Fitch Ratings says it has a negative outlook on European gaming as it expects fierce competition, weak consumer spending and the costs of intense innovation efforts to weigh on the revenues and profits of core industry players in 2012. The industry has not yet come to a point where its declining profit margins have stabilised.
Despite a degree of resilience in consumers’ spending, competition remains fierce both in retail and online gaming, especially while smaller online operators are able to compete against larger players by arbitraging across the inconsistencies of national regulatory environments and often not fully operating in compliance with legislation.
Larger companies would surely benefit from more stringent regulation but, despite the likely benefits to governments from levying taxes on online gaming, it remains to be seen if effective regulatory changes will be introduced and create a more level playing field in 2012. Another factor of competition is innovation – now a defining feature of the online gaming industry – which companies are finding costly to keep up with.
A heritage of legal risk carried by pure online companies seems to be a hurdle to M&A activity in the sector, possibly together with differing expectations on strategy and economic return by current shareholders. With the exception of the merger of bwin with Party gaming in early 2011 and the joint venture between William Hill and Playtech, all other merger discussions have not led to a deal during 2011, nor has the industry experienced many bolt-on acquisitions of small companies by the larger players.
Rather than pursuing M&A opportunities, Fitch expects major industry players to now focus their attention on strengthening their own in-house online and mobile operations by hiring experienced professionals and investing in IT infrastructure. Ladbrokes (‘BB+’/Negative) have earmarked GBP50m to spend across 2011 and 2012. Gala Coral (‘B’/Negative) is also increasing investment as it looks to re-platform its existing sites to Playtech’s technology.
The trading outlook for UK retail gaming remains mixed as continued weakness in over the counter (OTC) revenues is being offset by strong growth in machines and Fitch expects a continuation of this trend in 2012. Thanks to a successfully renovated machine estate, Ladbrokes will be well poised to benefit in 2012 from the migration of spending to machines. However further increases of gross win per machine per week are likely to slow as this number approaches the GBP1, 000 mark.
As a result of the step up in marketing and promotion aimed at attracting customers, companies are likely to suffer from further margin pressure in 2012 compared to 2011. These capex efforts will also partly reduce cash flow generation. Despite all this though, Fitch still expects all operators, with the exception of Gala Coral, to post positive free cash flow and be able to pay down some debt.
Refinancing conducted by both Gala Coral and Ladbrokes during 2011 mean that both companies have limited debt maturities until 2017 for Ladbrokes and 2018 for Gala Coral.
Fitch forecasts only marginal improvements in credit metrics in 2012. The agency notes that achieving this is also subject to companies refraining from debt-funded acquisitions. These would likely result in negative rating actions given the currently tight rating headroom.