Technical As technology has been put into use and thanks to its convenience and availability, the internet gambling becomes more popular in Australia. However, impacts brought by internet would affect both health and consumption of consumers. Hence, relevant organizations should regulate the operation of online gambling.
2.2 Financial Analysis
2.2.1 Financial Performance & position on Tabcorp Holdings Limited
The provided information shows that the revenue of Tabcorp increased slightly from year 2005 to year 2010 and the average increase rate is 2.03%. It is estimated that the revenue of Tabcorp in 2011 and 2012 will increase at similar rate. But as the Victorian government decided to strip Tabcorp and rival Tatts Group of their electronic gaming duopoly licenses from 2012 (Sudarsanam 2011, p.385), and historically the business related to these licenses earned about 24% of total business revenue, the revenue from 2013 to 2015 is estimated to drop by around 24% of the regular revenue.
Via calculating the current ratio, ROE and ROA of Tabcorp and the industry’s average historical data, it can be seen that Tabcorp’s ROE and ROA are higher than the industry average. It means that Tabcorp has a better ability to use its asset to earn profit and Tabcorp’s stockholders have better return on their investments. Tabcorp’s current ratio is smaller than the industry ratio, which means Tabcorp have less ability to pay off its short-term debt.
Table 2 Ratios for Tabcorp and the industry
2.2.2 Financial Performance & position on Echo Entertainment Group Limited
The Half Year Results Presentation of Echo Entertainment illustrated exciting results. The Star and QLD revenue growth was up to 22.2% and 8.6% separately, which are the key drivers of the total revenue growth. With respect to successful initial openings in 2011, The Star is expected to have successive openings over the course of 2012. Significant new products will be opened, and key mass market visitation drivers are still expected to come. Therefore it is expected that these excellent performances would be maintained throughout the whole financial year, which will push the group revenue growth up to 15% in 2012.
The Group’s ASX announcement of Half Year results states that the Star’s redevelopment and expansion is going to be completed in 2012, thus it can be deferred that the Star won’t experience significant revenue growth after 2012. In addition, the domestic business of QLD is impacted by a tough consumer environment, the domestic revenues are largely dragged by non-gaming softness, which is partly due to the theatre redevelopment in Golden Coast, and this negative effect is expected to continue. Thus it is expected that from 2013 the growth rate of the group revenue will gradually decline, and in 2015 reach at approximately 8%, which is the average revenue growth rate of Crown Limited in recent five years. Here Crown Limited is regarded as a peer company comparable to Echo since they have quite similar operating businesses in Casino Industry and similar customer base.
2.2.3 Financial Performance & position on Post-demerger Tabcorp Holdings Limited
The new Tabcorp after demerger comprises four continuing businesses: Wagering, Media & international, Victorian gaming and Keno. Media & International was created as a separate operating segment at 30 June 2011. Previously Media & International was included in the Wagering operating segment. With respect to ASX announcement of Tabcorp 2012 half year results, the new Victorian Wagering and Betting Licence was issued on December 2011 to replace the old one, which will expire in August 2012. The Licence period is 12 years and will commence in August 2012. Therefore the negative influence of the expiry of previous Victorian Wagering and Betting Licence will be eliminated. The 2011 post demerger revenue decreased approximately 30% compared to 2010 pre-demerger revenue; however the continuing businesses demonstrate steady growth. The trading revenue for first half year of 2012 is 1573.5 million, assume the performance will maintain in the second half year, compared to the revenue of 2947.5 million in 2011 the revenue will experience a growth about 7% in 2012. Look into Tatts Group Limited, which can be regarded as a peer company to new Tabcorp as they have similar company structure and operating businesses, its average revenue growth rate is nearly 8% in recent years. As there are no further expiring licences in recent years, and the businesses are stable, it is expected in the following four years the revenue will maintain a steady growth rate at about 8%.
