Tabcorp Holdings Limited (TAH) Earnings Call Transcript

Good morning, and welcome to Tabcorp's financial results announcement for the first half of FY '20. I'm David Attenborough, CEO of Tabcorp, and with me is our CFO, Adam Newman. And for those of you who haven't yet had the chance to meet or hear from him, Adam joined us from AusNet late last year, and this is his first Tabcorp results presentation. And I'll be taking you through the presentation lodged with the ASX today, which should take around 20 minutes, and then we'll open up the line for questions. So on to Slide 3. And it's pleasing to deliver a solid group result for the first half driven by an excellent performance from Lotteries & Keno business. It was especially pleasing to see revenue growth of 4.4%, which compares with around 3% CAGR in the Australian gambling market over the last decade. The interim dividend has been maintained at $0.11 per share, fully franked. And it was another half of significant change as we entered the final phase of the Tabcorp and Tatts integration. We remain on track to deliver our FY '21 targeted EBITDA from synergies and business improvements of between $130 million and $145 million, and we have upgraded our target for FY '20. However, due to the complexity of this phase of the integration, we're now expecting nonrecurring implementation costs to come in at $135 million pretax, up from the previous estimate of $95 million. And in terms of the 3 businesses, the step change in Lotteries & Keno's performance continued into FY '20. And this business is going from strength to strength under a clear strategy that's being well executed. Strong digital and retail growth and the addition of 300,000 customers were among the highlights. The results in Wagering & Media was soft in a competitive market, transitioning post the introduction of point of consumption tax. Our key focus has been to ensure we compete well, while transforming and integrating the business for long-term success. And this has been a large multiyear program of work, which is now nearing completion. It means in FY '21, we'll have a fully integrated business under a single TAB brand with customers in the UBET states able to enjoy the full, transformed TAB offer. And the results in Gaming Services business were unsatisfactory, and we've commenced both an operational and a strategic review to improve business performance, including capital efficiency. The relationships that we have with our industry partners are very important to us. And several of our venue partners were impacted by bushfires. And I'm proud of the way our teams have responded to support them. We've also backed the recovery effort with donations of more than $2 million, which will come through in the second half. Slides 4 and 5 cover the headline results, with Slide 4, the group P&L -- sorry, and the group P&L is on Slide 5. Profit after tax pre significant items was $213.5 million, up 2.9% and significant items after tax totaled $14.7 million, resulting in statutory profit after tax of $198.8 million, up 10.8%. On to Slide 6. And we're now in the final phase of the integration. A program of works that's made up of over 100 discrete projects, the team continues to execute well and delivered an incremental $24 million of earnings through synergies on the pcp, and this includes savings in communications and call center operating costs. Recurring EBITDA synergy benefits are now expected to be $100 million in FY '20, up from our previous estimate of $90 million. And we're also on track to deliver our FY '21 target. We have, however, spent $93 million to date and are guiding today that one-off implementation costs are expected to be $135 million pretax. And what's driving this is the significantly increased complexity during this final critical phase of the program. We've deployed additional resources to manage this and the associated risks around the migration of UBET customers to the TAB platform. This adds more cost for longer than planned. Turning to the Lotteries & Keno on Slide 9. At the time of the combination with Tatts, we highlighted the potential for this business to reinvigorate the lotteries market. In the past couple of years, we've increased investment in customer-focused resources, supported the rapid introduction of product and channel initiatives and strengthened stakeholder relationships. This delivered a step change in performance in FY '19, which has been sustained in the first half of FY '20. Our customer-led approach is driving growth. And in the half, we achieved a significant milestone with the launch of our new omnichannel and retailer remuneration model. The alignment of retail and digital through this new model delivers a better customer experience, supporting the strong retail growth of 5.2%. The OpEx growth reflects various initiatives to support earnings, including our digital capability and increased promotional activity around large jackpots. On to Slide 10, as well as the omnichannel program, a strong run of jackpots and a step-up in personalized marketing helped drive the excellent result. We're now at 3.6 million active registered customers. And that illustrates the role that our lotteries play in many Australians' lives. And you'll see we've added a new disclosure this period on the cumulative jackpot value for Powerball and Oz Lotto. It's the size of the jackpots in addition to just the number of large jackpots that helps drive revenue. And we have had a very strong past 12 months. However, ultimately, the level and frequency of jackpots is somewhat uncertain in any given 6- or 12-month period. In thinking about the second half '20, you should note, we'll be cycling a strong pcp that included particularly favorable jackpot sequences in Lucky Lotteries and Oz Lotto. Digital turnover grew at 40% and now makes up more than 1/4 of total turnover. There is an opportunity for digital to continue to grow its share, further improving our VC margin. We also saw good growth in Keno digital active account customers. The sign of a strong lottery business is having a balanced portfolio with all products performing well. And to that end, the focus on game enhancements in 2020 will be on Set for Life. And for those not familiar with it, it's different to other games in that Division 1 winners win $20,000 each month for 20 years. The changes we'll introduce this March will increase its appeal to new and existing players. And they include the introduction of a Division 2, which gives players the chance to win $5,000 a month for a year. Another focus area is the continued rollout of the refreshed umbrella lotteries brand, The Lott, across retail. The famous state-based brands, such as Tatts, Golden Casket in Queensland, and New South Wales Lotteries won't disappear, but The Lott enables us to build a consistent umbrella brand across online and retail and that's important when omnichannel is so critical to our growth strategy. Now to Wagering & Media on Slide 11. And the performance reflects a soft market, which