Is Paddy Power Betfair stock overpriced?

Paddy Power Betfair (PPB) announced on Wednesday it would be reporting its Q1 results on 4 May, but financial experts are uncertain what to expect, with analysts arguing the newly-formed operator’s stock is both under and overpriced.

At this point, the market seems to agree with the bears, with share prices falling around 7% in the last week to 8,885p at the time of writing, giving the company a market cap of almost ?7.4bn.

Credit Suisse analyst Ed Birkin is among the detractors, setting a target price of 8,650p. While PPB announced plans to cut 650 jobs earlier this month, in a Credit Suisse briefing note this week Birkin claims cost-cutting is a bad reason for a merger.

“We feel that cost synergies alone are a poor rationale for M&A in a growth industry such as online gaming,” says Birkin. He believes that the market has potentially over-accounted for these savings as well as future revenue synergies.

“Revenue synergies will likely be relatively immaterial – the company has guided to the cost synergies of the deal, but there has been significant market focus on potential revenue synergies,” he says.

“By contrast, we do not think the deal has the potential to generate significant revenue synergies – in part due to the desire to keep the brands differentiated.”

Birkin also claims that scale is not as important as many in the industry believe, pointing out that Paddy Power and Betfair already had strong brands, high quality management teams and good product/technology offerings as separate companies.

“The consensus view on Paddy Power Betfair is that its scale will allow it to make significant market share gains and achieve strong operational gearing,” says Birkin.

“By contrast, we show that market share gains are very difficult to achieve in the UK, and PPB has consistently underperformed the market on a pro-forma view from 2010-14.

“Operational gearing is difficult in the online gaming space. While both companies showed underlying operational gearing last year, we think this was due to one off cost savings to offset the point of consumption tax rather than it being sustainable on a multi-year view. We use the case study of William Hill Online, where the company has seen little if any operational gearing, in a period where revenues have almost trebled.”

However Birkin’s views are not shared by all. Paul Leyland, a consultant at Regulus Partners, argues that scale is a key growth-enabler for the firm- especially in marketing.

“Marketing becomes more efficient and operational leverage starts to kick in,” Leyland tells EGR. “One of the stats that surprised a lot of people during the merger is that there is only a 3% overlap between active customers for Betfair and Paddy Power. And that’s because Betfair appeals to more serious customers and Paddy Power appeals to more casual players.

“When you have a dual-brand strategy you can have much more focus. You don’t have to try and cover the entire market with your brand. Betfair can retreat from all the recreational stuff they do, and Paddy Power now doesn’t have to even remotely think about the serious punters,” he explains.

Leyland also points out that scale allows PPB to spend more on its tech infrastructure than OpenBet generates in revenue – potentially creating a significant technology development gap.

Analysts at Davy Research stockbrokers are also bullish, raising their 12-month share price target for the company to 10,800p, based in-part on the aforementioned marketing synergies.

“Nearly one-third of the entire operating cost base of this business is currently being spent on sales and marketing,” Davy notes. “If a successful strategy can be devised that leads to marketing cost savings or simply more efficient allocation of future marketing spend, the potential returns could be substantial.”

Paddy Power Betfair is currently understood to be at the “advanced stages” of a pitch process to consolidate its media spend into one agency, according to Media Week.

Davy also predicts a 16% increase in online revenues with 22% growth in Australia, 6% in the US and 2% in the UK. The analysts also envisage further grey market investment.

“Online growth above and beyond our expected rate will likely depend on just how successful the integration of the two businesses is and the group’s ability to develop complementary brands to carve up the market,” says Davy.

Q1 has been a relatively bumpy quarter for the firm – with former Paddys CEO Andy McCue leaving the business and a subsequent senior management shakeup – but bosses will be hoping the results will convince investors that the merger is good news for both brands.

A PPB spokersperson declined to comment for this article.