The new licence fee and associated costs totalling $418 million have been recognised as a non-current asset (Intangible assets - licences) at 31 December 2011. The payable to the Victorian Government was disclosed as a liability (Payables) and was redeemed $410 million in January 2012. The licence will be amortised on a straight line basis over the life of the licence from August 2012 until expiry in 2024. Then it has been justified that the balance of ‘intangible assets – licences’ in 2012 will have a significant increase compared with 2011.
2.3 Valuation
The valuation of Old Tabcorp, New Tabcorp and Echo is based on both discounted cash flow model and the Multiples.
2.3.1 Discounted Cash Flow Analysis
The value of a business entity can be described as the value today of all future cash flows forecasted or estimated that have been discounted to the present at an appropriate rate (Mercer & Harms 2007). Free cash flow to the firm is the net amount of cash remaining after the firm has met all operating needs, including capital expenditure or working capital investments (Graham & Smart 2011). It represents the amount that a firm can distribute to all types of investors. Discounting the future free cash flow to the firm to the present at the weighted average cost of capital of the firm can generate the current value of the firm.
Free Cash Flow Forecast
In order to forecast the free cash flow to the firm, some assumptions have been made. The estimated revenue growth rates for the three entities have been discussed in section 2.2. Interest rate for Old Tabcorp is assumed to be 9% according to its announcement on interest rate determined in the year 2010, before the demerger. Interest rate for New Tabcorp is about 8%, based on its announcement on interest rate determined in 2012. It is assumed that Echo has an interest rate of 7%, lower than its cost of equity. Tax rate is supposed to keep at 30%. A sensitivity analysis in later section will demonstrate how different interest and tax rates can influence the firm value.
The provided information shows that the payout ratio for the new Tabcorp will increase back to 80% in 2013 because of the expiry of the Victorian Wagering and Betting License. However, the recent half year report of new Tabcorp shows that the entity has been awarded the new license. As a result, the payout ratio for new Tabcorp is assumed to keep at 70% after 2012. The expected payout ratio of Echo stays at 50% from the year 2012.
Other assumptions and the detailed free cash flow forecasts for the three entities are demonstrated in Appendix.
Weighted Average Cost of Capital
The weighted average cost of capital is calculated using the formula:
WACC = re
+ rd(1-t)
The cost of debt has been discussed in the previous section. The CAPM is used in order to estimate the return on equity: re=rf+β(rm-rf). Beta for the new Tabcorp and Echo is collected from FinAnalysis and Beta for old Tabcorp is assumed to be the industry beta. Market return is the average annual return of ASX 200 accumulated index in the past 10 years and risk free rate is the return of Australian 10-year Treasury bond. The estimated return on equity is demonstrated in Table 3.
Table 3 Estimated cost of equity for Old TAH, ECHO and New TAH
Since the market value of debt is difficult to get, it is assumed that the debt ratios for the three entities all keep unchanged at 25%, which is the target weight of debt. The WACC of the three entities is demonstrated in Table 4.
Table 4 WACC calculation for Old TAH, ECHO and New TAH
FCFF Valuation Results
By discounting the free cash flows to the firm at the WACC, the firm value of the new Tabcorp, Echo and Old Tabcorp at the end of financial year 2011 can be estimated. Firm values of new Tabcorp and Echo are about $6294.24million and 3518.42million respectively. While without the demerger, Tabcorp’s firm value is expected to be about $6567.93million. Since the total value of new Tabcorp and Echo is much larger than old Tabcorp’s estimated firm value (6294.24+3518.42 > 6567.93), it is obviously that the demerger has a positive outcome.
Sensitivity Analysis
In the above valuation process, it was assume that the interest rate of Old Tabcorp is 9%, Echo Entertainment Group’s interest rate is 7% and the interest rate of New Tabcorp is 8%. We also set the tax rate as 30% for these three companies.
