Paddy Power's CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug.28.13 | About: PADDY POWER (PDYPF)

Paddy Power Plc (OTC:PDYPF) Q2 2013 Earnings Conference Call August 28, 2013 4:00 AM ET

Executives

Patrick Kennedy - CEO

Cormac McCarthy - CFO

Andy McCue - Head of Retail, UK & Ireland

Peter O'Donovan - MD, Paddy Power Online

Analysts

Tom Holmes - Investec

David Jennings - Davy Research

Ivor Jones - Numis

Richard Stuber - Nomura

Victoria Greer - JPMorgan

Vaughan Lewis - Morgan Stanley

Ed Birkin - Credit Suisse

James Ainley - Citigroup

Operator

Good day ladies and gentlemen. Welcome to your Paddy Power Interim Results Conference Call. My name is Grant, and I am your event manager. During today's presentation, your lines will remain on listen-only. (Operator Instructions). There will be a question-and-answer session on today's conference. (Operator Instructions). I would like to advise all parties at today's conference is being recorded for replay purposes.

Now, I would like to hand the call over to Patrick Kennedy.

Patrick Kennedy

Good morning ladies and gentlemen. You are very welcome to the Paddy Power 2013 interim results presentation. I am joined on the table here by Peter O'Donovan, the Managing Director of Paddy Power Online; Andy McCue, our Head of Retail; Cormac McCarthy, our Chief Financial Officer; and Jack Massey, our Director of Finance and Company Secretary.

This has been a very good first half for Paddy Power; net revenue was up by 22%, with revenue growth in every division and a standout growth of 29% in our Online division, which accounted in the period for slightly in excess of 75% of our operating profits. Australia was a particular highlight, with a 30% uplift in operating profits.

Paddy Power operates in substantial regulated fast growing markets, in each of those markets, we look to develop and we look to sustain an edge. We are building scale for long term benefits, investing heavily in people, in product, in value and in brand. We invest in [different] payback in existing markets, and at the same time we invest in pioneering initiatives for the markets of tomorrow, and on that team of pioneering initiatives for the markets of tomorrow, as you know, over the last number of years, we have built an industry leading position in Mobile sports betting, in the UK, in Ireland, in Australia, and in the last 12 months, we have extended that leadership position, both into Mobile sports betting in Italy, and Mobile EGaming in the United Kingdom and Ireland.

Meanwhile, our retail businesses are also very well positioned and performing strongly. We opened a record 26 new shops in the period, and we saw a welcome return to topline growth in our Irish retail business.

Financially, the earnings per share in the first half were up by 13%. Our interim dividend was up by 15%. While sports growth in the first eight weeks of the second half of the year have been in favor of The Hunter, turnover has been very good with 25% growth in Online and 4% like-for-like in retail, and the prospects for the Group are as strong as ever.

Today's presentation is about our trading in the first six months of the year. It's also about our insights into the markets in which we operate, and our investment strategy that is delivering leadership positions and returns in those markets.

So let me pass now to Cormac to talk through the financial and operation performance for the first half, and I will come back on strategy and outlook. Cormac?

Cormac McCarthy

Thanks Patrick. Good morning everybody. Thanks for joining us today. As Patrick has said, the first half of 2013 has gone very well. Stakes were over €3 billion, and drove very strong revenue growth, up 22%. Sportsbook revenue increased by 24% and gaming machine growth came to a very pleasing 17%.

The first half last year, as you know, included stakes from Euro 2012 of approximately €70 million and revenue of €6 million associated with that. So if we adjust for this, revenue growth in the first half was an equivalent 24%.

It's probably worthwhile at this point of taking a look at gross win percentages in the Group, and give some color on those. The overall Group gross win percentage was up significantly to around 10%, and this was in line -- [booked] in line with our current outlook for a normal gross win percentage, following structural improvements in the expected gross win in all of our divisions. So if you look at retail, for example, we are benefitting from the growing popularity of virtual, more small stakes betting and more football multiples and coupons.

In Online, we benefit from the increasing shift to Mobile (inaudible) and a more mass market and attractive business mix with our strong risk management capabilities coming through.

While overall Group gross win percentage in the half was normal, there was some offset between our divisions given their different business mixes. For example, Online, excluding Australia, benefitted disproportionately from the strong football sports results we saw in first quarter, and retail was hit disproportionately by adverse racing results, particularly in (inaudible).

Turning to our tax rates of 13%, it's the same as it was in the first half of 2012, and our interim dividend at €0.45 per share is up 15% on last year. This dividend growth is ahead of EPS growth of 13%. It's worth noting that if we allow for the half-on-half impact of our Italian investment, product fees in Australia, and [MDG] in UK Retail, the growth in our operating profit would have come to 24%.

Slide 6 just gives a brief summary of the divisional performance; net revenue growth in all divisions, which translates into double digit operating profit growth in total and growth in all divisions, with the exception of the Irish Retail given adverse sports results; and what I will do is I will go through each division in turn now.

Firstly, looking at Online, excluding Australia, very good half year. The first half did have the benefits of European Soccer Championships, as I said earlier, with stakes growth of 14% was very strong and gross win grew more strongly for the reasons I mentioned already.

Active customers, up 20% to almost 1.2 million in the first half of the year. Almost two-thirds of our Sportsbook customers in Online were using Mobile in June of this year. In addition, the EGaming Mobile growth was particularly strong, up 253% year-on-year, helped by our proprietary games content developed by Cayetano in Bulgaria. We will return to the theme of Mobile later on in the morning.

Italy continued to progress well, which has boosted our year-on-year divisional top line growth. At the bottom line, Italy had an operating loss of €9.6 million. If we exclude Italy, our Online division operating profit grew by 25% and our margin expanded by 2% to 33%.

Turning to Australia, on slide 8, our Australian business is having a standout year. Growing net revenue and operating profit by 33% and 30% respectively in constant currency, and this performance was notwithstanding, increasing competition in the markets, and the 2 million half-on-half headwind from new product fees.

