Thoughts on the Betfair bid

A number of people have been asking me this week about the potential CVC bid for Betfair. It’s a very interesting position for the company for a whole host of reasons, and below is the first of two posts with some thoughts.

The background

Richard Koch, who is behind the bid, owns about 6.5% of the company by virtue of the fact that he was an investor in the third round, late in 2000 (if my memory serves). He made a seven-figure investment at that point, with the share price effectively at 25p (it was actually £2.50, but there has been a 10:1 share split since); and joined the Board for a couple of years. A straight-talking South African, he has always been a huge evangelist about the company, as his focus on it in his book The Star Principle demonstrates. In that, he categorises businesses as stars, cash-cows, dogs, and (I think the fourth category is) question marks – a model which I believe was first adopted by the Boston Consulting Group. He had Betfair down as a star business right from the word go, and believed it would (or should) be worth tens of billions of pounds.

As one of the core 14 shareholders (indeed, the largest individual shareholder after the two founders), he was locked in at the time of the float in October 2010. He would have had to sign an irrevocable undertaking to sell 20% of his shares at the float price (which was £13), in order to get the deal done; and the balance, he would not have been able to sell until April 2011. Whether he would have sold at that point had the price held up, I have no idea; but it’s academic, because by the end of the lock-up period, the shares were just under £9.

I believe I am right in saying that Richard never wanted the business to go public, and has wanted to take it private again since the first day it came to market.  What makes things interesting is what price is he likely to bid, and why now?

Bid price

The share price has not been above £9 since the lock-up ended, and dived to £5.71 back in August 2011. On average, it has been around £8, just as it is today after a week of speculation. Initial unattributed comments to the media clearly came from the potential buyers, in that the idea that the (then) £7.50 level already represented a ‘full’ price were laughable – if not on the basis of your view of value, then on the basis that if shareholders wanted to get out at that level, they could have done so at more or less any stage since the float.  It was me quoted in the Guardian last week as saying that “if they think Ed and Bert will sell at that price, they’re dreaming”, and I stand by that point of view.

Where people might sell, I can of course only speculate: I don’t know Ed or Bert’s view, and if I did, I wouldn’t be publishing it anyway.  I can’t see long-term shareholders wanting to get out of everything below £10 – not for any reason about what that says about the market cap, but because of the psychology of the number – but what will be very interesting, in the event of a £10 bid, is what the Board recommends to its shareholders.

It is, after all, less than three years since the business was brought to the market at £13, so advising that £10 is a good price will raise some eyebrows – particularly in a context of the wider market being up significantly, and other players in the gambling space being up 100%. The Chairman, who is new since the float, and the CEO (ditto), may feel it is possible to argue that £10 represents a 25-30% premium since their arrival. But they will need to keep a straight face.

Suggesting such a bid is rejected, though, will raise equally difficult questions: if the price falls back to the £7 it was at before this story broke, there will be some very unhappy shareholders out there. One would think that the £145m that is sitting on the balance sheet, plus the total absence of debt in the business, will be combined to deliver a bumper special dividend to cheer people up.

The timing and rationale

What price the bid is (and I am assuming that speculation will indeed culminate in a bid, as I think it will) will tell us an awful lot about the rationale. This might sound like a statement of the obvious, but it is particularly true of a business which generates radically opposing opinions.

There is an argument that the bid is simply speculative: that is, it’s designed to take advantage of the fact that the company has seen significant change in the last six months since the arrival of Breon Corcoran as Chief Executive, without there being any upward movement in the share price. This view is supported by the fact that the bid team apparently wants to retain current management, and in many ways it makes sense: despite the fact that there have been hundreds of redundancies, a complete restructuring and change in geographical focus, and the introduction of vast amounts of fresh blood, the stock price was (prior to the bid speculation) down about 10% since Mr. Corcoan’s arrival. As I have written before, there are good reasons to be optimistic about the direction the share price is headed. Picking the company up near enough to the current price should bring the buyer a decent turn.

But there could be a lot more to it than that. The complete change of strategy – focusing on fixed odds bookmaking and sidelining the exchange – seem to be aimed at making the business another Paddy Power. No disgrace in that: it could make shareholders a lot of money, if, like Paddy (and indeed William Hill), the company then doubles its share price in a year. But if he is consistent with the comments he used to make, it is a strategy which might fill Mr. Koch with horror. His definition of what makes a star business is that it must be in a fast-growing niche, and be the leader in its field. Betfair as a traditional bookmaker is neither: it’s a me-too operation in a crowded market, and as such becomes a cash cow (by the Star Principle definition). It doesn’t seem to me to fit in with what I have always understood to be Richard’s view of the world.

Like Koch, I am an exchange evangelist. Not that I have anything against traditional bookmaking – far from it – but for me, that’s not what Betfair is about. In fact – again, probably a statement of the obvious – I’m a bit of a Betfair tragic: despite where the company is today, I still cling to the belief that it could be returned to its former glory. I know I hold a minority view, not  even shared by every large long-term holder of the stock, let alone the wider public: only on Thursday, one told me over dinner that he thinks the company has gone too far from where it was ever to recover. If that is the opinion of former founder management, it is unsurprising that many in the wider world share it.

The recent change in direction to build a different sort of betting business from the one that Betfair started with (or, to put it another way, the same type as everyone else’s) is grounded in this second view. Perhaps that is what CVC and Koch are buying into. Or perhaps they are playing at Fantasy Betfair – a game which, given the length of this piece already, requires a separate blogpost altogether.