is still adjusting to the introduction of the point of consumption tax and a business that is in transition. This made it a challenging 6 months. The results show TAB competing well, but the ex-UBET business negatively impacted by its legacy offering. It simply doesn't yet have the products or services in place to win consumers in this competitive environment and will not be able to complete effectively until integration is done. And once the integration is complete in FY '21, ex-UBET customers will enjoy additional products such as Trackside flexi betting, Early Quaddie, and significantly more fixed odds books, which make up a material part of TAB's product set. This provides a significant opportunity to return the ex-UBET business to growth. The decline in VC margin is largely due to the impact of increased generosity spend which is weighted towards the first half, with the focus on Spring Racing. Expenses were well controlled, despite increasing investment in customer care and risk programs. And one of these is a trial of artificial intelligence age recognition technology in TAB agencies to minimize the risk of underage betting. We're continuing to shape the sustainability of the wagering industry and embedding responsible entertainment. And as part of this, we're supporting several racing-industry-led animal welfare projects, including the recently announced national thoroughbred welfare initiative. On Slide 12, we've provided some additional charts to give you a greater understanding of the key battlegrounds playing out in the market. Based on data we can see, our turnover share of the account market grew. Account being digital and call center. This reflects our investment in product and customer experience and in generosities. However, our revenue share declined, and that's largely because of a stronger relative yield uplift for our competitors with our fixed odds yield increases coming off a higher base. And TAB also got less of the benefit of favorable fixed odds results as almost half our revenues are from tote products. These have a fixed take out and have been in decline for some years. We haven't lost sight of the opportunity to reinvigorate the tote, including national pooling, which can only be done post integration. We've been able to maintain a competitive position on price, and that's been important in substantially improving TAB's value perception. The 7% growth in TAB active account customers in quarter 2 was pleasing, given the focus on customer retention and acquisition. The decline in UBET's active customers reflect its legacy offering. Reactivating the substantial database of UBET inactive customers with the more attractive TAB offer is a priority post integration. Slide 13 highlights the activity we've undertaken in the period as part of TAB's transformation. We've been reinvigorating the brand, and TAB would rank #1 in Google non-paid brand search over footy finals and the Spring Racing Carnival. It was significantly higher than the next competitor, and that points strongly to top-of-mind awareness and customer sentiment. We're leveraging TAB's brand strength through investments in personalization. And most recently, we were the first wagering operator in Australia to adopt Adobe's new data product, Experience Platform, and are focused on unlocking superior data-driven capability. Enhancements to Venue Mode have made the experience more attractive. A reminder that Venue Mode allows customers to switch their TAB app to Venue Mode while in the TAB retail environment to get exclusive markets and offers. Again, this brings together our retail and digital assets in a unique way. And our media platforms and content have continued to be modernized with the Sky Racing Active OTT platform and NBA and NFL content, which gives venue partners more reason to show Sky and another reason for customers to patronize their local TAB. Slide 14. This slide shows the progress that Wagering & Media have made and what that we continue to work towards in FY '21. Transforming the core TAB business while integrating UBET has been difficult, but important to undertake in a transitioning market. We have a full agenda in the second half to significantly advance these 2 large-scale programs and for the business to emerge in FY '21 as a strong national business. The business is facing some extra challenges in the second half with bush fires and the wet weather, which also affects our partners, particularly the racing industry. As an example, we've had as many canceled race meetings in the past 9 weeks as we would normally see in a 9-month period. On to Gaming Services and Slide 15. Performance was unsatisfactory with revenues and earnings down, and we expect a challenging second half, which will also be impacted by the expiry of a Telstra service contract. The Managing Director of our Gaming Services business, Frank Makryllos, has stepped down and an operational review has commenced, with the objective of significantly improving the performance of the business. We have appointed one of our experienced industry executives, Paul Carew, to step up to lead this business as Chief Operating Officer. In parallel, we've commenced a strategic review of this business. On to Slide '17 and capital management. BAU CapEx will likely be up to circa $160 million in the second half as we continue to invest in lifting our wagering customer experience and personalization capability and in other technology projects and the retail rollout of The Lott brand. We're nearing the end of integration, but there's a further $27 million in CapEx in the second half as we substantially conclude the integration and the data center consolidation. This means, we expect to come in just under circa $140 million of non-BAU CapEx over FY '19 and FY '20. And FY '20 is likely to be the high watermark as we cycle out of this intense period of transformation. On gearing, we're in the middle of our target range, excluding the impact of the change in accounting standards. And that's consistent with our position at 30 June, 2019. And finally, on this slide, we've reconfirmed that we'll target a dividend payout ratio of 100% of adjusted NPAT for the full year. So if I can now conclude on Slide 19, our diversified group delivered revenue and EBITDA growth in a soft consumer environment and while managing a complex transformation and integration. The second half will have some challenges in terms of environmental factors as well as the business-specific issues I've covered earlier. However, we're now on the cusp of having fully brought together Tabcorp and Tatts, and look forward to realizing the full benefits of the combination for shareholders, industry partners and customers over the coming years. And we have -- and as we successfully emerge from the integration and transformation in FY '21, there's a significant opportunity to optimize the group and achieve efficiencies. We'll have more to say on this at our full year results in August. Thank you, and I'll now open up the line for questions.