Online turnover in Australia grew by 25% and net revenue by 34%. Telephone activity has also returned to strong growth, because of the popularity of our betting in-play product, stakes and telephone were up 33% and net revenue up 15% in constant currency.

Mobile turnover in Australia doubled to €274 million or 35% of Online stakes, with 65% of our Online customers transacting with us via Mobile in June; and again, Mobile is -- similar themes in both Europe and in Australia. Online active customers increased by 35% and new actives by 14%.

Turning to UK Retail, like-for-like Sportsbook turnover was up 2% and revenue was boosted by a return to a more normal gross win percentage. Despite the new machine gaming, due to tax regime being a drag on profit of almost €1 million, operating profit grew to €7.8 million. Like-for-like net revenue grew 3% comprising a decline in machine gaming revenue of 8%, offset by Sportsbook net revenue growth of 14%.

The decline in like-for-like machine gaming revenue was both a result of increased competition and a generally weak market, particularly as we said before in London; and also, because of our investment in our new loyalty program and new terminal trials. The market is not going to be any less competitive, as we go further, but we do expect that our loyalty program and new terminal rollout and other initiatives we are taking in this area to improve our gaming performance in the second half.

We opened 19 new shops in the period at an average cost of 270,000 sterling, with exactly the same expectation of making about at least 100,000 pounds of EBITDA from these openings of maturity, which is around an average two years. This is consistent with our expectation for new openings in prior years, and we expect to open at least 40 shops in the UK this year.

Irish retail profits decreased by €1.4 million in the period to €7.6 million, driven mainly as I said before, by adverse sports results, particularly in (inaudible). Our shops in Ireland have never been busier, with a 13% increase in like-for-like bet volumes to €34 million, driven by more betting as I said earlier on virtuals, and increased betting on sports, including coupons, again.

We opened seven new shops in Ireland, while our competitors closed about 40 units, and outperforming our competitors at the per shop level and in terms of the state expansion, we have seen our market share in Ireland rise to 38% in retail in the period, compared to 35% last year.

Phone business is the market leader in the combined Ireland and UK markets, and grew operating profit by 9%. Net volumes in our phone business have grown by 128% since 2007, and we do see this is an important part of our overall offer, which will continue to make a positive contribution to the Group and to our customers.

I'd like to give some color on our operating cost dynamics, and you will see this in the slide as it travels from left to right. Our sector is seeing significant marketing inflation, as you can see 40% marketing, maybe 11 to 12 above the line, but our unique approach in Paddy Power and our brand strength, particularly through market leading offers and our use of social media had a very powerful impact. Patrick will talk about that later on in more detail.

I believe the marketing leaders (inaudible), we are seeing significant cash reinflation. So TV is a set, for example. For those, we'd require capability, investments in technology, display and social media, we are experiencing much less inflation.

Our retail business continued to be incredibly disciplined, with like-for-like direct shop OpEx growth of only 2% in the UK and 1% in Ireland. Although, we haven't covered it on the slide, it's worth noting that in Australia, where we still continue to invest heavily, Australian [COGS] growth of 30% was less than net revenue growth of 33%.

In Online, when we exclude Italy, operating costs in constant currency grew by 28% in the period, compared with growth of 30% in the same period last year, and this is despite the fact that we continue to roll out new markets and products, further investing in our technology stack, and you know, we have to support increasing multiple platforms across multiple geographies.

As you can see on the right of the slide in terms of the slowing of year-on-year operating cost growth, we are making real tangible progress in scaling our business, and as we have said before, scale is critical in this business, given the amount of change that is going on and the investment it requires.

So Group operating costs grew by 24% in constant currency in the half, and again, notwithstanding headwinds from marketing inflation, the demand of additional channels of investments were successfully slowing the overall pace of cost growth in the Group.

The next slide is a normal one we show on operating cost growth buildout and [outreach], and we give this detail to be helpful. The main cost increases are associated primarily with supporting future Online growth, new shops and markets. Referring to my earlier comments, if we even adjust for the year 2012, spend on marketing grew by around 20%, which was less than revenue growth of 24%.

Looking at cash flow on the next slide, our operating cash flow generation has exceeded after tax profit for each of the last five years and this period is no exception to that. We use the bulk of this cash to open jobs, improve products and technology and pay dividends, and it is worth [noting] that our dividend per share has grown by 19% compound in the last five years.

At the end of the half, we have, as indicated on the slide; we have €214 million in cash on our balance sheets, which includes €58 million of customer balances, and we continue to believe that our cash balances are worth holding on to the present, to give us flexibility for investments.

Looking at the regulatory environment, it's certainly keeping us busy, and in the UK, we expect point of consumption taxes will come in from December 2014, at a rate of 15%. If we have this tax in place at that rate, it will support growth [on the new gaming] net revenue it would have increased our tax payable by €20 million in the period. Now as we know, opportunities will exist to mitigate the growth impact of this tax to lower revenue share, marketing cost, and potentially and importantly, to market share gains from legal operators, who might have to exit the market or compromise their offer.

In Ireland in July, the government published an updated betting amendment bill. This will allow the expected expansion of our extension of the 1% tax in Irish retail stakes to Online and telephone, Sportsbook for bets taken from customers in Ireland, and such tax would cost €3.5 million in the period, if it would have been enforced.

The Australian government published a final report of its review of the 2001 Interactive Gambling Act in March of this year, and following this, the Australian government announced that it wouldn't pursue the recommendation to lift the ban on In-Play betting Online. Separately, after government intervention, the broadcast industry adopted a code in June restricting the advertising for betting around live TV sports coverage, what you might call, the (inaudible) effect.

In Italy, the Palinsesto Supplementare will significantly increase sports betting markets in Italy, and Patrick will talk about that later on. And in other markets, our business development teams are continuing to be monitoring legal and other developments to find new opportunities. So plenty keeping us busy in the tax, regulatory and also other environments.

Final slide for me, is to just talk about current trading. We are about eight weeks into the second half of the year, and turnover has been very strong in both Online and retail. Online stakes are up 25% and retail like-for-like up 4% all in constant currency. Results so far this year, as Patrick said, have been very much in the company's favor, and this has resulted in gross win being about €15 million less than we would have expected, before we make any allowance for cost of sales or recycling.

