Another step backwards for the gaming sector

Gaming sector
Downgrade to underweight (from neutral): In the same week that plans to introduce sports betting were aborted, all three number forecast operators (NFOs) — Berjaya Sports Toto, Magnum and Tanjong — announced that they received a letter dated June 29, 2010, from the Ministry of Finance informing them that effective June 1, 2010, the pool betting duty has been increased to 8% of net revenue (gross revenues less 8% gaming tax) from 6% previously.

The last time the pool betting duty saw an increase was in November 1998 at the height of the Asian financial crisis (from 7% to 10%). In December 2002, it was decreased to 6%.

One way to preserve margins is to lower the prize payout ratios. Recall that in April 1999, the NFOs reduced the first prize on 4D Big and 4D Small by RM200 each to RM2,000 and RM3,000 respectively, in response to the November 1998 pool betting duty increase.

The end result was that the NFO industry contracted every year until 2003 after the December 2002 pool betting duty was reduced owing to competition from illegal operators. Taking a leaf from history, the option of lowering the prize payout ratios may not be pursued this time. Perusing the NFO websites, the prize payouts have not changed yet.

The alternative is to absorb the increase and suffer margin compression to maintain revenue growth. Of the two companies with NFO businesses under our coverage, Tanjong is the least affected as only 20% of its earnings are derived from the NFO business.

On a full-year basis, we trim our Tanjong earnings estimates by 5% and discounted cash flow (DCF)-based target price by 5% to RM17.66. We downgrade Tanjong from buy to hold.

Pure NFO Berjaya Sports Toto (BST) will be the worst hit. On a full-year basis, we trim our BST earnings estimates by 11% and DCF-based target price by 11% to RM4.39.

We also downgrade BST from buy to hold. Coupled with our concurrent downgrades on the larger capitalised Genting and Genting Malaysia, we downgrade our stance on the gaming sector from neutral to underweight.

We do not discount the possibility of more tax or duty increases at the 2011 Budget in October. — ECM Libra Investment Research, July 2


Written by Financial Daily
This article appeared in The Edge Financial Daily, July 5, 2010.