This week: ASX v Wall Street
FYTD: ASX v Wall Street
One of many anomalies we witnessed last financial year was the divergence in performance between companies based on their size (market capitalisation).
As inflation woes hit and commodity prices soared, we saw the larger end of town hold firm (well, relatively speaking), partly due to the strong dividends they delivered.
Meanwhile, many of the pricier names at the smaller end of town, those that promised to grow into their prices, deflated.
Many smaller companies have been left in the dust (some, rightly so). Yet, amongst the wreckage, there are a handful of names that we think retain strong prospects for growth and are now on sale.
These are companies that we see as having the potential to grow into large businesses several times their current size. In some cases, we feel investors are now paying little for these growth opportunities.
One of these companies is PointsBet (ASX: PBH), a company we have followed for several years. The recent sell off gave us an opportunity to establish a position at what we see as an attractive price. (Please note: this position has not been purchased for clients with gaming/gambling prohibitions.)
Sports betting: out of the shadows, into the mainstream
On the 14th of May 2018 the United States Supreme Court repealed the Professional and Amateur Sports Protection Act (PAPSA).
What was PAPSA? Put simply, another eccentricity of the US legal system: a blanket ban on sports wagering that applied to all states in America (except Nevada, Oregon, Montana, and Delaware).
With its repeal, a veritable Cambrian explosion has ensued. Sports betting has emerged out of the shadows and into the mainstream.
Individual states may now legislate to allow sports betting, with over 30 states having done so (and several more expected to). In tow, bookmakers have sprung up across the country, looking to plant their flag on what we conservatively estimate is a $10bn market.
With bookies only allowed to operate intra state, a state-by-state war is being waged for market share.
Enter PointsBet: a successful sport betting franchise in Australia that has looked to take its unique wagering offer to the North American market.
We expect that the competitive landscape will consolidate much like it has in Australia, providing a backstop to what we see as a strong opportunity for growth.
Who are Pointsbet?
PointsBet Australia first launched in February of 2017.
It vaulted itself into what is a consolidated Australian betting market, dominated by locally grown TAB and two large multinationals: Flutter (Sportsbet, Betfair) and GVC (Ladbrokes).
From here it has grown to hold an approximate 5% share of the Australian sports betting market (by Net Win in 2021), in a relatively short period of time.
The company’s US wagering operations were launched in July of 2018, first in New Jersey. Here, PointsBet has gone on to win 2.6% market share (based on bets placed in the March-22 quarter), despite considerably more muscle carried by larger listed rivals such as DraftKings and Fanduel (Flutter).
PointsBet’s strategy centres around two key elements: targeted marketing and product differentiation.
The low hanging marketing fruit in wagering, of course, is promotional activity through offering customers free or bonus bets. This can be a slippery slope, particularly if only a small proportion of these customers are retained.
What has impressed us, is that PointsBet’s marketing is conducted in-house and has a multichannel, targeted focus, beyond the low hanging fruit of “free bets”. Essentially, PointsBet has looked to acquire customers cheaper, and retain them through a superior customer experience/product offering.
The company’s product differentiation centres around its technology platform. Unlike many of its rivals, PointsBet has developed its own cloud-based, proprietary betting platform. In practical terms this has meant punters have access to better real time, in-game wagering/odds and are able to access to a huge number of evolving markets (types of bets).
What has also been a key differentiator for PointsBet is its expertise in spread betting markets. This is where a bettor wins or loses money depending on the margin by which an outcome varies from the spread of outcomes quoted by bookmaker.
Anecdotally, spread betting (or points betting) is one of the most popular forms of sports betting in the US. We feel this means PointsBet’s offer translates well as sports betting moves into the mainstream.
The illustration below explains the concept more clearly:
An attractive entry point
After the announcement of its strategic partnership with NBC (mid 2020) we saw PointsBet’s share price catapulted to multiples of its current level.
However, competition in the sector is high and the sums spent on marketing have been elevated of late (particularly when new states are opened – we expect marketing expenses to ease). This has led to a fall in PointsBet’s share price and those of its peers to what we see as more reasonable levels.