(Inaudible) recently, if it continues, it would also reduce operating profit by about €4 million in 2013 compared to where we would have seen it in May, and obviously for a larger amount in the full year, again compared to where we would have seen it in May. Despite this, we are on track for low to mid double digits operating profit growth this year in constant currency, and we feel very good about the prospects for this business.

I will now hand it back to Patrick. Thank you.

Patrick Kennedy

Thanks Cormac. So, I just want to talk about strategy and outlook, and let me start on page 18 with the Group strategy. The Group strategy is consistent, and nothing changed. Let me just remind you of the key components. We identify attractive markets. We built a strong position there. We invest on an ongoing basis, in products, in value, in brand and in people to ensure we execute well, and we invest for the long term, to grow our scale, and that has generated strong payback in our existing markets, and also given us the capability to enter new markets.

And that's how we think about the Group, and we certainly think about the individual businesses within Paddy Power, so let me talk about how those individual businesses are positioned within that strategy.

Starting with our largest individual business in the United Kingdom, our Online business in the United Kingdom; if you look at the overall gambling spend, Online and offline in the United Kingdom, this is very heavily correlated to consumer spending growth, and has been for many years. The Online proportion of that total gambling spend has grown and will grow substantially in excess of the total, as evidenced by the 38% growth in regular betters in the last two years, as you can see on the chart here.

The reason for Online disproportionately growing is -- and you know these reasons, but to reiterate, the new consumers are disproportionately Online consumers. More retail customers are also becoming multi-channel. On that theme of multi-channel, as you know, we do a lot of work in this area. We estimate that 5% of retail over-the-counter gross win every year migrates [either] retail into Online, and Online growth would also be supported by device rollouts. 85% of Mobile phones now sold in United Kingdom are smartphones and we see tablets as the next big opportunity. There were less than 10 million tablet users last year in the United Kingdom, by 2015, that figure will have grown to 20 million. In that attractive market, we build standout divisions and we overindex in the hotspot of growth.

Online is three-quarters of the Group profitability. Within Online, we have built market leading positions in Mobile in tomorrow's markets. Almost two-thirds of our Online Sportsbook customers now transact with us via Mobile and 45% of our H1 Online revenues came from Mobile, that's more than double the rate of our quoted competitors, with good leadership, as you can see on the page here on the right, in both sports and EGaming.

On the theme of hotspots, a third party research indicates that because of our e-commerce expertise, and because of the strength of our brand the loyalty of our customer base, we have an Online kicker in the areas where we have shops, that's more than double the kicker that competitive shops deliver.

So strong positions in attractive markets, and on page 20, you can see how we are investing heavily to enhance those positions in product, in value, in brand, in people, I've grabbed some examples, there were many of them in the first six months of the year.

On the left hand side, you can see that we have a very rich Mobile product roadmap, a new release every month. The principal focus of those releases this year have been on TV and on content. For example, we significantly increased the number of Mobile games we offer in the first half, and we grew the Mobile games we offer from 28 at the very start of the year to 68 by the end of June. We received our first Mobile games in the period from our in-house games development unit in Bulgaria, and Cayetano accounted for 14 of the 40 new games -- new Mobile games we launched in the first six months.

Mobile gaming is interesting. Gaining share wallet of customers with a Mobile or a tablet preference, that penetration is lower than with customers who have a desktop preference, because the screen size, in particular in Mobile, will be always a challenge, but that penetration is growing year-on-year and helps fund new product releases.

Moving to the right hand side of the page, as you know, our Money Back Specials, are a mile more generous and a mile more creative than the competition, and our brand continues to pull away from the competition. For example, our odds and offers on the election of the new Pope, coupled with our presence in Saint Peter's Square, generated over 8,000 articles worldwide, reaching over 170 countries, and in my view, our marketing team [owned the] chatter around The Royal Baby, the betting chatter at least, with over 80 TV interviews and over 1,900 global TV hits.

So we invest heavily in great positions in growing markets, and we get strong payback from that as on page 21. Our UK Online active customer base has grown on average by over 40% per annum over the last four years. Our average revenue per customer has grown, despite big growth into the mass markets in UK in that period, just to contextualize that growth into the mass markets, we have grown from just over 200,000 active customers to almost 1 million active customers in that period; and when you couple strong growth into the mass market, with growth in revenue per active, you get what you see on the page here, especially in the middle chart, very strong net revenue growth, averaging 43% per annum over the last four years.

So that's the United Kingdom; strong payback from strong investments, in great positions, in great markets. If I move to our second biggest Online market in Australia, the themes are exactly the same. The Australian Online sports betting market is growing well, it's growing consistently, it has more than doubled in the last five years. It's already larger than retail, and given the faster dynamics, it will become the dominant channel for betting in Australia over the next decade.

The fundamentals are robust, Australia has the highest tablet penetration in the world and the second highest smartphone penetration in the world; and our telephone activities in Australia are growing well from betting in-running, which is not allowed Online, as Cormac mentioned earlier.

So an attractive market, and then on the right hand side, you can see how we built, I think a very strong position of leadership. We are ahead of the other corporate bookmakers at every stage of the operating funnel, as a percentage of Online betters who are aware of our brand, who visit our website, who open an account, and who has made an account in Sportsbet.

And as elsewhere, our approach to driving growth is the same; significant investments in people, in products, in value and in brand. We have some examples here, there are many others that could have been brought on the page. For example, we developed new mathematical models for MRL and AFL in the period. As the graphic shows, we now offer 700 more AFL betting markets than our nearest competitor, and I like the class of the world's largest ever painted sign there on the right hand side. (Inaudible) and it greeted The Lions and their supporters as they landed at Melbourne airport, for the second test and was the hot topic in the Australian media at the time.

