Gaming sector: Maintain underweight: Over the weekend, our industry sources informed us that the three NFOs (Berjaya Sports Toto, Magnum and Tanjong) will lobby to the Ministry of Finance to reduce the 4D first prize payout by RM200 to RM2,300 (4D Big) and RM3,300 (4D Small). This will reduce the 4D theoretical prize payout ratio by two percentage points (ppt). We understand that no proposals were made to reduce the prize payout of other games.

Obviously, the proposal is meant to preserve margins in the wake of their June 30 announcement that effective June 1, 2010, the pool betting duty would be raised by 2ppt to 8%. Some 75% of BToto’s sales are derived from 4D. Therefore, the reduction in its theoretical prize payout ratio is 1.5% (2% times 75%). As for Tanjong, where more than 95% of Da Ma Cai’s sales are derived from 4D, the reduction in its theoretical prize payout ratio is near the full 2%.

The 4D first prize payout reduction by RM200 will raise our BToto earnings estimates by 10% and Tanjong earnings estimates by 5% on a full-year basis. This mirrors the 11% reduction in BToto earnings estimates and 5% reduction in Tanjong’s earnings estimates during our July 2 sector downgrade in tandem with the pool betting duty increase of 2ppt. Also, our discounted cash flow-based target price for BToto will be raised to RM4.84 from RM4.39 and for Tanjong to RM18.73 from RM17.66 (assuming no change in revenue growth assumption).

As explained in our July 2 report, empirical evidence suggests that revenues will contract due to competition from illegal  operators which offer higher

prize payouts. Recall that the NFO industry contracted by 2% CAGR every year from 1999, after the NFO reduced the 4D first prize payout by RM200 to RM2,000 (4D Big) and RM3,000 (4D Small) in response to the November 1998 pool betting duty increase from 7% to 10%, until 2003 after the December 2002 pool betting duty was reduced to 6%.

Our source points out that lotto games will mitigate the impact illegal operators will have on the NFO industry. Illegal operators do not offer lotto games. That said, we observe that punters appear to be jaded with lotto games with lotto revenues per draw stalling.

Traditionally, lotto revenues per draw grow in tandem with jackpot sizes. We maintain our BToto and Tanjong earnings estimates for now pending confirmation of this news, and underweight stance on the gaming sector. — ECM Libra Investment Research