Analysis: Paddy Power Betfair and becoming a mass-market leader

There is something of the reinvention of the wheel about Paddy Power Betfair (PPB) in 2019. The talk from management at its Q1 results was returning Betfair to former glories, growing its recreational customer base, improving geographical diversification and focusing on a switch from volume to value. It’s a story we’ve perhaps heard before, but there was more to it than just PPB re-focusing on some well-established egaming fundamentals amid a backdrop of weak growth and toughening regulations. In fact, the most interesting comments are regarding responsible gambling and the US.

PPB CEO Peter Jackson called it a good quarter for the group, but for online it was another quarter to forget in terms of revenue growth. Online revenues increased by just 4% to £228m with the newly acquired Adjarabet representing the entirety of that positive momentum and online revenues otherwise down 1% year-on-year. Sports betting revenues were particularly disappointing, down 6% year-on-year, which the operator blamed on unfavourable sports results in racing and football and the impact of the equine flu cancellations in February.

Digging a little deeper the sports results are worse than they appear with exchange and B2B revenues returning to 1% growth in the period while sportsbook revenues declined some 10% from a 5% rise in stakes with results going against the operator in the period. This came against a reported 22% growth in actives at Paddy Power, but the additional commentary around new responsible gambling and AML measures give a picture of declining customer yields, especially on the less traditionally recreationally focused Betfair brand. And it raises some questions over the well-established dual-brand strategy within PPB.

Paddy Power is positioned squarely at the “betting as entertainment” end of the market and Betfair at the value-focused, more thoughtful punter. It’s a misnomer to think the latter isn’t also a recreational bettor, but the brand, product and marketing feel very different for both and the management comments suggest more focus is on the entertainment sector than value at the present time. Much like the rest of the industry, it seems PPB is chasing at Sky Bet’s shadow a little and an unusual comment in the results spoke directly to this.

Margin down, but hopes high

Margin was down notably in Q1 at 6.6%, some 1% down on the previous year. But the operator stated that “normalising for sports results, we estimate that the underlying expected margin for Q1 2019 was 7.4% compared to 7.0% in the prior year, with the increase reflecting positive customer bet mix changes (including Same Game Multi usage and an increased recreational base) as well as our ongoing strategic focus on profitable revenue growth rather than volume growth”. In other words, we’re successfully pushing our players towards higher margin entertainment-led betting products, which feels more applicable to one brand strategy than another.

But this is all a little parochial and possibly misses the bigger picture. Betfair showed extremely strong growth in its sportsbook prior to the merger and some of the focus drifted from the core exchange product. There has been a concerted effort to course correct in 2018 and 2019 so far. There is also a big wide world outside the UK and Ireland that PPB is trying to attack and Betfair is the core product with which to do that. Jackson spoke of the operator taking advantage of small positions Betfair has around the world in future quarters, which likely implies some increase in grey market exposure.

“Normalising for sports results, we estimate that the underlying expected margin for Q1 2019 was 7.4% compared to 7.0% in the prior year, with the increase reflecting positive customer bet mix changes” – Paddy Power Betfair

But the message is clear. Growing the mass market is the “most important thing” to PPB in 2019, as regulatory pressures increase, and the market dynamics continue to change. PPB, he says, is focused on growing the recreational base and not the staking levels, which is a mission strategy shared by several of its peers, not least Kindred. It’s also a mission that segues neatly with the perceived industry transition we are in the middle of, from a lightly regulated open market flooded with competitors on <10% market share and one where there are a handful of powerful operators acting at scale, protected by a high regulatory and tax burden and increasing marketing restrictions.

Jackson seemed to almost embrace the moves to cut back on advertising in regulated online gambling markets, suggesting that they would only serve to reinforce the positions incumbent operators have in local markets. It appeared to be an indicator of an appetite for more M&A as he also added it wasn’t a huge hurdle for markets where it currently had no or limited market share. There was also the suggestion it could buy into the market via a “local hero” and use its marketing and technology expertise to extract greater value from the acquired brands. It’s a compelling story, but it does come with more modest revenue growth prospects over the long-term for both PPB and the wider industry.

Embracing regulatory change

A mass market proposition, where speaking directly to the mass market is heavily restricted, seems like a tough circle to square, as does growing the recreational base in fairly mature markets such as the UK where the total number of online gamblers is thought to be around eight million at the present time from an adult population of around 50 million. But preparing for a future based on lower spending, less engaged consumers in the major regulated markets seems inevitable for all operators and it’s arguable PPB is a little ahead of the curve here. While others are possibly pushing harder into grey markets to find APRUs of old, the business seems to be repositioning itself for a more responsible future.

