Why Paddy Power Betfair’s share price drop is good news for believers

The reason I haven’t written my blog for more than a year is that I was trying to put plenty of distance between my last post about gambling and returning to the fold on other subjects, so it might seem perverse that I am back writing about a gambling company. But you know what they say: you can take the man out of Betfair, but…

So I thought I would just briefly pen some thoughts on the dramatic collapse in the PPB share price last week. I know that whenever I write about that subject, some people accuse me of talking my own book, and I stress, as always, that this is just my view. I barely know a soul at the company any more, and I have no great insight, so ignore it or treat it with scepticism if you want. (Although I notice, for what it’s worth, that the people who responded to my previous posts on why Betfair shares were a buy by adding a load of vitriol to either my Twitter feed or my blog post have conveniently deleted what they wrote. Apparently my suggestion last time they fell 10% that it represented a good buying opportunity wasn’t quite so daft after all.)

Anyway… The shares, which have a high since the merger of £107, closed on Friday night at £83.75, down from £96.90 at the start of the week. The reasons for this seemed unclear to me, so I have done a bit of digging around to try to find out what is going on, and what I’ve found suggests to me that the price movement is bordering on absurd. That is not to make any judgement on the absolute value of the shares as such; rather, it is to talk in relative terms: if they were right at £96 at the start of the week, then they were wrong at £83 by the end of it.

Two things happened last week to cause the price fall. The first was a research note from Credit Suisse that questioned the value proposition of the merger and suggested that scale isn’t everything. It’s a point of view, I suppose, but it seems a very odd time to be expressing it, and it is based, from what I can see, on the fact that SkyBet doesn’t have scale and SkyBet is doing particularly well thank you very much. What is fails to mention is that SkyBet is clearly in an exceptional position: they have outstanding brand recognition; they are punching the lights on out execution (and good on them for that); and they have benefitted from links to what was their parent company.

You might not buy my counter-case. You might also not share my view that it is a fundamentally flawed approach to look at the top three companies in the market and make a judgment on the value of scale, because doing so assumes that they work in harmony with each other when it is abundantly clear that they don’t. Even if you were in that camp, I’d be fascinated to hear your reasons for thinking that such a piece of research justifies the stock falling to 3% below where even this bear case maintains it should be. In short, if the Credit Suisse note is the reason for the sell-off, it looks significantly overdone.

It seems, though, that there is another reason, which I think is worth further analysis. That reason is a concern among some about the potential impact of the EU’s 4th Anti-Money Laundering Directive, and specifically, comments that I gather were made about it last week at an investor breakfast hosted by the analyst at Investec. By SkyBet, as it happens.

The comments in question were that SkyBet had trialled the part in the directive about getting the appropriate documentation from customers who were betting more than €2000 – a trial that, I gather, led to a drop in revenues of 5%. I don’t know the full details, but I gather that they went on to say that if that was the impact on them, then the impact on PPB would be greater. And everyone, it seems, panicked.

Now, I’m a long time out of this game, and it may be that PPB’s AML processes have weakened considerably from the days when PPB was just BET. But I doubt it very much, and suspect, in fact, that the opposite is the case. And given that I know that the 4th AML directive was not a topic of the least concern to the AML team when I was around, I’d be mighty surprised if it suddenly was now – particularly given that it is just about the only team left at PPB which is run by the same person I worked with back in 2010 (which, it probably goes without saying, is at least in part because he is bloody good at what he does). I haven’t talked to him, I should stress, but I do know what he thought then and I would be extremely surprised if he were any the less confident now, even taking into account the fact that the combined company has a High Street presence.

For those short on sleep, I have copied the relevant parts of the 4th AML directive below. The key point you need to know, though, is that unless (as I say) something has changed for the worse, PPB already do all of the requirements in it, demanding verification of source of funds or wealth when customers hit various specific triggers. Equally – again unless a lot has changed (although it would seem to me that if it has, it will be the other way – towards smaller players, not larger ones) – the 4th AMLD would affect a very small percentage of the company’s customer base. Meanwhile, in addition to both those points, it will be entirely up to the Treasury here in the UK as to how they interpret the 4th AMLD, and PPB (should they have any concerns, which I doubt) will at least have discussions about that before anything happens. My previous involvement in those types of discussions mean I find it very hard to believe that the 4th AMLD should be of any real concern.

So the long and the short of all this is that last week the shares fell 15% on the basis of a fairly weak analyst report and some comments from a competitor CEO at a breakfast. The comments in question were him taking a wild guess about another company’s AML procedures on the basis (it seems fair to assume from their trial’s impact) that his own company appears to be playing catch-up, and in my view are entirely without foundation. They also fail to take into account the fact that there will need to be interpretation of the directive by our own government, such that the current format with which PPB already fully complies is as tough as it is going to get. As I said, bordering on the absurd.

All of which you can ignore completely if you wish, or indeed rubbish to your heart’s content. I’m not really bothered. To be absolutely clear, yes, I am still a shareholder in PPB, and so yes, I have an interest in the price being buoyant. But I’m a long-term holder of my remaining stock, so I haven’t written this because of that: I’m writing it because I get asked by people what has happened to the price, and what I think of it. And the answer on this occasion is that having looked into the reasons for it, I think the move makes no sense whatsoever and will be corrected. So if, like me, you believe the absolute story of the business, you will, like me, think that this 15% fall represents a good opportunity to get in.

(And that, honest, is my last post on gambling. But at some point soon, I will come back and write about other stuff. If you give a monkey’s about my views on anything else. Which you probably don’t.)

Article 11 references who and when Customer Due Diligence (CDD) is a requirement. It says:

Member States shall ensure that obliged entities apply customer due diligence measures in the following circumstances:

(d) for providers of gambling services, upon the collection of winnings, the wagering of a stake, or both, when carrying out transactions amounting to EUR 2 000 or more, whether the transaction is carried out in a single operation or in several operations which appear to be linked;

Article 13 references Customer Due Diligence and states:

Customer due diligence measures shall comprise: (a) identifying the customer and verifying the customer’s identity on the basis of documents, data or information obtained from a reliable and independent source.

It goes on to say under sub paragraph (d) that source of funds should be the subject of scrutiny where necessary. It falls under the ongoing monitoring process, and I would imagine is questioned when risk thresholds are met, rather than as a matter of course.

(d) conducting ongoing monitoring of the business relationship including scrutiny of transactions undertaken throughout the course of that relationship to ensure that the transactions being conducted are consistent with the obliged entity’s knowledge of the customer, the business and risk profile, including where necessary the source of funds and ensuring that the documents, data or information held are kept up-to-date.

The only reference where this is specifically referenced as mandatory action is under Article 20 which relates to Politically Exposed Persons. Not many of them are big gamblers, to my knowledge. But for what it is worth, here is what it says:

With respect to transactions or business relationships with politically exposed persons, Member States shall, in addition to the customer due diligence measures laid down in Article 13, require obliged entities to: (a) have in place appropriate risk management systems, including risk-based procedures, to determine whether the customer or the beneficial owner of the customer is a politically exposed person; (b) apply the following measures in cases of business relationships with politically exposed persons: (i) obtain senior management approval for establishing or continuing business relationships with such persons; (ii) take adequate measures to establish the source of wealth and source of funds that are involved in business relationships or transactions with such persons; (iii) conduct enhanced, ongoing monitoring of those business relationships.