Current prices provide an attractive entry point for a small position. We feel sufficient value has been built to provide a level of downside protection
This is based on our estimates of future cash flows under a number of scenarios. Furthermore, at lower prices PointsBet is no doubt attractive to an acquirer, with rumours of NewsCorp already having made an offer for its Australian business.
As we have seen in the Australian wagering market, over time the allure of synergies (marketing and alike) are likely to lead to a consolidation of players in the space.
On the other hand, the potential upside, we assess, remains large.
This is given the potential size of the market, which itself could prove to be multiples of our estimates and what we see as PointsBet’s unique proposition to customers.
Even a modest share of this market (single to low double digits) presents upside that is multiples of clients’ entry price.
We catch up on some Company News this week, after a lull in company activity towards the end of the financial year.
Clients may have noticed their position in Cardno is looking a lot smaller – for the right reasons.
On Wednesday Cardno began trading ex-capital return and ex-dividend.
As a reminder, the stock, which previously traded at around $1.60 per share, will return $1.92 per share in cash to clients, after the sale of its International Division.
This return will consist of a $1.70 per share dividend (unfranked) and a $0.24 per share capital return and is expected on the 14th of July.
A small residual position remains (circa 0.1% of Australian Equity sub-portfolios), which the market is currently valuing at or around $0.27.
We suspect this consists of $5m cash that remains in the vehicle (circa $0.12), the value of the runoff businesses that remain and the value of the vehicle itself.
The return of proceeds puts a cherry on what has been a great outcome for holders of Cardno over the past year.
This week we exited clients’ position in Endeavour in full.
Clients will remember the position arose out of Woolworths spinning of its hotels, drinks and gaming businesses mid last year. We took the opportunity, shortly after the demerger, to add to the position.
Overall, Endeavour has been an incredibly successful position returning more than 47% since that time (in the context of a market that fell by more than 6%).
However, it is now trading far above our long-term valuation, which we suspect is partly due to a flocking towards the Consumer Staples sector, given current economic uncertainty.
Added to this, we see that there are several areas of uncertainty that we feel are not currently discounted.
This includes whether consumer preferences seen during COVID, which produced eye-watering results for the group (liquor sales and gaming revenue), will be maintained and whether it will be able to achieve acquisitive growth given meteoric prices paid at auctions for hotels with gaming licenses.
BWX greeted us in a disappointing fashion last week. The company has downgraded its expectations for earnings for a second time this year. In doing so, it has sought to raise capital to firm up its balance sheet.
Management pointed towards a reliance on sales in late June, a historical practice in the business. While several explanations were given, ultimately what it signals is that inventory levels are high throughout its various distribution channels.
This tells us little, as there could be various reasons for this (for instance, challenges in managing inventories given rapidly changing consumer habits as we came out of lockdown).
Rather, our focus has remained on whether underlying consumer demand continues to be strong for BWX’s products. Our channel checks thus far indicate BWX’s brands continue to resonate with consumers and health/beauty buyers at a wholesale level.
In hindsight, our timing in entering the stock could have been better. And while it doesn’t bring us much comfort, we clearly weren’t the only ones, with Twiggy Forest’s Tattarang taking a large stake shortly before the announcement.
While BWX is a small position in portfolios, we still see upside if a successful turnaround instituted, and suspect we will be adding to the position in the near term.
Our position in Jervois was established on the basis of volatility. That is, given the concentration of cobalt production and supply, price shocks may be experienced in the future to the upside.
This expectation was realised as the Russia-Ukraine conflict began, with approximately 4% of Cobalt supply going offline. This saw prices rise from $25 per pound at the time of our investment to $37 per pound.
We took the opportunity to exit our position as the market began to extrapolate these prices, leading to Jervois trading at a level above our long-term price target.
While small, the position delivered a strong return of 81% in FY-22 (in a challenging market).
We have been sceptical of the ability of Pushpay to penetrate the Catholic market in the US (our models factor in little upside from this).
However, this week the company delivered an announcement which was encouraging, it has added the Archdiocese of Seattle as a customer.
Growth in this area is encouraging and provides material upside to our long-run valuation, which already implies strong returns.