Five questions William Hill needs to answer

William Hill and Ladbrokes kicked-off reporting season last week but for once it was the blue team that was facing up to some tough questions. An online operating profit drop of 37% was explicable in the face of unprecedented cost pressures but a group-wide profit warning for the full-year saw its share price drop to a three-year low.

With three mega-mergers pending from its online rivals it couldn’t have come at a worse time. And while this is not a business in crisis – it remains a fundamentally strong operation that leads the sector in a number of areas – there are a number of issues raised by its recent performance it will need to address in the next six to 12 months.

1. Are they big enough?

The announcement of the Paddy Power Betfair merger would have caused shockwaves at William Hill. Not only will it place Hills as second place in terms of UK market share it will also displace its position as the largest listed sportsbook operator. But does any of this matter?

Arguably Hills is already big enough to effectively compete with Paddy Power Betfair. The benefits of scale are already evident at Hills with its ability to launch in a number of international markets, invest heavily in technology and continue to spend phone book numbers on marketing.

Hills executives, as you might expect, are believed to have had preliminary conversations with a number of operators over potential M&A deals, but to date the firm has been an interested spectator rather than a player in consolidation. Its attempt to acquire 888 last year fell at the first hurdle but it would be no surprise to see talks revived following 888’s aborted bwin.party takeover.

The issue for Hills will be making an acquisition large enough to move the needle. This is after all one of the largest online gambling businesses in the world with an EBITDA, even at the lower end of consensus, in excess of most other listed operators. And it feels like any acquisition or merger would need to be hugely strategically compelling or very easy to integrate to avoid being a costly distraction at this time.

2. Are they spending enough?

One of the big questions regarding the introduction of PoC in the UK was what effect it would have on marketing spend, with many analysts predicting it would fall and many executives conversely lining-up to say they had no intention of doing so.

But the 11% drop in marketing spend at Hills during Q3 seems at odds with a top-tier of the industry that pledged to carry on spending to gain market share from smaller operators who couldn’t absorb the short-term loss. Instead it seems the firm has taken a slight backwards step, with affiliates the hardest hit, although this may be a temporary measure prior to the wider rollout of Project Trafalgar.

Investors will be hoping it is, because it’s a simple truism in online gambling that often the more you (smartly) spend the more you earn. Hills’ in-house Vegas casino product showed huge growth in the tail-end of 2014 on the back of a major TV campaign and is still feeling the benefit from this investment with 19% growth in Q3.

It would be wrong to draw a direct line comparison between 11% marketing spend decline and a 9% fall in sportsbook revenue, but in a market flooded with pricing offers and TV ads it would be remiss to ignore it. The firm’s CEO James Henderson said its new front-end rollout, Project Trafalgar, was a distraction in the period and Q4 results and the attendant marketing spend will be watched closely.

3. Is there now too much in-house reliance?

William Hill’s digital revival under Ralph Topping is often unfairly attributed solely to the influence of Playtech, but in truth it was far more the combination of digital marketing expertise with Hills’ existing strengths that made the difference. But since then the firm has been moving swiftly to re-take control of its own destiny and identity.

Within gaming there has been a stark shift in focus from its Playtech-powered Casino brand to its in-house Vegas brand and it has spent over two years moving to an in-house responsive front-end platform. There is consensus in the industry that this type of in-house, differentiated product will be a key driver of customer loyalty and revenue growth but it brings with it its own difficulties.

The relaunch of its iOS app on Trafalgar was met with a barrage of one-star reviews on the App Store and a host of reported issues. It’s hardly atypical for a major relaunch to meet with substantial customer resistance, but the nature of the complaints related to front-end issues which were meant to be the core strength of the Trafalgar project.

These are likely to just be teething issues, and we should wait until the end of Q4 to draw any conclusions about its impact. Taking control of its own front-end is undoubtedly a positive and Hills has the scale and the investment to cope with becoming its own technology supplier, but it needs to ensure it doesn’t become a distraction to its core marketing, trading and operational strengths.

4. Can it compete internationally?

There is no doubting Hills’ prowess in the UK market. Its success is one of the reasons its rivals are hurtling towards mega-mergers at a rate of knots and it remains the operator to beat for domestic dominance. But away from home its results have so far been less spectacular.

Despite big investment in Australia through the acquisition of Tom Waterhouse and Sportingbet the firm has yet to firmly establish itself in one of the world’s most important sports betting markets. An Australian operating profit fall of 91% is partly explained by significant changes to its operating model there, but it will need to quickly return to growth if its strategy is to be proved correct.

In Europe prospects look more promising with double-digit growth in both Spain and Italy during the period, but both countries still face major headwinds and are unlikely to be hugely profitable in the near-term. On the back of this Hills reported a drop in non-core revenues during the period.

With such a broad, and growing, international portfolio and declining revenues from grey markets it faces a tough battle to make its international expansion profitable. But this is an industry-wide issue and Hills seems as well placed as any UK-focused operator to make it work with continued growth in Italy vital for the next few quarters.

5. How quickly can it bounce back?

The big question is to what extent this is a temporary blip or whether there are bigger structural issues at play. The answer to this won’t likely be known for several months as Hills is still in a period of significant transformation within its digital business.

What is clear is the firm retains some huge strengths, not least in its executive team, differentiated product and an extremely strong brand proposition. The competition is stronger than ever and Hills has recognised this and moved early to be ahead of the game in a number of areas such as technology, international and CRM.

It may be paying a short-term price for doing too much in the face of increased external cost pressures but it would be a brave man that bets against it returning to top and bottom line growth in the short-to-mid-term.