-single digit revenue growth after completion,” Richard Stuber of Numis Securities claims.

The merger of Flutter and Stars is expected to accrue £140m in pre-tax annualised cost synergies at 10x EBITDA by the end of the third full year post completion, with one-time costs to achieve this at an estimated £180m incurred within a two-year period. EGR understands £140m is significantly more than what was being estimated when Flutter previously tried to buy The Stars Group. City analysts, however, actually believe this figure is very much on the conservative side of what can realistically be achieved at just 3.6% of combined revenue.

Break the mould

Many analysts do remain cautious about Flutter/Stars’ ability to execute the merger without significant disruption to the business. If history is anything to go by, merging two industry giants is never an easy task and is a process which often hurts revenues, staff morale and the end-user product itself. “Paddy Power and Betfair itself wasn’t a total success story from a tech migration perspective, as new product roll-outs were delayed and their competitors caught up,” another analyst tells EGR.

Such a slowdown was even more noticeable at Flutter as its two core brands, and Paddy Power in particular, previously had a reputation for being at the forefront of many industry product trends. The prospect of another large-scale integration, therefore, does indeed seem rather ambitious, particularly now Stars also owns Sky Betting & Gaming.

“That [Sky Bet] for me creates a unique integration challenge,” one former Flutter exec tells EGR. “It would be hard to say across any dimension that the integration at Paddy Power Befair worked in the UK – it just didn’t. The two brands haven’t really grown market share at all and I think that’s because a lot of good people left who had grown the two businesses beforehand. It also took a while to work out how the brands were going to compete in the UK as they were actually competing in similar spaces.”

As Albert Einstein famously said, the definition of insanity is doing the same thing over and over again and expecting different results. So, will a Flutter/Stars tie-up actually prove a success? And just how does management plan to ensure that the integration goes as smoothly as possible?

According to Flutter CEO Peter Jackson, one way is that the group will take a more “cautious” API-based approach towards technology integration which he believes will give each team more freedom to control the front-ends and their product roadmap. A lot of work has also already been done from the previous Paddy Power Betfair integration to decouple the platform and reduce the legacy of OpenBet. Jackson claims this approach will allow the new combined group to maintain both business momentum and the individual identities associated with the brands. Some City analysts surmise this approach will indeed substantially de-risk the integration process and is why potential technology savings were capped.

“We believe that this approach will safeguard the momentum the business currently enjoyed,” Jackson explained to investors. “If I look at how we manage the Paddy Power Betfair integration work, we effectively had to turn the Betfair technology stack into something that could operate on a certain multi-brand, multi-jurisdictional basis. And we then migrated all of Paddy Power onto its back, and it’s a big, complex thing to do.

“Since then, we’ve actually been able to separate our front-end and back-end platforms so our front-end platforms communicate [with] back-end platforms via APIs. And that will allow us, under this transaction to effectively allow teams with their own front-end platforms to maintain those product roadmaps, but then just to fit into our back-end betting platform and our global risk and trading capability.”

Home of the brave

If this approach does indeed help Flutter/Stars de-risk the integration process, it will feel the world really is its oyster. Firstly, there are arguably significant opportunities to cross-sell to a combined active customer base of some 13 million people, with the company pointing to the previous success PokerStars has had in cross-selling customers into casino as well as Betfair’s track record in cross-selling customers from the exchange into fixed-odds sports betting. What was particularly interesting was that Stars CEO Rafi Ashkenazi personally picked out the potential to cross-sell between the exchange and poker as an area of real potential for the group.

The key highlight of the deal, however, is the sheer dominance Flutter/Stars will have in the fledgling US sports betting market. The combined group will bring together some of the early market-leading brands in the US, with FanDuel alone currently boasting more than 50% share of New Jersey’s online segment and having a huge database as a result of its daily fantasy sports dominance before the repeal of PASPA. FanDuel has also reported $2bn being handled since launch and has more than 200,000 sports betting customers.

Meanwhile, The Stars Group’s Fox Bet brand has also been making significant early strides in the US by attempting to replicate the Sky Bet model. This has led to Fox Bet’s free-to-play Super 6 App boasting more than 400,000 downloads on the Google Play and Apple App stores since making its debut in September. In addition, Fox has taken an 18.5% equity interest in FanDuel, which provides Flutter with a new distribution channel and a formidable brand, while the combined group will have sports betting market access in 24 states, horseracing in 33 states through TVG and daily fantasy sports access in more than 40 states.

