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Analysts Assess Potential Impact of UK Gross Profit Tax

27 Jun, 2012

In a top-down analysis of the proposed 15 percent gross profit tax (GPT) to be levied on the UK businesses of online operators, analysts at Jefferies have estimated that Betfair will see its earnings hit harder than UK-facing peers Ladbrokes, Paddy Power and William Hill.

As part of a sector note published on Tuesday, the Jefferies analyst team lays out the estimated pro-forma impact on the profitability of Betfair, Ladbrokes, Paddy Power and William Hill, should a 15 percent tax on UK-derived gross gaming revenue be implemented in December 2014.

The proposal to tax UK-facing companies at the point of consumption and prevent offshore companies from avoiding paying tax was confirmed by Chancellor of the Exchequer George Osborne back in March, focusing attention on the extent to which operators will be able to mitigate the extra cost.

Using their 2014 estimates for the four aforementioned operators and the suggested 15 percent GPT rate to give a broad indication of the impact in 2015, the Jefferies analysts forecast that Betfair will see net revenue impacted to the tune of £32m, ahead of reductions of £29m, £28m and £23m at William Hill, Paddy Power and Ladbrokes respectively.

The analysts expect the impact of the GPT to be far more pronounced in terms of operators’ earnings, with Betfair suffering to a greater extent than its peers due to the weighting of its profits derived from online in the UK.

The Jefferies analysis projects a 31 percent negative impact to the betting exchange giant’s 2015 EBITDAR, dwarfing reductions of 12 percent, 8 percent and 9 percent at Paddy Power, William Hill and Ladbrokes respectively.

Estimating an even deeper 48 percent dent in Betfair’s 2015 earnings per share, the analysts explain: “Betfair’s lack of rent exposure, high level of depreciation and net cash position leads to a relatively higher impact on EPS than EBITDAR.”

William Hill, Ladbrokes and, to a lesser extent, Paddy Power are expected to experience less harsh declines in earnings due to the significant profitability of their retail arms, which will be left untouched by the remote gaming tax.

With regard to Paddy Power, the analysts write: “Despite Paddy Power’s circa 70 percent exposure in its online (ex-Australia) division, the UK GPT impact is reduced by: (i) the high rate of growth in other divisions (such as UK retail); and (ii) the higher margin earned by the online division itself.”

While the Jefferies analysis takes no account of potential mitigating factors, the analysts note that the market share of major operators should benefit from the imposition of a 15 percent UK GPT rate, “if the tax is stringently enforced and the ‘grey market’ is restricted”.

“With fewer competitors, it is also possible that marketing costs could fall, although the opportunity to gain market share may encourage a further step up in marketing spend,” add the analysts.

In spite of the projected impact to earnings from 2015 onwards, the Jefferies team currently holds ‘buy’ recommendations on the shares of Betfair and Paddy Power, explaining: “We prefer companies with a greater online weighting and clear differentiation, namely Betfair (by dint of its unique exchange and online business model) and Paddy Power (majority of business focused on online.”