[Operator Instructions] Your first question today comes from the line of Anthony Longo from CLSA.

I just had a couple of questions on wagering, if I may. So firstly, in terms of the synergies that you managed to realize in this first half '20, are you able to give a sense as to what that number was to get an underlying EBITDA ex-synergies, if possible?

Yes, I'll take that, David. Yes, an underlying ex-synergies, it's about flat in the wagering group. So slide -- yes, actual amount from a wagering synergies perspective for the half was approximately $9 million.

Okay. No worries, I was probably just missing that. Secondly, I mean, looking at gross and net yields across the wagering business, are you able to give a sense as to how much of that gross yield improvement was from -- favorable results from your end? And then how much of it was from those increased over-rounds?

We'd need to get back to you on that. I haven't got the number in front of me. We haven't broken it down.

Yes, not to worry. And another one for me. In terms of, I guess, the amount of consolidation that you have started to see in the segment at the minute, are you starting to see more rationality starting to prevail within the industry? I mean, it feels like generosities are still very much up there, but any sort of color on that would be fantastic?

Okay. I'll try and give you a little bit of color on the rationality. We are certainly seeing, obviously, continued investment in generosities by our competitors and continued investment by them in competing with us across the product set. However, we have seen a pullback on above-the-line advertising. We have seen indications of a focus that is on their P&Ls and on profitability. And certainly, we've seen some activity around some advertising and sponsorship assets that seem to indicate that people are really focused on where they can pull back on expenditure. So yes, there is certainly some real focus, both from ourselves and our competitors on managing our P&Ls.

Yes, right. Okay. And sorry, last one for me. I mean, lotteries was obviously a great half and you did talk about step changes coming through there. How should we ultimately be thinking about the second half '20, obviously, cycling some pretty tough comps year-on-year? But it sounds like you guys are pretty comfortable in your math and metric changes of the games. And I guess there was -- those other initiatives that you are flagging, so Set for Life and others. Are you able to give a sense as to how you'd expect the second half to play out on the lotteries business?

So we -- certainly, we've entered the second half with some momentum. So we've had a very good second half. But if you think about the second half, we've -- and how you should think of it, large jackpots really helped us. And in the last 2 halves, we provided you with some new information on cumulative jackpots, and we believe that's instructive and will help you, and -- so that you're able to think about the discounts for the outcomes of things like Oz Lotto in the second half '19 and Powerball in the first half '20 as part of the thinking. So you start to sort of think about the sort of outliers. We're obviously cycling a very strong second half '19 in terms of both Lucky Lotteries and Oz Lotto. And just so you remember those supporting facts, we're cycling around $20 million incremental EBITDA from those, what we called out particularly favorable jackpots in the second half '20 of Lucky Lotteries have gone through, $80 million. If you remember, an $80 million cycle, and we had the 2 Oz Lotto, $70 million and $80 million jackpots.

