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On June 29, Betfair reported financial results for the 2011 fiscal year, the company’s first annual report since going public on October 22, 2010. Revenues were up 15% to £393 million from £341 million last year. The company said profits before tax increased to £27 million, representing earnings per share of 22 pence, and a 50% rise from the £18 million reported in fiscal 2010. Management also announced the payment of a maiden dividend of 5.9 pence per share, giving shares a dividend yield of 1%. Betfair has £155 million cash on hand with no debt, and the company revealed plans to buy back up to £50 million of its stock.

Despite the strong results, Betfair shares are down 34% this year and 59% since the company went public, hitting a low of 598 pence on August 2. Compare that with rivals Ladbrokes and William Hill, whose shares are up 20% and 35%, respectively, this year. Investors have bid down Betfair over the lack of opportunities for growth. The beleaguered betting exchange has also been swept by a wave of middle-management departures. The list is over 15 long, including Mathias Entenmann, former chief product and services officer, and outgoing Chief Executive David Yu. Betfair’s latest private poll of staff revealed that its employees think the company lacks direction and guidance.

Betfair went public for several reasons, few of which have succeeded. For one, management hoped that a public listing would make the company look more reputable in the eyes of potential regulators. However, regulatory body Italian Gaming Authority suspended one of Betfair’s licences this spring, and the company may be frozen out of the German market if lawmakers do not make favourable changes to the latest draft of legislation. Betfair also wanted the “the flexibility to react to a developing and consolidating online betting and gaming industry,” according to a regulatory filing announcing the company’s intention to list on the London Stock Exchange. Management’s plan to acquire companies with shares instead of cash, however, has failed because the company’s stock has lost more than half its value and investors will not tolerate further dilution. As a result, opportunities for growth cannot be bought.

Another reason for flotation: to “assist in the incentivisation and retention of key management and employees”. This has failed, too, as more than 15 middle-management employees have left since October 2010. And despite shares losing more than half their value, executives are taking home fatter cheques. In the last fiscal year, David Yu saw his salary jump 125% to £824,676; Stephen Morana, the company’s finance director, was handed a 445% rise earning £1.6 million. Management also claimed flotation would “provide ongoing flexibility and liquidity for existing shareholders,” though the bulk of shares remain in the hands of Betfair’s largest shareholders—SoftBank, who purchased 23% of the company in April 2006, and founders Andrew Black and Edward Wray. A mass sell off or shift in ownership would put even further pressure on the company’s share price.

Before going public all the excitement and hype was over Betfair’s betting exchange model, the company’s unique selling point. A betting exchange allows gamblers to bet at odds set and requested by their peers rather than by a bookmaker. Punters can make both back bets (bets on a selection to win) and lay bets (against the selection), removing the need for a traditional bookie. Many analysts, now blushing with embarrassment, predicted the peer-to-peer model would to lead to the demise of traditional fixed-odds bookmakers. Not quite the case. Traditional bookmarks have continued to flourish a decade after the debut of the exchange model, and Betfair has even started offering fixed-odds wagers. “Betfair’s updated growth strategy is effectively turning it into a conventional bookmaker over time, diluting the original exchange proposition,” notes Geetanjali Sharma, equity analyst at investment bank Execution Noble.

The ability of punters to lay odds has drawn criticism from bookmakers like Gala Coral, Ladbrokes and William Hill, citing concerns over corruption. Betfair has hit back at the UK’s three biggest traditional bookies, claiming that they are not concerned about the integrity of the markets, only protecting their profits. Betfair is also quick to point out that customers are required to create personal accounts and the company keeps records of each customer’s betting history. Compare that with Gala, Ladbrokes and William Hill who all accept anonymous cash bets. Betfair has information-sharing agreements with nearly 30 governing sports bodies, such as the Lawn Tennis Association and the British Horseracing Association, and has aided in several high-profile investigations into corruption and suspicious betting.