And we get payback from that strong investment, on page 24; we built out into great position over the last four years in Australia, with average annual growth in the excess of 30% annually in active customers, revenue, and profits. And that has been supported by our increasing investment since we bought out our partners in Australia two and a half years ago, and the general investment strategy that we espouse across the Group and in each of our individual markets, I think Australia is a great example of how that works, and has worked for (inaudible).

And to put some context on the momentum in our Australian business today, our turnover growth rate in Australia in the first half was the fastest top line growth rate that we have achieved since we first invested in Australia in 2009; so despite [all big numbers], the momentum here is stronger than it ever has been.

Moving to Italy, as we have said in the past, Italy is the largest gambling market in Europe, and the Online Sportsbook and Online casino markets, where we have a presence is growing strongly. I have captured here in the top left corner, the latest published figures for the markets, for quarter one, which showed 49% year-on-year growth in the market.

As elsewhere, there are structural fundamentals supporting this growth. Overall e-commerce growth rate in Italy are the highest in Western Europe. It has the second highest penetration of tablets in the world, behind Australia, and given the relative size of the retail markets, having 1% of migration from retail to Online, will grow Online by in excess of 10%.

Cormac alluded to the Palinsesto Supplementare that's being introduced this month, it will result in a significant increase in the range of betting markets that can be offered in Italy, so it will grow the markets, but also I think it will allow Paddy Power to differentiate, and bring some of the key capabilities that we have proven in the UK and Ireland in betting in-running at the Italian markets.

We will increase the number of live tennis and live football matches that we offer markets on by eightfold to tenfold. We have completed testing, and we are ready to go. We will be amongst the first group of operators to go live, and we will then support that advantage with the national TV advertising campaign.

Since we launched in Italy just over a year ago, we have had as you can see in the middle of the slide, a very heavy product delivery schedule, there is more to come. Success in EGaming initially is a crucial part of our business model, and has been a big focus for recent product rollouts as you can see, and the prospective product rollout with Bingo, poker, and our tablet optimized casino to come in the next 12 months, as well as Mobile streaming and virtual products.

The vision we had for Italy, which was of a disruptive innovative, engaging, Online-only brand is working and our market share has grown consistently since launch. You can see there on the top right corner, we estimate that our Online Sportsbook market share was in excess of 90% in each of the last three months.

As in other markets, we have built positions of leadership in Mobile and in social, let's talk about Mobile for a moment. Mobile accounted for 40% of our Sportsbook stake in June in Italy, and that compared to an estimated industry average of up to 20%, and we therefore believe that we have close to 20% of the Italian Mobile sports betting market.

Turning from Online to retail; the same themes apply. I think retail is a very attractive market. It is very substantial, very resilient and it can be grown, as we have done so by ongoing product innovation such as virtual products and self-service betting terminals. Retail produces, as you can see on the deck, on the slide here, excellent returns on capital. Over 50% on our portfolio of openings over the last four years. Multi-channel product offering has significant potential. One in two regular Online gamblers still visit betting shops every month.

Then if you look at the strong position we've built in these attractive markets, I think our retail positions in both Ireland and the UK stands out. Our customers, as you can see on the slide here, rate us more highly than customers of all other leading brands, in both the UK and in Ireland, and we are increasing our share in both markets, and we have a lot more to go, particularly in the United Kingdom.

We are investing heavily to enhance our position in the number of new shops and also in the quality of our shops. We now have shops in over 90 towns and cities in the United Kingdom. Our new shops this year have included our first in Newcastle and our first in Wales, in Swansea, and we opened -- with another one to follow in Cardiff, in October.

We are investing heavily to enhance our position. We would be the first (inaudible) operator to try the new inspired Eclipse cabinet, it's fully touch-screen effective like a tablet, and we have an option to roll that cabinet out to our fuller stage by the end of this year. Other shop enhancements include improved screens, in-shop fit-outs, privacy screens and new loyalty scheme for our (inaudible) offering.

With that investments in attractive markets behind, while I think our great position is delivering strong payback. We have shown the payback here, and some examples of this, in both UK and in Ireland in page 28. In the UK, that outperformance versus the competition is increasing. We now have double the turnover per shop, versus the average shop of our quoted competitors, and a strong consistent track record of profit growth.

Our Irish business also has good growth prospects. For the last six years, we have been telling you that our shops have never been easier. Cormac repeated that point earlier on. When you aggregate the last six years of increased activity, you see that despite economic backdrop, as we've captured here, we have increased our net volumes in our Irish shops by 63%. The overall top line in that period has been held back by declining average stake per bet, principally due to the economic backdrop, but we have seen that stabilize recently, as you can see here with 2% like-for-like turnover growth in the first half of the year, and we now have 38% of the Irish retail market.

I'd like to spend a few minutes on social media, because we are aiming to build the very same position of leadership in social media that we have built in Mobile over the last three years. It's a very attractive market as you know, and now every man over the age of 18 on Facebook in the UK is connected to at least one Paddy Power fan. So we now have the capacity to target those 15 million then through a friend of theirs, and we also have strong reach through friends and fans in both Australia, and indeed already in Italy.

If you aggregate the two charts in the middle here, we now have over 1.7 million Facebook fans and Twitter followers. That's more than double the level of our nearest international industry competitor. We also have much more engaging content. This is not just another channel to hard sell a message. It's said that selling it in Google, like selling in a department store; but selling on Facebook, is like going to sell at a drinks party. So you need your fans to be much more engaged, and I think that's a key point of distinction for Paddy Power.

And do we get payback from this? I think we get it in many ways, and I quote some of them out in page 30. Half of our fans in the UK are Paddy Power Online customers, and that contributes to our industry leading marketing efficiency. Online marketing spend, as you can see here, represents 20% of Online revenues for Paddy Power, as compared to an average of 29% for our major UK competitors.

And a strong social media presence has also contributed to the continued strong, I'd like to think, inexorable growth in our spontaneous brand awareness in the UK. I also think it will contribute to the success of Paddy Power In-Play, the first real money sports betting product in the world on Facebook, which we are beta launching this week. Developed in-house, here in Dublin in part, and in Bulgaria. The app will drive -- will add rather, social engagements to Online betting, will enable customers to bet on a wide variety of sporting events to Facebook, whilst also giving them visibility of and the opportunity to engage with other users.