Table 5 Sensitivity Analysis
In the sensitivity analysis, interest rate and tax rate are used to see how the firm value would change. When interest rate increases from 0.05 to 0.12, the one-dimensional firm value of these three companies increase, whereas all firm value decrease along with the increasing tax rate. But from the two-dimensional data it can be seen that following the increase of interest rate and tax rate, the firm value of Old TAH and New TAH decrease while ECHO’s firm value increases. As a result, the firm value of Old TAH and New TAH are more sensitive to the change of tax rate while ECHO’s firm value is more sensitive towards the change of interest rate. And the reason is probably because ECHO has more liability and big amount of interest expense relative to its smaller firm value.
2.3.2 Multiple Analysis
Multiples valuation is a method for determining the current value of a company by examining and comparing the financial ratios of relevant peer groups. (‘Valuation using multiples’n.d) The selection of comparable companies should depend on company size, products, , growth rate, , etc. (‘Valuation Using Multiples’n.d).
Here, EV/EBITDA and EV/EBIT are picked up as multiples to estimate the enterprise value. Those two financial ratios are independent of capital structure, so they won’t be influenced by changes in capital structure. Echo and New Tabcorp’s EV/EBITDA and EV/EBIT are used to calculate the actual enterprise value for the year ended Jun 30 2011. In the meantime, multiples from peer companies, like Crown and Tatts are chosen to estimate the expected enterprise value in 2011, for the reason that both Crown and Tatts did not experience significant event like demerger in that year and grew steadily.
Table 6 Multiple Analysis
It can be seen that the total enterprise value of Echo and New Tabcorp is much larger than the estimated value of the Old Tabcorp, which implies that the Old Tabcorp suffered a conglomerate discount. The demerger is a wise decision for both firm and shareholders.
2.4 Other Issues
2.4.1 Further Corporate Activity
Based on the financial valuation and forecasts above, it can be established that the performance became great after the Tabcorp separated into two commercial entities. Both Echo and new Tabcorp have a bright future.
The spin-off of Tabcorp attracts a larger potential investor base, especially for who are only interested in parts of the group. Because the priorities of the demerged entities began to diverge, creating a compelling case to give investors shares in the separated business, it provides more investment choice. (Sudarsanam, 2011, p385)The separated entities can focus on their core business and adopt a more tailored capital structure. The efficient capital structure and potential investor base will bring more funds and growth opportunities to the entities. Then, those two entities can enhance their market power and capabilities through merger and acquisitions. Therefore, the demerger is a catalyst for further corporate activity in the gaming and leisure.
2.4.2 Synergies Analysis
A spin-off may also be a way of restructuring a diversified group, so that separated entities can be sold easily. (Sudarsanam, 2011, p158) For instance, the Echo may be bought by its peer company like Crown for horizontal merger while the new Tabcorp may be merged by Tatts. Or the Echo can be consolidated by Tatts and the new Tabcorp can be bought by Crown for conglomerate merger. According to the data on FinAnalysis, the Echo’s market capital is $3027 million, and beta of the company is 0.97, it’s close to the industry beta. Meanwhile, the market capital of the New Tabcorp is $2154 million, the beta is 1.13, which is higher than the average of the industry. It means that to merge the New Tabcorp is a risky decision.
The potential merger will bring new growth opportunities and increase market power for both targets and bidders. The synergies arising from the merger are revenue enhancement, cost saving, asset reduction, financial synergies and tax deduction. Take one example into details. If Echo consolidates with Crown, the revenue will be increased. Since the Echo and Crown have the same operation mode, it will save a lot of cost and time on integration.
Conclusion
From the valuation process, it can be seen that the demerger benefits both Echo Entertainment and new Tabcorp and increase their total value. After the demerger, the organizational complexity is reduced and both entities can focus on their own main business; Echo focuses on its casino business and Tabcorp focuses on wagering, gaming and keno. Moreover, after demerger, the two entities can attract different group of investors and potential bidders. For example, those investors and potential bidders interested solely in casino business other than wagering, gaming and keno will pay more attention to Echo Entertainment. In conclusion, Echo Entertainment and new Tabcorp operate much better separately and the demerger of Tabcorp does make sense.
Reference
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Appendix
