Stephen Bartholomeusz
Good will evaporates
The Victorian Government’s extraordinary $1.3 billion attempted heist of the shareholders’ funds of Tabcorp and Tatts Group is so brazen as to be breathtaking.
For 14 years Tabcorp shareholders have apparently been labouring under the misconception that, if their company failed to retain its gaming licence when it expired in 2012, they would be compensated.
They had good reason for that belief, given that it was printed in the Tabcorp prospectus when the company was privatised – when it was sold by the Victorian Government to private shareholders in 1994.
According to the prospectus, if Tabcorp didn’t retain its licence, it would be reimbursed its original licence fee (there is a complex formula that has inputs for its investment and inflation) or the price paid by the new purchaser of the licence, whichever was the lesser.
The provision for reimbursing the licence fee was designed to help maximise the proceeds. By promising to repay the $600 million (under the formula it is probably closer to $700 million), the Government effectively ensured that Tabcorp wouldn’t have to amortise the license over its 18-year life.
That was handy, because Tabcorp was forecast to earn only $63 million in 1994-95. Amortising the license would have wiped $33 million off its after-tax earnings each year (the amortisation charges were non-deductible) and reduced the float proceeds from about $675 million to about $300 million. For a cash-strapped government, maximising the float proceeds by giving the licence fee back in 2012 must have looked like a pretty good deal.
A similar deal was also negotiated with Tatts Group, which had initially been simply given its licence. It has $598 million at risk if the Brumby Government makes good on its threat not to pay compensation.
The Government is trying to do what it would condemn if it weren’t itself directly involved – trying to escape its obligations by relying on a technicality or loophole in the legislation.
There is no doubt what the original intent of the agreement between the Government and Tabcorp was. Arguing that under the new regime there either are no licences or, that if there are, the licenses have minimal value, is so disingenuous as to be offensive.
The Government may have "formed the view" that the companies aren’t entitled to compensation, but that view is, whatever the technical legalities – which Tabcorp and Tatts will have no choice but to challenge aggressively, given the size of the stakes involved – morally wrong.
Tatt’s Dick McIlwain, who stands to lose more than 40 per cent of his earnings and nearly a quarter of his shareholders’ funds if the Government’s "view" prevails, has described it as "an ambit claim". Tabcorp, which would lose a quarter of its earnings and 20 per cent of its shareholders’ funds, says it is reviewing all available options.
Because of the reimbursement clauses in their contracts with the government, both companies are carrying the value of the licences as goodwill in their accounts. They’ll now have to decide whether to write off that value at 30 June or over the remaining four years of the existing licences.
Their gearing and cost of borrowings will be affected by the Government’s stance, not to mention their share prices when trading resumes today.
The market has been blindsided – no one, including this Government, had foreshadowed that there would ever be an attempt to avoid the reimbursements. The Government, which has been reviewing the sector for several years, has had plenty of time to forewarn and inform the market.
The Government has destabilised two very substantial Australian – and Victorian – companies and may cost their shareholders, including many Victorians (as a consequence of the company’s histories), more than the $1.3 billion of licence fees.
The market had expected to the companies to either retain their licences – in which case it attributed value to the income they were expected to generate beyond 2012 – or to be able to generate income post-2012 by reinvesting the reimbursed amounts.
The Government’s agenda must be about more than just money, as it could have maximised the proceeds from the re-licensing by accepting bids from Tabcorp and Tatts that would have given it between $3 billion and $4 billion. It is improbable that the new structure will go even close to compensating the taxpayer for the value foregone.
The Government is entitled to create whatever industry structure it wants post 2012. It believes that a move towards an industry owned by pubs and clubs, when combined with a new tax system, will "create a level playing field" between large and small operators without undermining the Government’s $2.5 billion of gaming revenues. The venue-focused model is the same as those used in NSW and Queensland.
The costs that will be imposed on the venues as Tabcorp and Tatts withdraw, combined with the complexity of regulating a host of individual operators, will create inefficiencies and may mean that 20 cents in the dollar of gaming losses that has been flowing to Tabcorp and Tatts (the Government gets about 50 cents and the venue operators about 30 cents) may have to be directed to the venues rather than the Government.
Apparently the venues are going to have to bid directly for their entitlements. It will be interesting to see how that works and whether, if the economics for the venues are attractive, that ultimately leads to windfall profits as the operators sell out to corporate buyers seeking efficiencies through re-aggregation.
The NSW and Queensland experience doesn’t support the view that giving venues control of their machines lessens problem gambling – the venues care as much, and probably more, about their profits as any big corporate. The measures the Government will introduce to try to reduce problem gambling could have been imposed on any industry model.
Woolworths and Bruce Mathieson would appear winners from the proposed changes, given that an operator is allowed to own up to 35 per cent of the machines in the state. It isn’t, however, quite that straightforward.
A 35 per cent market share would give them a much higher revenue share, because of the size and location of their best venues relative to other operators. They would, however, already be over that ceiling. A big pub without pokies is a licence to lose money. They would be forced shedders of machineless and therefore devalued hotels – and may also face a higher tax rate than smaller competitors.
While briefing their QCs, Tabcorp and Tatts will use the next four years to milk every last cent they can from their franchises. Between them they spend more than $80 million a year on the infrastructure of their gaming businesses. They have already signalled they will spend as little as possible and start reducing their operating expenditures as well.
That suggests the industry will have to be totally re-equipped with new machines and systems, as well as operators, in 2012.