For operators who get this right, the Facebook platform of course is a huge opportunity. Wanted to add, just put some context on that, every month Americans alone spend over 100,000 collective man years on Facebook, for better or for worse. We see it as an acquisition channel for the brand. We could target to fans of other betting brands for example, and we also see it as a means of growing our share of wallet of our existing Online customers.

And so to conclude, this industry is still very early. Mobile will account for 90% of industry growth over the next six years, and is changing how customers interact with our sector, and Paddy Power is at the leading edge of this. Social may well do likewise, and Paddy Power is at the leading edge of that also. The geographic diversification of our Online activities into Australia and into Italy is working well, and therefore the prospects for our overall Online division in the UK, in Ireland, in Australia and in Italy, which account for three quarters of Group profits are very good.

In retail, we continue to capture market share and achieve strong returns from new shop openings and indeed provide a disproportionate ticker for our Online business. And so, all in all, we look forward to the balance of 2013 and beyond with confidence.

Ladies and gentlemen, that concludes the formal presentation, and thus we would now be very happy to take questions. It's a full room here, and there are people on the line, we have a microphone here in the room and I think we will start with any questions that there may be in the room. So if you can just put your hand up, and we will get a microphone to you and go from there.

Question-and-Answer Session

Unidentified Analyst

Good morning. Gavin Gallagher from (inaudible). Just firstly on Italy, can you give a figure for the actual investment and loss that you expect in the current year, and how that might trend into FY 2014? Are we still expecting to reach breakeven, that's firstly on Italy? And then, on Australia, very strong underlying performance in Australia, has there been any signs of weakness more recently due to consumer, and maybe, just give us a bit of color on where gross win margins can get to in Australia, maybe in the full year and next year? And on retail, for Andy, in terms of machines and obviously page one, a bit disappointing, new cabinet coming on-stream. Do you see an improvement in H2, or do you see a like-for-like improvement, or do we have to wait into FY 2014 to see a like-for-like improvement in machines?

Patrick Kennedy

Okay, thanks Gavin. Cormac, do you want to deal with the investment losses in Italy, breakeven trajectory and the gross win margins in Australia?

Cormac McCarthy

So we said that the loss in Italy in the first half was €9.6 million. We expect that loss to be for the year around €15 million to €16 million, which is approximately as we said before about two-thirds of what last year was. And going into next year, not giving you a number, but our expectation holds as we said before, which is that we expect Italy to breakeven next year. We said that when we launched, and we are holding to that. So breakeven, sometime next year.

And on Australian margins, sportsbook gross win margin in the half was 9.5% or about 9.1% from the same period last year. We expect that to trend 9.5% to 10%, because we are getting structure improvements as we are offering more and more markets to risk management, and also, we got the benefit of what we said earlier, about betting in-running coming through on the phone. So that tends to be a richer margin multiples as well, with more fixed odds betting coming through in our business in Australia as well, and that tends to get better margin. Over the last number of years, the Australian margin has improved relatively steadily over time, and we see that progression continuing. So guidance is around the 9.5% to 10%, and you asked the question about recent weakness in the business is very strong in Australia and continues to be so. So as Patrick said, the momentum gets better.

Patrick Kennedy

Thanks Cormac. Andy, retail?

Andy McCue

Yeah, in terms of outlook of the machines, (inaudible) Gavin. So first of all, we have been trialing alternative machines in the marketplace through the course of this year. That had some inevitable disruption effect on the performance through the course of this year. That trial will unwind to the end of September, so inevitably, we'd expect to see some uptick in the performance trend when that unwinds. When the new machine is introduced, there is some potential that has some adoption impacts as well, and so it's reasonably uncertain. But we are very confident, we are going to be connecting the best machine in the marketplace.

Then, we continue to refine our loyalty scheme. So over time, we have collected a lot of data, we have been refining that data, built in-house a number of CRM models, and through that, we continue to optimize that return through that loyalty scheme and the efficacy of our marketing improves through the course of the year as well. So we expect to see some continuing benefit from that. And then also, we kind of -- we (inaudible) what we describe are some of the one-off effects of the competition catching up. So the competition has caught up, and what we describe are some hygiene factors. So for a number of years, for two years, we had extended opening hours in our shops, taking (inaudible) the evening. The competition has caught on to that last 12 months and for seven years, we have had a maximum density of machines per shop and again, the competition has obviously been catching up on that front over the last 12 months. So that reset the base going forward as well, in terms of growth.

Unidentified Analyst

Thanks.

Patrick Kennedy

Any other questions in the room? Yes.

Tom Holmes - Investec

Good morning guys. Tom Holmes from Investec. Just touching on Italy, I know your market share is up strongly in the last few months. How competitive are you finding that market, and what you see is the reasonable medium term targets in terms of market share there? And also, could you just give us an update on your licensing activities in the U.S., and whether you are more or less positive on the prospects on entering into that markets than you were, say six to 12 months ago?

Patrick Kennedy

Peter, do you want to talk about Italy?

Peter O'Donovan

Sure yeah. On the competitiveness point, it is obviously a competitive market, both in terms of the incumbent operators that are there, and also some of the newer entrants like ourselves [are] really new. We have gone in with the value offering that comes with Sportsbook, so we go in with very competitive pricing around value driven offers that are in pricing, are in our Money Back Specials, etcetera.

In terms of market share, we are not giving guidance on what our market share is going to get to. We are very focused on continuing to grow and we continue to grow quite strongly for the last three months, we have averaged about 9%. I think interestingly, we feel that our Mobile market share is nearly double that, and if we look in similar themes in UK, Mobile being the tomorrow's markets, again, where we make our Mobile leadership position that we have in the UK into Italy, is something that is also going to help us drive share ultimately.