“We continue to refine our responsible gambling operating capabilities, with the launch of an enhanced CAAP proprietary model that enables us to identify and interact with at-risk customers,” the operator noted in its Q1 statement. “The model now monitors over 115 customer behaviours daily and assigns risk scores to each active customer. Continuing to be proactive both with our own initiatives and through collaboration with our industry peers is imperative as we focus on the long-term sustainability of our operations and our industry,” it added. Further commentary suggested management felt there were more changes to come in the market and they would look to guide and influence those.

PPB is not alone here, with William Hill, GVC and Sky Betting & Gaming all pushing hard to get to a more responsible future and dragging the rest of the industry along with it, or quite possibly leaving it behind to a very uncertain future of its own. And one big impact of this is likely going to be a short-term drop in APRU for operators genuinely engaging with responsible gambling measures as PPB noted in its results. “Consistent with a focus on long-term sustainability, we are continuing to grow our recreational customer base and enhancing our anti-money laundering procedures and proactive responsible gambling interventions. This is having some impact on our revenues from higher value customers, particularly for Betfair,” it noted.

This is particularly interesting in the context of gaming, which is the one area of online where PPB is showing a lot of growth. Gaming revenue was up 31% in the quarter or 14% excluding the addition of Adjarabet. This, we’re told, was driven by Paddy Power, which has notably increased its above the line direct acquisition for casino in the past year and has a lot of catch-up growth to gain based on its user base and relative gaming revenues compared to its peer group. Due to the group’s relative underperformance in the casino sector to-date, however, there is likely far less exposure to problematic customer types and it can establish a more sustainable business as it grows share of wallet.

Where to turn for growth?

How much more headroom for growth PPB has in gaming remains to be seen, but you suspect it should be able to continue double-digit growth at least through Q2 prior to the hike in Remote Gaming Duty. The other question is how easily it can continue to grow beyond the UK and Ireland, and will it need to do so via acquisition as with Adjarabet? You suspect the answer is yes unless it can pull off something truly spectacular with Betfair’s planned international growth. The concept there is to truly localise the Betfair offering now it’s able to do so on the core PPB platform and you sense there should be some immediate growth opportunities from that, but it’s questionable how high the ceiling of that growth is unless it aggressively attacks some darker grey markets globally.

But there is one other market of real interest, and the one market everyone is keeping an eye on for future growth. That is, of course, the US. US revenues, which comprise the existing TVG horseracing business, FanDuel’s DFS operations, Betfair Casino in New Jersey and the emerging FanDuel sports betting business were a real growth highlight in Q1 19. “US revenue increased 47% with good underlying growth in our non-sportsbook businesses (up 12%), supplemented by $24m of sports betting net revenue,” the operator said. “Betfair Casino growth (up 83%) has accelerated due to sportsbook cross-sell and as a result, our New Jersey casino market share increased to 14% in Q1 2019 from a steady 11% over the previous two years.”

Paddy Power Betfair’s US revenue increased 47% YoY in Q1 2019

The FanDuel sports betting business was a particular highlight with PPB noting its “unique proposition of brand, product offering, existing fantasy customer base, US market experience and global sports betting expertise”, and the unsaid proximity to New York, gave it a Q1 New Jersey sports betting market share of 50%. In global terms it’s still a very small business, with sports betting stakes in Q1 of $598m and revenue of $33m, but the performance in New Jersey must give management a lot of hope for what is yet to come across the pond. With a fairly uninspiring collection of platform technologies, it is performing very well so far against some fairly tough competition and there is clearly more to come.

PPB noted it launched a retail sportsbook in Pennsylvania in March, with “online expected to follow in the coming months. Several other states currently have draft bills circulating to legalise sports betting (at various stages of the legislative process) with the timing of any potential legalisation, regulation and launch dates uncertain,” it added. And this is the key factor for PPB’s US ambitions: the scale and speed of the rollout. You wonder how long the City’s patience will last with the seemingly slow and gradual expansion of sports betting in the US with many states going land-based only initially and realistic projections showing 2021 as the earliest point anyone will make meaningful revenues from the US.

But as a long-term play, the US remains one of the most attractive in gaming and PPB is as well placed as most to take advantage there. But as with all the big opportunities and challenges facing the group, you sense it comes with a lot of question marks attached as to how big, how soon and how easily the promise can be delivered on. You sense that PPB is starting to provide some positive momentum both in the US and in Europe and looks to be positioning itself well as we head into a very tricky period with regulations and taxes rising. But you also feel more questions remain than answers as we head into the second half of the year.