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Watchlist Wednesday: Tabcorp Holdings Limited (ASX:TAH)

Tabcorp Holdings Limited (ASX: TAH) is probably not a business that excites investors at first glance.

Its revenue hasn’t gone anywhere for two years. The business is facing increasing competition. And institutional investors are moving to companies with better ESG credentials.

Even if its share price has lagged the market, basically unmoved over five years.

So why add Tabcorp to your watchlist? It’s about to undergo a big change.

TAH share price

Source: Rask Media TAH 5-year share price
Source: Rask Media TAH 5-year share price

Chalk and cheese

Tabcorp operates two main divisions within the company.

The first is its sprawling gambling activities across Australia including owning “TAB” venues, digital wagering websites and apps.

This business has become highly competitive as digital disruptors like Sportsbet take market share.

The lesser-known, but much more exciting division is Lotteries.

Lotteries own the licenses to run public lotteries in every Australian state except Western Australia.

Notable brands include TattsLotto, Powerball and Keno.

It’s effectively a monopoly business, with no competition (unlike wagering).

Most of the revenue received from administering a lottery is returned to the respective state government, with Tabcorp keeping about 27% to pay for costs.

Fortunately, running a lottery does not require a lot of firepower.

In the last financial year, the Lotteries division earned 19% earnings before interest and tax (EBIT) margins.

It’s steady, predictable and will benefit from the shift to online, which will reduce the commissions paid to newsagents.

It’s not you, it’s me

After originally merging the Lotteries and wagering activities together in 2017, Tabcorp is now spinning off Lotteries into a stand-alone business.

Source: TAH FY21 presentation
Source: TAH FY21 presentation

The market will be able to value each division independent of one another.

Bidders have previously circled the wagering and gaming division, with two bids of $4 billion put on the table.

With a $10 billion market capitalisation, this infers a valuation of $6 billion for the Lotteries division.

At face value, Lotteries looks too cheap, given it did EBIT of $516 million in FY21.

Don’t forget this

The simple valuation above looks good in theory. But it relies on the market valuing wagering and gaming at a takeover premium.

Furthermore, the combined entity has $2.3 billion of net debt. If the spinoff saddles Lotteries with most of the borrowings, its valuation won’t look nearly as attractive.

It’s also worth noting that investors will receive shares in both entities. Selling could occur on either side, depressing respective share prices.

Final thoughts

Spinoffs can be a fruitful hunting ground for investors.

Lotteries is a wonderful business and one that looks optically undervalued within the combined entity.

With the demerger scheduled for the first half of 2022, today could be a great chance to get a slice of Lotteries before the crown notices.

If you enjoyed this Watchlist Wednesday, consider signing up for a free Rask account and accessing our full stock reports.

Alternatively, check out other editions on TyroTelstraAlliance Aviation, Audinate, Temple & Webster and Whispir.

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At the time of publishing, Lachlan does not have a financial or commercial interest in any of the companies or funds mentioned.
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