Ladbrokes shares jump 15 as it confirms pursuit of Coral

Ladbrokes shares marked their best day in 10 years less than half an hour into Tuesday trading after the bookmaker confirmed it was in talks with privately-owned rival Gala Coral.

Shares of Ladbrokes, the largest retail bookmaking chain in the world, had galloped more than 15% higher at the time of writing on the news that it aimed to combine with Coral to increase scale and create synergy savings.

The talks, which were at a relatively early stage, with no guarantee of a deal, could create a combined firm with about 4,000 betting shops, enabling Ladbrokes to close the gap with its best-capitalised UK rival William Hill Plc.

Shares of the latter traded more than 1% higher, getting a moderate tailwind from its peer.

Ladbrokes has been under pressure in the UK as per its onshore rivals, from tighter regulations hand in hand with increasing taxes in Britain.

These factors have fuelled deal-making in the sector as players seek the benefits of scale, to offset the erosion of profits due to increasing competition from Internet-based rivals, like Betfair Plc., which are free from many of the regulatory restrictions facing bricks-and-mortar firms.

The situation for Ladbrokes is just as pressing, considering its profit-after tax is currently forecast by consensus to collapse by 43% in the full-year ending in December 2015.

It comes after profits were eroded by 6.2% year before, and after another dump of about 40% between 2012 and 2013, which Ladbrokes partly put down to much lower than originally expected earnings from its e-gaming division.

The firm has felt the full heat of risks related to lower margins, a disruptive transition to digital, poor attention to user interface details and marketing, inherent in starting from scratch online.

Like its betting shop rivals, Ladbrokes is pitted against the much smaller, nimbler digital players that have proliferated during the last decade.

Gala Coral could be valued at more than £1.6bn, judging by filings from private equity investors Candover Investments, Cinven and Permira which bought the firm in 2003 for about £1.24bn.

It would probably bring to the table a number of low-margin but steady revenue-generating bingo clubs, but more promisingly, it also operates around 1800 betting shops, and perhaps most interestingly, a number of well-established digital properties.

Should the two parties reach agreement to combine their businesses, Ladbrokes said it would “undertake a non-pre-emptive equity placing to strengthen the balance sheet of the combined entity”.

The firm’s stated option to fund its intended acquisition might represent some risk to LAD’s current share price—the stock has still yet to recover about 7% of its fall since June 2014 year-to-date, and zooming out even further, the loss since the heady days of 2007 has been closer to 70%.

That potential concern was clearly not front-and-centre of investor minds at the time of writing though, as the shares touched gains above 15%, keeping the stock the best performing FTSE 250 mid-cap, in terms of its rise and volume traded on the day.

However, before a prior leap by Ladbrokes’ stock this summer, on 7th May—which formed a gap of some 6.4% before the 3% void created by Tuesday’s opening rush— the shares had struggled to escape the magnetism of all-time lows between 100p and 110p.

The Election Day jump coincided with news that Ladbrokes’ chairman was departing after five years in that role, suggesting that shareholders had tired of faltering attempts by the bookmaker’s management team to successfully re-orientate it to a rapidly evolving sector which threatened to leave LAD and its Luddite bookie rivals behind.

This inherently raises execution risk for any merger plan by a notch, in my view.

A swift conclusion of the talks could neutralise much of that risk, but with the parties having been bounced into going public about their discussions after they were revealed by a horse racing industry website, the chances of them coming to a quick agreement don’t seem odds-on.

Whilst momentum could currently favour the upside for up to a couple of weeks more, a lack of further material news about this deal in the near term would surely lead investors to wind back the large bets on Ladbrokes seen since April.