It's Adam here. I'll just come pick up your earlier question with regards to the impact of favorable racing results in Wagering & Media. And I think we would say fixed odds yields for the half are about 14.5%, inclusive of the favorable racing results. And if you sort of back them out, we would say a more normal net yield is probably in the range of 13.5% to 14%.

Your next question today comes from the line of Desmond Tsao from Goldman Sachs.

Just a couple from me. Firstly, can you just provide a bit more color around the integration program given that, I think, it's a couple of halves now where you guys have pulled forward the synergy expectations, but still maintained your overall $130 million to $145 million target. Perhaps just talk a bit more detail around it as to what is driving the pull forward? And I suppose, why the overall target has remained the same, particularly in light of the -- I think the $40 million of increased implementation cost that you're guiding to today?

So I'll start, and then I'll probably let Adam come in and give a bit more color on some of the expenditure. The first side of -- the reason the costs have gone up, and I called it out in the sort of approach, is this final phase is incredibly complex. We've essentially completed all the coding that's required, and we are going through a large regulatory approval process across all the systems, and we've resourced up to manage that complexity and to try and de-risk the program. And in managing that complexity, it has shifted the customer migration from the third quarter to the fourth quarter of FY '20. And our main focus in derisking is to ensure that systems don't fall over and that we manage all the AML and compliance issues as we roll out and move to system transition. And why we have confidence in the synergies and they did -- and we're able to reaffirm them is that there is really a significant opportunity in relation to UBET. And when I call out that significant opportunity, we are aiming to have the UBET customers migrated this financial year. And in migrating those, they gain a large number of TAB products that they don't currently have. And again, I called them out in my overview. And those TAB products contribute more than 10% of TAB's total revenue. So those products will then be available within UBET. There is also a significantly higher market share enjoyed by TAB in its states than we see UBET enjoying in the UBET states. And that is an opportunity where we can start to leverage the work we're doing in the digital in venue, in retail with TAB and the work we're doing around personalization that will all be available to UBET, and will allow us to really drive a better and enhanced retail experience across the UBET states. And then finally, we'll be migrating well over 300,000 customers with that migration, of which under half of them are active, and there is a big opportunity to reactivate those going into FY '21. So that's the opportunity. The work we've done is all about underpinning, and we have a high degree of confidence as we go into FY '21 that we can drive some good revenue synergies.

And maybe I'll just pick up and talk a little bit with regards to the cost synergies. And I think the observation would be, previously, I understand the guidance for the full year was $75 million and we're now calling it $85 million after being at a run rate for the first half of $41 million. So there's not a significant amount in the second half to get to the $85 million. So I think we feel pretty confident in that regard. Obviously, we're getting pretty close to the final stages from delivering of the cost synergies perspective. And into -- if we look forward into FY '21, the tail of that particular part of the program relates to really 4 main areas in relation to call center exits, data center consolidations and some work with regards to -- in the technology space around operating model and retail land consolidation. So I think on the cost side, we've progressed very well. And I think we've got a pretty high degree of confidence with regards to where we get to by the end of the program.

That's really clear. Just picking up on that. Just in terms of that UBET migration through the second half, I think that's still subject to regulatory approval. Are you comfortable that, that's going to be completed in the second half, and that's not going to be at risk of being potentially pushed out into FY '21?

So we're working very closely with the regulators. They -- we've been communicating and continue. And as comfortable as one can be, there is always some risk with regulatory approvals, but there is a high degree of confidence that, that migration will happen in the second half.

Okay. And just -- second question just around Gaming Services. Obviously, very soft performance there this half. Can you perhaps just talk to the drivers of the performance in the half and then also the -- more broadly, the competitive dynamics within that space? And just perhaps give us a feel for the timing of the review that you're commencing for that business. And how we should think of -- about contract extensions for the business in the second half in light of the strategic review and the change in management?

It's Adam here. I'll take the first half of the question in regards to the performance for Gaming Services in the first half, and I'll let David talk to those couple of other points that you've raised. The performance at a PBIT line perspective for Gaming Services was down about $16 million half-on-half, and that really break down across the 3 areas in terms of variable contribution, OpEx and depreciation and amortization reasonably evenly. In terms of VC, a lot of the downturn there, and it was approximately $6 million, was essentially in relation to gaming machine renewals or loss of venues rather in the prior period that started to come through in this particular period as well as some lower project-related work in the OpEx space, and we called this out in the slide. The increases there were impacted by a increase -- sorry, a release of provision in the prior period of approximately $2 million and some increase in some A&P expenditure. And then within the depreciation and amortization charge, we had some impairment of the statewide links assets and that was about $2.5 million for the period. And we had some accelerated amortization in relation to the Telstra contract we called out there as well. And they -- the 2 of them combined is the major part with regards to the increase in the D&A for the period. So I think that kind of covers off of -- the factors that were impacting the performance for the half. I'll just get David to talk to a little bit with regards to the couple of other questions that you have.