Patrick Kennedy

I think in relation to the United States, Tom, and specifically New Jersey, because of New Jersey, this is as you know, a state by state issue, and New Jersey is in the vanguard, and we don't have any more -- we have a (inaudible) license, as people are aware. We have don't have any update on it, and the regulator has been given obviously substantial flexibility by legislation, and we don't know as yet, who will be allowed to play. We don't know as yet what the cost base for operators will be, in other words, what resource needs to be specifically in New Jersey as opposed to elsewhere and can be shared, and this would be substantially a Poker market, so we don't know how liquidity will form, and will be allowed to form in the Poker market. So there are still too many unknowns for us to be very specific about which way the ball will bounce and we continue to work closely there.

David Jennings - Davy Research

Good morning. David Jennings from Davy. I had just one question. I was wondering if you could give us an update in terms of your thinking, regarding a post point of consumption competitive environment? Specifically, you mentioned the scope for mitigation. I am just wondering, how you balance the need to protect near term earnings and improving long term returns, as weaker competitors essentially [enter] the market?

Patrick Kennedy

I think, we are very focused at one level on point of consumption and at another level, we are building our business for the next 10 years, and so -- and Cormac used a phrase earlier on, there are easy levers to pull, and I think some operators in the market are pulling easy levers and this television media is a big part of that. I think what Paddy Power does, is try handling best across the piece, and aggregating multiple advantages across, what we'd like to think is smart investment across products, across technology, across people.

So I think that what will happen post POC is -- is structurally the market will continue to grow for the reasons we have pointed out. I think that the market's concentration will increase and has been increasing in any case, but I think, that POC would accelerate that, and I think what we are doing is, as you can see from the presentation, we are just trying to position ourselves to grow our share and to be one of the top winners and performers in that market in both sports betting and EGaming, and I think the dynamics of those two sectors are somewhat different. There is greater concentration of sportsbook. There is greater fragmentation, relatively speaking, in EGaming, and therefore, there may be greater fall out there, and we, as I say, in both are continuing to position ourselves to be the winners.

Okay, if there aren't any other questions in the room, we now go to the telephones, and hand over to the operator on the phones.

Operator

Thank you. (Operator Instructions). Our first audio question on the phone line comes from the line of Ivor Jones from Numis. Please go ahead, you are live on the call.

Ivor Jones - Numis

Good morning. It's Ivor Jones from Numis. I wonder if you could talk a bit more about what's going to happen to costs, may be whether point of consumption tax that you were talking about, that's going to be an inflection point for costs overall. But I was looking at slides 12 and 13, and you show 500 more heads in headcount over a couple of year period, and slide 13, marketing, the driver of the business that you talked about a lot in the presentation, was sort of flat year-over-year and now on a high base. But then €16 million more of costs on stuff that I would have thought, wouldn't have required more cost, more betting markets and events, new racing and football pages, new gaming content fields like stuff; existing headcount would have been delivering.

So you talked a lot about where revenue is going to come from, can you just talk about what the trajectory of costs is going to be? You make a point that cost growth is down to 24%, but excluding marketing changes, when is cost growth going to be zero? Thanks.

Patrick Kennedy

Cormac, do you want to answer that?

Cormac McCarthy

Yes, good morning Ivor. Thanks for the question. Well, when cost growth is going to be zero in an industry that changes and that's growing as rapidly as it has, and in the past, [it's not what it looks like] -- up to 2018, the amount of change we see, it's very hard to see cost growth going to zero. But nonetheless, to answer your questions; firstly, just to clarify points on slide 13, the marketing inflation is relatively flat, because last year, we had significant investments in Euro 2012. This year we didn't. I said in my commentary, that if you adjust for these marketing costs, that's up about 20%, half on half, and that's notwithstanding significant inflation above the line cash (inaudible). So we continue to grow our marketing costs, when we grow it less than the industry, and that plays back into the investment we make in social media, etcetera.

On the €15.6 million, I mean, when you look at the Group as a whole, and the amount of content we are offering, I mean, in the first half of this year, we offered some 295,000 [events], which is up 20% than last year, and 4.25 million markets for those events, which is about 30%. So we are covering betting -- in live sports coverage, for betting in-running, that increased by over 30% on the first half of last year. The number of unique new customers we are getting, those require that we have a technology infrastructure that supports that. We continue to invest in that.

The growth in Australia as well, as we said earlier, we continue to invest in growth in Australia. We have over 400 people in our business in Melbourne now, and the growth in people in the last couple of years, reflects the fact that we are now on multiple platforms, in multiple geographies, going heavier into Mobile. We have iPads and tablets growing as well. So there is a lot of investment that has to come down the pipe, and again, in retail as well. New shops, new presentation styles, all require investment for growth. And the reason we trailed -- in the previous slide, that the rate of growth is slowing, as we think, we are starting to get some scaling effects in the business. So that's a good sign from our perspective.

But, you know, there is a lot of change in this industry. There is a lot to go for we think in the next few years, particularly, where our Mobile goes, and that investment is well worth making. And again in things like social media, in Paddy Power In-Play, we believe that that's an investment worth making in Italy, we continue to invest, as Patrick said, we have got over 90 people working on that, and that is still a story in progress.

So, we are growing our footprint in our business very significantly. That requires investment. There are multiple platforms that we have to build and support. They will continue to require support as we go forward, and we are putting more people into our Online marketing business, where we have had a lot of success and that's important to continue to invest in, I suppose in Europe and in Australia. So we are not shy of saying that we continue to invest for growth and to support both resilience and both platforms. We are very pleased that in -- of course itself, into the Grand National this year, we were probably the only bookmaker that stayed open and live for the whole of that week, and try to remember, that without a particular glitch, and the [same] for the Grand National. That's important customer service that we have to differentiate on.

So rate of growth, slowing; absolutely. We are getting some scaling back down to zero. Not in the next couple of years, I am afraid I have -- I am very happy with the progress we are making.

Ivor Jones - Numis

Patrick, you talked about UK and about Online in Australia being in payback phase, and yet even ex-Italy? Although, maybe I should be exing out the Italian revenue too, but it looks like operating profit growth was less than revenue growth? So does payback get to a point where operating profit grows more than revenue, or the operating leverage does not come through, because there will always be additional costs required, was that what Cormac was saying?