“I can see why the City is so excited by the US aspect of the deal,” the former Flutter exec adds. “The original deal Flutter did in the US with FanDuel was epic if you look at the numbers, and what Stars did was quite smart too in trying to replicate the Sky Bet model. So, Flutter was incredibly well placed anyway, but if they were to do a merger this is probably the one they’d want to do because of the sports distribution component to it.”

Could such a formidable position force DraftKings (rumoured to be buying SBTech) and William Hill (looking for a distribution partner) question their current strategy? The only concern from a US perspective, which has little relation to the Flutter/Stars deal itself, is there remains a big question over when companies are going to get a return on the money invested given the pace and nature of regulation across the States. Indeed, it’s not beyond the realm of possibility that it takes more than a decade for operators, including Flutter, to see any major return from the market.

Cleared for take-off

It’s not only the US where the group will have a market-leading position. The combination of Paddy Power, Betfair, Sky Bet and PokerStars will see the new company obtain a 38% market share in the UK, while it will have a similarly dominant position in Australia through Sportsbet and BetEasy. This does, however, reduce Flutter’s weight towards the UK and Ireland from 59% to 49% and increases its revenue base from the ‘Rest of World’ segment by 6x.

One stumbling block that may come up as a result of having a substantial lead in such mature markets is getting the seal of approval from the relevant competition authorities. There is currently little consensus as to how likely this actually is. In Australia, most experts seem confident the Australian Competition and Consumer Commission will wave through the deal given the approval of the Tabcorp/Tatts Group merger and the size of that group. But in the UK, the situation is arguably more complicated.

Flutter Entertainment has had a strong start in the US through FanDuel

A recent research note from Canaccord Genuity claimed the UK Competition and Markets Authority (CMA) may argue a Flutter/Stars deal would lead to a substantial lessening of competition. The financial services company pointed to comments from the CMA during previous rulings and that it could argue the merger would lead to less attractive odds for customers and a higher overround from the operator. If this were the case, Canaccord believes the most “logical decision” would be to sell Paddy Power’s digital and retail businesses, which would show just how important the US is to the business and the role Sky Bet will play in this regard.

In a conference call following the merger announcement, Jackson sought to dismiss any issues with the competition regulators. “We’re very respectful of the competition authorities such as the CMA in the UK and the important analysis that they must do in relation to this proposed transaction,” he said. “We look forward to engaging and working with them in due course, and we’re confident that we’re going to receive the relevant approvals at the appropriate time.”

Another exec who has experience of the CMA’s process is also optimistic the tie-up will get the necessary approval. He says: “I don’t think it will be a problem because of the availability to access different operators and the level of competition already there, particularly with the likes of other industry giants like bet365 and GVC.” The bigger problem in this regard is the fact it will take approximately nine months to clear all the competition hurdles, and in that time Stars/Flutter could lose some key personnel as they would be hindered from making a number of commercial and strategic decisions.

Consequences of a deal

But regardless of Paddy Power’s fate, a consequence of the agreed merger is that the M&A rumour mill is once again in full swing. The last few months have been relatively quiet with regards to tier-one industry mergers, with smaller deals like Paddy Power/Adjarabet and William Hill/Mr Green becoming more common. Indeed, the rationale behind the smaller recent transactions was more about technology and geographic diversification than it was about building scale, mitigating margin erosion and finding synergies.

There is now speculation that the Flutter/Stars deal may kickstart a new wave of industry mega-mergers. The fact the markets initially welcomed the deal – Flutter’s share price soared approximately 20% following the announcement – would certainly suggest there is an appetite, while investors also seem more receptive to higher leverage in the short term with Flutter/Stars approximately 3.5x net debt to EBITDA.

“The original deal Flutter did in the US with FanDuel was epic if you look at the numbers, and what Stars did was quite smart too in trying to replicate the Sky Bet model”

But who are the likely M&A candidates? GVC is clearly the favourite given its long track record. The online gambling juggernaut has spent much of the past year integrating Ladbrokes Coral into the business and, with much of the heavy lifting with Playtech now done, it could well be the right time to explore merger talks once again. CEO Kenny Alexander last year alluded to the fact that it would be at least 12 months before it would look to complete any big M&A deals.

Some have speculated that William Hill could be a target, if only to slow the CMA approval process down further. Another rumour doing the rounds in recent weeks is that GVC may actually attempt to scupper the Flutter/Stars deal and make a bid for the PokerStars owner itself. It would certainly be an audacious move by the London-listed operator but, as many industry insiders have told EGR, this is exactly the sort of thing that gets the likes of Alexander out of bed every morning.

At this stage this is all pure speculation. What it does show, however, is just how much of an industry gamechanger a merger between Flutter Entertainment and The Stars Group would be.