New Zealand Thoroughbred Racing has taken the first significant step towards the game changer it believes is required for industry sustainability with the release of a list of strategic priorities as well as an executive summary of the widely discussed but previously unsighted Deloitte Report.
The content of yesterday’s release to racing clubs and sector organisations of NZTR’s vision for the future – and more specifically the content of the Deloitte Report – runs counter to current NZ Racing Board strategic planning based on significant investment in an upgraded fixed odds betting platform combined with a customer and channel strategy.
The Deloitte Report was commissioned by NZTR to review NZRB strategies aimed at improving the racing industry’s financial performance, and the risks of that strategy. Central to that was a belief that a better option to major investment by the NZRB would be a partnering arrangement with an offshore betting provider, taking advantage of such an organisation’s own major investment in required technologies as well as its far greater scale.
At the NZRB’s 2016-17 annual general meeting in November, questions were raised as to the relevance of the Deloitte Report – which at the time was still in the hands of NZTR – only for NZRB Chair Glenda Hughes and CEO John Allen to summarily dismiss its veracity.
At that point the NZRB, basing its strategy to a large degree on work commissioned by KPMG, had already signed off on a FOB platform deal with offshore providers, committing to what the Deloitte Report estimates to be in the range of $59 million and $72 million. The essential fault that the Deloitte Report identifies in this investment strategy is whether it will achieve the predicted return to the industry – or worse.
“Our analysis indicates the success of the NZRB initiatives are dependent on very significant changes in terms of both the number of people betting, how they bet and how much,” state Deloitte. “We question whether sufficient allowance has been made for offsetting effects and, in particular, the impact on tote betting of an acceleration in the move to fixed-odds betting and the increased competition and margin pressure that could be expected in a market dominated by this form of betting.
“The KPMG stress testing does not appear to have tested the sensitivity of prospective distributions against a material ongoing decline in tote turnover and increases in operating costs. For this reason, we developed a high level financial model to estimate the impact on profitability of these scenarios.
“Using plausible assumptions, based on current trends and industry knowledge, financial scenarios can be constructed which show financial results that are cumulatively between $49 million and $135 million lower over the FY18 to FY21 period than currently assumed.”
As well as highlighting the migration of betting from pari-mutuel to fixed odds, Deloitte also point to headwinds such as Anti-Money Laundering obligations and the impact of Australian legislation blocking access to the New Zealand TAB. Another crucial element identified by Deloitte is the NZRB’s inability to contain costs.
“Our analysis shows NZRB has struggled to contain fixed and variable costs and, as a consequence, revenue growth has not translated into an enhanced bottom line. Further, it appears that on both a trend basis and in absolute percentage terms, the cost structure of NZRB is high relative to its peers.
“This is not a reflection on NZRB management but simply a function of a lack of scale. The lack of scale means it is unlikely NZRB will be able to achieve a sustainable competitive advantage against international wagering competitors.
“Based on our experience of the benefits achieved with industry consolidation in other settings and our analysis of the NZRB current cost structure, we are of the view material cost synergies would be achievable if a more substantive outsourcing or similar initiative were to be pursued with an appropriate party. Our initial assessment is that gross annual benefits could be in the vicinity of $63 million.”
The New Zealand racing industry’s lack of scale is seen as fundamental to the risk being taken by current NZRB strategies. “They do not address the two most critical issues faced by the industry being its lack of scale and cost inefficiency,” say Deloitte. “Internationally, a need to overcome diseconomies caused by a lack of scale has been a major driver for industry consolidation.
“Scale creates the capacity that enables the investment needed to innovate in response to changing market expectations and to respond to increasing regulatory challenges. The NZRB historic level of investment appears very low relative to its peers, which suggests that in addition to responding to these future challenges there may well be a requirement for additional catch-up investment.”
The Deloitte Report executive summary projects a firm view of the benefits of an alternative strategy. “Our preliminary analysis suggests the combined benefits from an appropriately structured transaction could increase distributions to the codes by $38 million to $63 million annually. The difference between the mid-point of our downside scenarios under the NZRB initiatives and the mid-point of our assessed benefits under an outsourced arrangement is in the vicinity of $280 million over the FY18 to FY21 period.
“While our analysis is only indicative and based on assumptions, these assumptions have been formulated by practitioners and analysts directly involved in facilitating similar transactions in an Australian racing setting.
“We recognise there are risks associated with the pursuit of a more substantial restructuring of the industry. There are significant issues that would need to be negotiated successfully by the NZRB to ensure a fair share of benefits were achieved. However, in our view these risks are manageable and do not outweigh the benefits of the industry exploring such an option.
“Furthermore, the benefits of a substantial restructure are not mutually exclusive from other strategic priorities, indeed all options should be considered rapidly and contemporaneously. Clearly, it is only when a formal proposition is on the table that all the risks and benefits can be fully evaluated.
“While we acknowledge an outsourcing transaction, as contemplated in this paper, would be a challenging transaction to execute, there is potentially over NZ$1 billion in value to share between NZRB and the outsourcing provider. Accordingly, we would advocate that it is in the best interests of the racing industry and NZRB to commit to spending a small amount of time and money to conduct further investigations on the opportunity.
“To this end NZRB should hold preliminary high level discussions with the outsourcing provider to see if there is a possibility of executing a high level in principal term sheet.”
*A full account of the Deloitte Report and associated issues, penned by Brain de Lore, will be published in this week's edition of The Informant.