Patrick Kennedy

You are right. I believe, you have to take Italy out of it. And I think -- the term payback phase, it sounds like we are into the phase of [milking] the business. We are not. We think this business is very early. The (inaudible) we are getting payback. But in general, we see the Online markets that we are in, notwithstanding the very substantial growth they have to deliver, and the opportunity that we'd invest in to capture that. We do see the cost base growing by up around the rate of growth at the top line, and as we continue to invest for that.

Ivor Jones - Numis

Okay. Thank you.

Patrick Kennedy

Pleasure.

Operator

Thank you for your question. Our next question comes from the line of Rich Stuber from Nomura. Please go ahead, you are live on the call.

Richard Stuber - Nomura

Hi, good morning everyone. Just a quick question on Mobile and the differential between Mobile gross win margins and Online gross win margins. Within UK, you've got now 50% to 55% or so is now done by Mobile, and you have got overall gross win margin of more than [seven]. Could you just break out what it is this year, Mobile versus non-Mobile Online, and how that essentially has changed over last couple of years? And also finally, where you think Mobile penetration can get to in this year and are there any (inaudible) for getting any higher, as I understand from (inaudible), the Android app can be downloaded from the Google Plus? Thank you.

Patrick Kennedy

Richard, just on Mobile penetration, I will ask Peter to answer that, and Mobile margin, I will pass to Cormac. Peter?

Peter O'Donovan

Yes, in Mobile penetration, obviously we continue to invest in products, where we look (inaudible) country gaming, we expect the penetration rate to increase. Where that will get to, I mean, there are obviously, some savings there that you point out, in terms of our -- redundability to be in the Android app store [levels], to some extent, the [main issues are] distribution channel. However, as we continue to invest in products, and as we follow the overall momentum of consumer adoption of smartphones, UK adults over the age of 18, 85% smartphone penetration, so there is a natural feeling there as well.

However, if you expand Mobile out into tablet devices, we do feel that will be the next phase of growth in terms of Mobile device penetration, and we do expect that figure to continue to increase. But I guess, we are not certain, and that's probably in the hands of the consumers, but, we are totally focused on entering at our products, that follows consumer demand, and when it comes to devices and tablets are the next key areas of focus to follow -- assert leadership position in Mobile.

Patrick Kennedy

Thanks Peter. Mobile margin, Cormac?

Cormac McCarthy

Hi Richard. On Mobile margin, in our Online business, excluding Australia. In the first half of the year, Mobile margin was about 10.7%, and tab was about 8.8%. So there is a differential of 1.92% between the two, and that differential has expanded, since the first half of 2012 by 20 or 30 basis points. The reason for that is, we have more offers on Mobile, so we have increased what we are doing, and the market is growing in that arena. So it's -- at this point, the growth in Mobile and the offering we have, the more that penetrates, the more that will accrue to our margin, and it offers us opportunities for margin expansion.

In Australia, in sportsbook, these are sportsbook numbers. The differential again is about 2%. So sportsbook Online excluding phone, Mobile margin is about 11.8, 11.9, and that's up about 10.1, 10.2. So we see similar expansion in Australia in Mobile versus desktop.

Richard Stuber - Nomura

Okay. Thank you.

Operator

Thank you for your question. Our next question comes from the line of Victoria Greer from JPMorgan. Please go ahead, you're live on the call.

Victoria Greer - JPMorgan

Thank you. Good morning. The first question I had was talking about UK (inaudible) multi-channel outlets, that we see (inaudible) slide 19 talking about being Online ticker from [new results], more than (inaudible). Could you just talk a bit about what that means, and how that's measured, I didn't quite get that? Second question on the Facebook project that you talked about. First thing you said I think in the presentation, that you see the project as a means of growing share wallet of customers, and I just wondered if you could go into that just in a bit more detail. And then secondly, this is probably at a fairly early stage, but I wondered if you could talk about, to what extent you think the Facebook project is something that could mean significantly more investment and development, and (inaudible).

Patrick Kennedy

Okay. Thanks Victoria. Just on multi-channel, I will pass the Facebook point to Peter. The way that that multichannel Online revenue uplift has been measured is, we have looked at our Online penetration, we have studied this carefully right across the United Kingdom, and then we have looked for the -- we have looked at the penetration that we have in the radius around -- in the economical radius around our shops, and the difference between the market share that we have in the near radius to the shops overall market share is how this has been calculated. And consistently we see that we have a disproportionately high share around where we have shops, and consistently we see that we have a disproportionately high share relative to our competitors, right around where they have shops, and that's the point that's being made. And I think the reason for that, as I mentioned in the presentation, I think they are quite a number, but I think the main ones are that -- I think our e-commerce funnel, we gave an example of our e-commerce funnel in Australia, but I think our e-commerce funnel is very strong. So when somebody does actually get attracted to the Paddy Power brand, I think we can work well.

Secondly, I think Paddy Power customers love Paddy Power disproportionately, and when you're a Paddy Power loyalist, if you go to a Paddy Power shop, you are much more likely to go Paddy Power Online than retail customers of our competitors are to go to their Online websites. I think there is a difference (inaudible).

Peter, in relation to Facebook?

Peter O'Donovan

Yeah, so when one thinks of Facebook, one really needs to think that it's predominantly a Mobile platform, and it's really that -- that's one of the key advantages that we are taking into account, when we think about the business opportunity, which as Patrick outlined, we will be [rolling] real money, sports betting application available through the Facebook platform, which I said is predominantly Mobile. So we feel having that exposed to every male over the age of 18 in the UK, we know some are betting with other Online providers, although we ask them not to. But they will -- the product will allow us to grow their share wallet through betting through the Facebook platform, and that's one of the key -- the (inaudible), the design and the overall investment behind the business opportunity.

In terms of investment going forward, we will invest as we see success in this. We have a team more focused on at the moment, and they have a number of further releases after this initial beta release that they are working on. We anticipate they will be working on that for the next period of time. If we see success take off out of those, we will invest further behind that. But it will be with growth in mind, and ultimately the profitability in mind.