Since Betfair opened up shop in June 2000, it has grown into the largest online bookmaker in the United Kingdom and the biggest betting exchange in the world. The Hammersmith, London-based company claims to have over 3 million customers, taking more than £50 million in bets each week. More than 50% of customers are in the United Kingdom and Betfair has gambling licenses in Gibraltar, Malta, Italy and Tasmania. The company is launching a horse racing betting exchange in California in May 2012, but has never taken action from the United States in the past. As a result, Betfair was not hit as hard as peers were when the Unlawful Internet Gaming Enforcement Act (UIGEA) was snuck into the SAFE Port Act in the waning hours of the 2006 congressional session.

In March 2011, Betfair moved its online operations to Gibraltar to take advantage of lower taxes. Currently the UK Gambling Act of 2005 does not require operators to obtain licenses and pay taxes in Britain. As a result, most sites have chosen to operate and be headquartered offshore, taking away potential revenues. This is set to change. On July 14, the Department for Culture, Media & Sport (DCMS) announced that operators will now have to obtain a licence from the Gambling Commission to advertise and operate in the United Kingdom, which is the largest regulated poker market in the world. Martin Cruddace, Betfair’s Chief Legal and Regulatory Officer, called the announcement a “significant step forward”. He said that for years Betfair operated at a “considerable competitive disadvantage” to peers offshore before finally dropping its UK licence earlier this year.

Betfair’s biggest problem, however, is not where it is licensed or regulated. It is the restrictive shareholder agreements that it must abide by as a public company. For one, growth is limited geographically. While countries are beginning to warm to the legalisation of gambling (and its tax potential), there is less enthusiasm for sports betting and in particular betting exchanges, which are considered a haven for corruption and match-fixing. Betfair is bound by shareholder agreements to operate in markets where its betting exchanges are completely legal. This is not a long list and not one that is growing fast, either. As a result, Betfair cannot establish a presence in Asia, the biggest betting market in the world. Without access to the Asian market, Betfair cannot achieve the international expansion that it highlighted for future growth.

Betfair is also running into trouble with the latest raise in its premium charge. In September 2008, the company introduced a premium charge for gamblers whose winnings are out of line with the commission they pay. Betfair says some 500 gamblers have won £250,000 or more on its exchanges. This June, management announced that the premium charge is rising to 60% for some customers. Despite Betfair claiming this would only affect a small fraction of its customers (less than 0.5%), the announcement has caused outrage. According to an article published in The Guardian, the rise in the premium charge has significantly changed the company’s relationship with customers and that Betfair is no longer a neutral exchange “where winners are welcome”. Analysts are also worried. “We are concerned by the possible exchange liquidity impact of increasing commission charges for higher value customers,” says Geetanjali Sharma.

While management is looking to new products and platforms to provide growth, Betfair is unable to easily enter new markets or acquire companies (at least not with shares instead of cash) to provide new growth. The market restrictions facing Betfair are constricting, but going public was not easy for the company. In October 2005, then-Chief Executive Stephen Hill resigned when the board voted against floatation, with investors holding out for a higher valuation. Since finally going public, however, it has not gone as expected. A daring move that may save Betfair: repurchase not just £50 million in shares but all of them, taking the company private and removing the restrictive shareholder agreements that are preventing it from aggressively pursuing growth.  

Still the company is likely to remain public. For patient investors, Betfair shares may offer some value. The stock will more than double in value if it can return to its float price of £13. Though most remain negative or cautious, analysts who are bullish on the stock acknowledge the company’s problems, though claim they are already priced into the current share price. “We think all of the bad news is well understood, and see scope for out performance from here due to a low valuation,” says Morgan Stanley’s research analyst Vaughan Lewis. He says shares trade at 16 times projected earnings for 2012, though removing investments and cash, as well as adding the savings from the company’s move to Gibraltar, brings this multiple down to 11. “We forecast 36% compound EPS growth for the next four years, reaching 80 pence per share in 2015,” Lewis notes.

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