Two months after the merger, which was completed at the start of February, Paddy Power Betfair announced 650 job cuts, but Credit Suisse says cost cutting is not the best reason for combining the two businesses. Analyst Ed Birkin said:
We feel that cost synergies alone are a poor rationale for M&A in a growth industry such as online gaming. Furthermore, we believe that scale is not as important as many believe, and is no indication of potential market share gains. With regards to Paddy Power and Betfair, as both companies already had strong brands, high quality management teams and good product/technology offerings, we question the extent of the benefits from a merger.
We think the post-merger share price reaction has been overdone and, given the integration risk and limited revenue synergies, we initiate with an underperform rating and 8,650p target price (c.9% downside potential).
The valuation looks expensive versus peers, with only 15% of the current enterprise value of Paddy Power Betfair being generated by cash flows over the next five years, compared to 29% for William Hill and 28% for Ladbrokes, on our numbers.
The negative comments have helped send the company’s shares down 250p to £90.80. Birkin said there was potential for increased earnings from the the merger but said:
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.
By contrast, we show that:
- Market share gains are very difficult to achieve in the UK, and Paddy Power/Betfair has consistently underperformed the market on a pro-forma view 2010-2014.
- 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.
- 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. By contrast, we do not think the deal has the potential to generate significant revenues synergies – in part due to the desire to keep the brands differentiated.