Patrick Kennedy

And Peter, the number of people of working on through this opportunity, the Facebook opportunity?

Peter O'Donovan

Yeah, in terms of -- we have about 20 people working on it at the moment, in terms of developers, and as we go in live, we are going to add to that, a team of five to six people, who we manage [in that] as well. That's broadly the -- sort of the SAU requirements around that.

Patrick Kennedy

Thanks Victoria.

Victoria Greer - JPMorgan

Thanks.

Operator

Thank you for your question. And our next question is coming from the line of Vaughan Lewis from Morgan Stanley. Please go ahead, you are live on the call.

Vaughan Lewis - Morgan Stanley

Morning. Just to clarify on Italy. You said breakeven next year, is that an exit rate for 2014 or will it actually be breakeven for the full year for the P&L? Similar question for BetDash and costs, how those are performing relative to their budgets, and when will they break even? Then just a quick on the outlook, you are saying, missed double digit EBIT growth in constant currency and a 4% headwind. So you are looking for sort of 10% reported EBIT growth value, is that the way to think about it? Thanks.

Patrick Kennedy

Thanks Vaughan. Cormac, do you want to take those -- Italy is the easy one, it is -- the brief one which is the exit rate, that's the last hour of the last day of the last week of the last month of 2014. So it's basically 2015 we enter in profits, and the outlook, Cormac?

Cormac McCarthy

Yeah, I mean, thanks Vaughan, good morning. Yeah Patrick's clarified the Italy point which I should have done earlier on, so apologies for that, and he has said correctly. BetDash, Cayetano are BAU now, so we don't disclose any particular numbers about those, because they are in full production there, and Patrick mentioned earlier, the number of games we are getting from Cayetano now in our live business, and thankfully those games are actually outperforming the rest of our games. So our expectations in Cayetano are, they have been more than deliberate, and promising to be a production within the Online business. So nothing exceptional to be disclosed. That actually is now -- its part of the kind of Paddy Power stack overall. Interestingly, we learnt a lot from BetDash, it has helped us with Paddy Power In-Play, and so it's an offering that will continue.

Just on the outlook, you are right. At the end of the day, we are seeing mid-double digits growth, given what we said about the performance so far this year, in terms of sports events and also currency headwinds. But when you adjust for the currency headwinds, that brings it down in nominal terms. So 10 to 15 headline and you know, you can make your mind up in the nominal, when you take the currency into account.

Vaughan Lewis - Morgan Stanley

Great. Thank you.

Operator

Thank you for your question. Now our next question comes from the line of Ed Birkin from Credit Suisse. Please go ahead, you are live on the call.

Ed Birkin - Credit Suisse

Morning guys. Just a quick one on your strategy for UK Retail. You have talked about strong retail profile with your openings, and given the -- your continued negative rhetoric in the press about proliferation of shops. Do you see any reason to perhaps increase your rollout ahead of any potential clampdown in their [current feature]?

Peter O'Donovan

Not really. I mean, there is always and has been for some years, some political noise around number of shops we are posturing and sometimes that translates into negative (inaudible) machines as we have seen in the recent past as well. That doesn't change the way we think about the business. We think about finding good jobs that make good returns, and we have a very clear target list that we work to, and our biggest constraint is finding the right locations in right [pitches], and we don't compromise on that. And consequently, what that means is we don't make mistakes. So we haven't closed a shop, I think since 2006, and we don't intend to.

So it's more to say, we have slightly increased the run rate over the recent years, as you will have seen, and we wish to -- our numbers are probably somewhat on the upside, because of the pipeline as we see today.

Ed Birkin - Credit Suisse

Okay great. And just a quick follow-up on machines. There is still a big differential between the net revenue and gross win numbers for free bets. So assuming, the MTB being constant. Is that something we call close as you go further along the overall active loyalty scheme, or should we expect the differential to increase going forward?

Peter O'Donovan

Yeah. So there's two components to free bets. The one is those associated with the loyalty program, and with those associated with sort of standard promotional activity in the marketplace, (inaudible) promotions, what have you. And so with regards to those connected to the loyalty program, those will fall and are falling, and we expect it to continue to fall, and as was my point earlier, as we continue to optimize data around our loyalty solution, we get more, frankly, bank for a buck on that margin spend.

Ed Birkin - Credit Suisse

Okay great. Thank you very much.

Operator

Thank you for your question. And our next question comes from the line of James Ainley from Citigroup. Please go ahead, you are live on the call.

James Ainley - Citigroup

Yeah, good morning guys. Just had a question on Mobile cross-sell and (inaudible) gaming -- can you take us through where you are in terms of the technology there, and whether you got a single wallet enabled or whether -- your customers are very much downloading those free apps at this point?

Patrick Kennedy

Sure. Thanks James. Peter?

Peter O'Donovan

So across the board with gaming is it is a single (inaudible), and the strategy we have adapted today, is that they are just great apps, as we begin to improve the interface to upload those great apps. One of the areas that we are focusing on a lot at the moment, is actually that sort of cross-sell from app-to-app. So that's a key opportunity to improve the cross-sell rights, and the one that we are focused on at the moment.

James Ainley - Citigroup

And when might we expect to see that coming through?

Peter O'Donovan

We have a number of penetrations. I think the first penetration comes in towards the end of this year. You have some already in market at the moment in terms of improving the cross-sell. So that will be an ongoing area that we are looking at, in terms of improving. The more substantive upgrade will be toward the latter part of this year.

James Ainley - Citigroup

Thank you.

Operator

Thank you for your question. We have no further questions currently in the queue.

Patrick Kennedy

Okay. Ladies and gentlemen, thank you very much for joining us, and we'd be delighted as you know, to take any further questions, any further context you might have, further to the meeting. You know where we are and just feel free to reach at us. But thank you for your time this morning.

Operator

Thank you. Ladies and gentlemen, that concludes your conference call for today. You may now disconnect. Thank you all for joining and have a very good day.

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