Betfair’s share price is up more than 10% in three weeks and 5% in the last two days, following their announcement of Q2 figures on Monday morning that showed 22% year-on-year growth. This much is well known, and plenty of analysts have put out notes in the couple of days since the publication of numbers. I will not, therefore, go into any depth about them: there is plenty of information in the public domain from people who are significantly more knowledgeable about today’s business than I am. I’ve written before about why I think the shares are a buy, since when they are up 50%. But for those who have asked for my view, I have one thought to offer about why I think that they still remain a buy at this level. It comes with the usual caveats: I have no line into the business (indeed, I have not spoken to a single person in the company for months); and I am a shareholder and therefore will be seen by some to be talking my own book. But to be clear: this is not investment advice. It is just my view, for what that’s worth. You could argue it is the reason why I am a shareholder, long after I might have decided it was time to move on.
When people looked at Q2’s 22% revenue growth, a number of analysts were keen to stress that 9% of it was the result of favourable sporting results leading to strong sportsbook margins. The clear implication was that this cannot be expected every quarter, and that therefore investors should really only consider the 13% that remained.
This is a traditional, not to say tried-and-tested, approach which on the face of it makes a lot of sense. Indeed, history supports it with every other bookmaker out there.
But here’s the thing: despite what people say about it having moved its business model and sold out, the reality is that Betfair still isn’t the same as every other bookmaker out there. And despite what people say about liquidity on the exchange being much poorer than it was (and in some places, it is; but in actual fact, as a whole, volumes have tripled in the last three years), the exchange is not dead. And in my view, these two things are very important, at least in relation to the topic at hand.
Sportsbook margins are determined not just by sporting results, but by risk management around those sporting results. And Betfair has, built-in, the best risk-management system that anyone could possibly have. Indeed, by finally linking the sportsbook to the exchange, in the way that was first mooted (but which we failed to deliver) back in 2005, Betfair now have a platform which should allow them to take the best of both worlds, and move the margin north for good.
The downside of the exchange was always that it delivered a low-margin product even to people who were not price sensitive. This is one fundamental reason why other bookmaking operators did not simply move towards an exchange model with its keener pricing, the moment that the technology was available. If 10% of your customers are very price sensitive and 90% are not, then to offer everyone out there a product with a 2-3% commercial margin when you could charge a 10% commercial margin and still be best price simply doesn’t make commercial sense. But this, for years, is what Betfair has done, because the low-margin exchange was the only product it had.
The downside of the sportsbook, in turn, was that, first, it exposes you to risk to the outcome of the event (which leads to you cutting back the bet size of your shrewder punters – or sometimes not even the shrewder ones, but ones on a winning streak), and second that (as a result) it is harder to deliver keener pricing to those who are conscious of the margin on every bet. In short, it is not as easy to engender loyalty in your customers: you piss them off either because you charge them too much or because you won’t stand their size.
A combination of the two genuinely means the best of both worlds. But more importantly, it means that you can manage the risk on your sportsbook, if you so choose, much more effectively. You offer prices based on the due diligence on your customers, like everyone else out there; but if you are asked for a price by someone whose success rate is likely to damage your commercial margin, you can manage the risk of his or her bet without having to knock it back.
The result of this should be obvious: the customer experience is better; the margin on the occasional punter can be maintained at a level which makes better sense. When you add to this clever little gizmos like Price Rush, which I would guess do wonders for both acquisition and retention, the opportunity to become the destination of choice for punters at both ends of the spectrum is dramatically increased.
Back in 2000, when we launched Betfair, a lot of people shared our view that we had built a better machine. In some respects, we were right, because what we created was the best risk-management system out there; but in fact we had only built half of it. For various reasons, we failed to deliver the other half, and the company went through a difficult period. But that second half has now been built, and the whole – it seems to me – is now purring very effectively.
Some will argue that the current price reflects that: it is double what it was at the lows, and many will say that it has run its course. But, far from approaching the highs, it has still not quite gone past the level at which the company came to market – which it did at a time when Paddy Power was worth about a third what it is today – and there is now good reason to believe that the company genuinely can reach the sort of heights in the betting hierarchy to which its 2010 IPO positioning aspired. For all that some people today rubbish its flotation pricing, those that bought the story then did so because they thought Betfair was a lean, mean, fun company that had built a better machine than anyone else’s. There are lots of reasons to believe that today, at an offer price just lower than it was back then, that is exactly what it is.