Sportech: Sports betting could be a game changer, but it's no sure bet

In the past few years, Sportech PLC has ditched its legacy UK gaming market, and placed its chips on the USA: the company, which divested its football pools and Dutch pari-mutuel operations, decided future growth potential could be found in the American market.

The company's US operations primarily provide pari-mutuel wagering technology to the horse racing industry. This technology allows racetracks to accept wagers from multiple channels (on-track, off-track, and online), comingling them into a single pari-mutuel pool. However, with American horse racing in long-term decline, and Sportech's competitors being owned by larger racetrack operators (Stronach Group, Churchill Downs), this business will not likely "move the needle" in the years to come.

It is Sportech's sideline business (the "Venues" segment) that investors are banking on for future growth. "Venues" consists of Off-track wagering facilities (OTBs) in the state of Connecticut. Last May the US Supreme court removed restrictions that prevented most states from legalizing sports betting (prior to May, only Nevada could offer full sports wagering). With this decision, states from New Jersey to Delaware have legalised sports betting, and sportsbooks have opened up in casinos and racetracks.

Connecticut is interested in legalising sports betting as well, with a proposed bill allowing casinos and OTBs to offer sports betting.

While New Jersey and Delaware were quickly able to work out a deal between legislators and gaming operators, Connecticut faces an additional challenge: the dominance of Native American tribal gaming, and their belief in holding an implied monopoly on expanded legalised gambling.

The Native American tribes have a compact with the State of Connecticut to exclusively offer Vegas-style casino gambling on their reservations. The tribes believe this arrangement extends to sports betting.

Connecticut also has an arrangement with Sportech regarding the OTBs: Sportech has the exclusive right to offer wagering on horse racing, either via brick-and-mortar OTB facilities, or online (Sportech's horse wagering site, mywinners.com, is the only horse wagering site available to Connecticut residents).

This debate has resulted in the proposed bill being shelved until the next legislative session.

Because of the delay, investors have started to sell off their Sportech shares. The company, which trades on the LSE, has fallen back to the 70p level after reaching highs of ~85p following the Supreme court decision. This is still a strong rebound from last March, when shares fell below the 40p level on poor guidance and the announcement the company's attempt to find a buyer failed.

Allowing sports wagering at Sportech's Connecticut OTBs would be a gamechanger: based on a American Gaming Association study, a conservative estimate of sports betting revenue for Connecticut is ~$140m ( £110m). After eliminating estimated federal and state gaming taxes, this gives sportsbook operators ~$123.7m (£97m) in net revenue.

With their network of OTBs in population centers, Sportech likely would likely a large share of the market. The marginal cost of adding sports betting to the OTB betting menu would be minimal, as many of the fixed costs are already being expended. This would jolt Sportech's bottom line, which in recent years has seen unprofitability ( 2017 pretax loss of £21.6m on £66.3m in revenue).

Sportech may one day be able to generate £25m to £30m in operating income from the sports betting business, if the following projections bear fruit:

• Sportech gains 50% market share of the Connecticut sports betting market (£48.5m)
• To reduce costs and hedge exposure to sports results, the company outsources the management of the sports wagering to William Hill or another large competitor, splitting revenue 50/50 (£24.2m). This 50/50 arrangement is based upon a deal William Hill made with Monmouth Park racetrack in New Jersey.
• The lion's share of operating costs is already being expended from the OTB operations, allowing the company to generate 70-80% operating margins from the sports betting concession (£17m-£19m).
• Sportech continues to generate £7m in adjusted EBITDA from their legacy operations.

In this ideal scenario, the company could see EBITDA reach ~£25m, giving the company at the current share price an EV/EBITDA ratio of less than 5, a sharp discount to the EV/EBITDA ratio of peers William Hill (~8.3x) and PaddyPowerBetfair (~14x).

Bottom Line: The current share valuation compensates investors for the high risk of the Connecticut bookmaking catalyst "paying off". Investors should further investigate the legislation situation in Connecticut to assess whether the "game changer" will "pay off" within a reasonable investing timeframe.