Yes. So the way I'll try and answer your other questions is, first of all, we recognize the performance is unsatisfactory, and we've acted on it in terms of moving to an operational review. And that operational review resulted in a management restructure, MD stepping down and a move to tackle the focus of that business. And when we look at that operational review and what it's focused on, it's focused on driving revenues and the key buckets to drive revenues are already built around more EGMs under management, and that's under the 2 key areas of the business, more EGMs under management within what we call the [ MPS ] business, the old TGS business under TAB, which is the contracted EGMs that we manage for venues. And we've just received a license in Queensland to roll out also in that state. And then there's also EGMs under the management system that we have up in Queensland, where we have around 77% market share and the opportunity that we have up there to increase the number of machines under management within the machine monitoring side. So that's the revenue drivers. There are also a focus on cost. And as part of the structural review, the operational review, there's a real focus on streamlining the structure and achieving cost efficiencies, and as you saw in the half -- the first half, there was some growth in the OpEx costs, and we think that we can deal with those and reduce the cost base. And finally, we need to ensure we're getting an adequate return on the substantial capital that's been flowing into that business. And that's really resulted in us also moving to what we've talked about, which was a more detailed strategic review.

Your next question today comes from the line of Larry Gandler from Crédit Suisse.

I might just start with -- just following on from gaming. Just to be clear, those accelerated amortization, that should drop out once the Telstra contract finishes up?

Larry, so the Telstra accelerated amortization for the half, it was about $1 million. That related to some purchase price accounting adjustments in relation to that particular contract, which will now accelerate through the second half of the year. And we called that out in the slides there from a Gaming Services perspective. So once we get -- we'll cycle through the remaining part of that amortization by the end of this financial year.

Right. And David, does the strategic review also consider whether the division should be part of Tabcorp? Or is it more along the lines of assets within the gaming division?

It's all options.

All options. Okay, great. Yes, David, I just want to maybe ask a question about wagering naturally. We've seen that turnover has responded to higher over-rounds in the last 6 months. And I guess, that's an indication of how punters behave. I'm wondering, when it comes to the -- you talked about reinvigorating the tote. I'm wondering if we can take a leaf out of that and consider the tote's pricing, I know it changes day-to-day and race-to-race or even within race, but the overall extraction rate may be dear such that there might be an opportunity to promote more value out of the tote. How do you think of the tote's position? And how is it going to change as you try and reinvigorate it?

So that's some very good questions in there, Larry. And I know you've been thinking about the tote for a number of years. The -- as we move post integration, the reinvigoration of the tote is a real priority. And that's not only national polling. One of the frustrations with pari-mutuel is the way tote systems work and yet, you're probably aware of this, is every night they sort of do an accounting sort of round-up and the system gets shut for a few hours and then it resets up the following morning. And having real-time information to market and deliver the personalization that you see in fixed odds has been really difficult. We have been investing hard in the digitalized data and personalization and doing a number of drops that have really nailed it for fixed odds. And we're certainly intending to nail it for pari-mutuel this calendar year. And from the way that we can really deliver value to a tote customer real-time, that then means it's less about take-out adjustments, which I think you've always raised, why don't we lower the take-out and add more value, and more about adding really bespoke value per customer built around generosities that are bespoke to pari-mutuel, and we'll have the ability to do that. And I think that will add considerable value when coupled with national pooling, if -- once we can get the industry to all align on how that will work.

Yes. That actually sounds interesting. Makes sense. So the national pooling, what's the process to get national pooling from here?

So there is an exercise that's ongoing to get all the racing industries aligned on the -- what national pooling looks like. In other words, how it will work for each of them. And if we can get them all aligned, that's a big tick. And there's some work going on with the regulators as well, because, obviously, you need to get rule alignment so that you can actually combine all the pools. Good progress being made. And there's a real appetite from the racing industry to get this done. And so I think that we have a better chance than we've ever had to deliver this. And it's certainly something I'd like to see done, and we'll be getting behind hard in FY '21.