Tattersall’s is an entertainment business that has primarily owned lotteries licenses in Australia for many decades, writes Jarod Dawson, Portfolio Manager of the PM Capital Enhanced Yield Fund.
Lottery licenses tend to be very long dated. As businesses, lotteries typically generate fairly stable, dependable cashflows for their owners. There are very few licenses available, so they tend to be highly coveted. In particular, licenses such as some of those owned by Tattersall’s where the relevant government attaches guarantees that a competing license will not be issued within a certain jurisdiction, are particularly coveted. We would argue that in many cases, lottery licenses exhibit certain monopolistic attributes.
Over the years Tattersall’s had successfully positioned itself as the go-to operator in Australia when state governments have made licenses available to private operators, with a long and reputable track record of delivering in this industry. This reputation is critical when bidding for a license, and then ultimately running a lotteries business.
Given the complementary interests between lottery licenses and other gaming and wagering offerings, it was only a matter of time before Tattersall’s looked to merge with another powerhouse - Tabcorp. After much speculation over the years, this came to fruition at the end of 2017 and has now created a prized lotteries, gaming and wagering business with significant scale benefits.
The investment opportunity
In 2012, Tattersall’s issued a 7 year senior unsecured bond and listed it on the ASX. It was originally issued at a yield of 3 month Bills + 3.10% which to us seemed an extraordinary yield for a business of this quality. But alas, this was only a few years after the GFC, where most if not all yield securities had been significantly repriced, and was thus a sign of the times. We have often found that, when markets are at their most unpredictable, there are often very good business that get thrown out with the bathwater, so to speak.
When we looked closely at the Tattersall’s bond, a number of things stood out to us:
- The yield of 3 month Bills + 3.10% seemed almost like the market was pricing the bond as a hybrid security closer to the bottom of the capital structure, rather than the top!
- We believed at the time, and still do, that the business was comfortably of investment grade quality, but was being priced as though it was not.
- The margin of 3.10% above cash was above that of issuers we considered to be its peers in the industry. Indeed some of those peers we considered to be lesser quality businesses.
Our analysis at the time in part led us to the overall conclusion that the fact that Standard & Poor’s and Moody’s were no longer willing to assign credit ratings to yield securities listed on the ASX significantly reduced the universe of potential buyers for the bond, thus forcing up its yield and partly creating this dynamic.
Put another way, something that was completely unrelated to the fundamentals of the investment was having a significant impact on its yield. This is the sort of market anomaly that we are constantly looking for at PM Capital.
PM Capital investment philosophy
When we are looking for new investments for the Enhanced Yield Fund, it doesn’t get much better than the Tattersall’s opportunity. It has been one of the largest investments in the Fund for some time, and we have added to the position numerous times since we made our first investment. Interestingly, the anomaly in the yield has been maintained to varying degrees over the years (adjusted for the reduced time to maturity) which highlights the importance of making your own disciplined and diligent assessment of a company’s true value, rather than relying on someone else’s opinion – such as a credit rating.
Whenever we get an opportunity to invest in a market leader within an industry, which is well run and is backed by assets that are widely desirable – whether they be hard assets or high quality long term licenses - we get excited.
We get even more excited when the debt securities of that business are trading at anomalous yields for reasons unrelated to the company’s fundamentals.
At PM Capital we deliberately keep our investment mandate flexible, so that when we locate one of these global anomalies we are able to take advantage of it, and are not constrained by arbitrary portfolio allocations which hinder returns, and often force investors to look at investments that they may not otherwise consider.
In this instance, it has allowed us to earn around a 30% total return for us and our co-investors, on a very good quality investment. You don’t get a chance to do that every day!
This article reflects opinions as at the time of writing and may change. PM Capital may now or in the future deal in any security mentioned. It is not investment advice.