OPAP SA: Why Investors Shouldn't Write Off The Greek Gambling Monopoly

| About: Greek Organisation (GOFPY)

"Regulatory capture" happens when the regulating agency, under the guise of protecting consumers, is in reality acting in the interests of the industry it regulates. The discrepancy between the agency's initial goal and reality happens slowly and unnoticeably over time. Ultimately though, the agency loses its independence thereby allowing the industry to shape regulations as it sees fit.

That central insight by economist George Stigler explains a lot of the cozy history of the Greek gambling monopoly OPAP (OTCPK:GOFPY) which for the better part of last decade fought tooth and nail against any type of liberalization pressed upon by the European Commission. It also sheds light on the upcoming privatization, which will cut with a vengeance the umbilical cord between OPAP and the Greek state.

Regulatory capture will be more difficult in the future and OPAP shareholders, used to the perks of a "wide moat" such as strong cash-flow generation and a high dividend payout, are conceivably nervous. The news two weeks ago that starting in 2013 OPAP and its customers would be submitted to the same taxation levels levied on online competitors sent the stock stumbling 30%. However one could also see the privatization and the required accompanying tax harmonization as a defining moment for OPAP; once unleashed, it will finally be able to deploy its wings.

OPAP SA (or the Greek Organization for Football Prognostics) was established by royal decree in 1958 as a private legal entity. Initially specialized in betting on soccer games, OPAP grew into a numerical lottery and sports betting giant with over 5,000 licensed agencies throughout Greece and Cyprus. Turnover in 2011 was €4,358 billion, Gross Gaming Revenues (or wagers minus winnings) €1,413 billion.

Despite very strong macro headwinds OPAP's business has been resilient so far. Wagers are down 23% from the 2008 peak but thanks to cost restructuring, net profit margins have been maintained in the 12-13% range. With the exception of 2011, dividend payout ratio has been in the 100% range. Nevertheless, high profitability, very low debt level and monopoly status can only do so much when investors rush for the exit: OPAP has lost about 75% of its value in the last 3 years. Its stock trades now for less than when shares were offered for the first time to the public in 2001 (€4.43 as opposed to €5.50).

Interestingly enough, it is when OPAP's enterprise value is at one of its lowest levels ever that a cash-strapped Greek state is forging ahead with the privatization. What years of regulatory tangle could not achieve (the European Commission started infringement proceedings against OPAP's monopoly back in June 2007) the economic crisis painfully did. By agreeing to sell a 33% stake in the company and to keep only 1%, the Greek government is also accepting to liberalize the Greek gaming market by leveling the playing field for OPAP's online competitors.

The harmonization of taxes mentioned before was an important step in that regard. Another one will be the ruling by the Court of Justice of the European Union (CJEU) some time soon on whether OPAP's monopoly is justified. And the overall consensus is that it will likely come up with a negative answer. Based on an early opinion by Advocate General Jan Mazak, OPAP has failed the two objectives that would justify its cherished monopoly status: (1) instead of reducing the supply of games of chance, OPAP "pursued an expansionist commercial policy", and (2) by not offering attractive alternatives to illegal gambling, it was unable to combat related criminality. The CJEU's negative decision would be the final nail in the coffin for OPAP, as it was until now.

Where does that leave investors? For once the uncertainty around OPAP's legal status is already priced in. One could also argue that the loss of monopoly would affect OPAP only marginally. By securing exclusive licenses for its 13 games until 2030 both online and offline (the only exception is blockbuster sports betting game Stihima: OPAP has the offline license until 2030 but its online license ends in 2020), OPAP is de facto limiting the entry of new competitors such as British bookmakers William Hill (OTC:WIMHF), Stanleybet and Sportingbet (OTCPK:SPBTF). As it stands their only real competitive opportunity would be online live casino/poker games for which licenses have not yet been awarded.

The license for state lotteries (with their lucrative scratch and win instant tickets) is up for sale by the Hellenic Republic Asset Development Fund (HRDAF) and could be an additional point of entry for foreign competitors. But all in all, we are not speaking about major threats to OPAP's dominance of the Greek legal gaming market. Moreover, by securing the license until 2022 to operate 35,000 VLTs (Video Lottery terminals allowing players to bet on the outcome of a video game), OPAP has shown that it is willing to tap into a new market of players and gaming venues (gaming halls as opposed to licensed agencies). Its partnership with Italian lottery giant Lottomatica (OTC:LTTOY) to develop online betting also sounds promising.

In the end though, protecting aggressively its own turf will not be enough. Competition and higher taxation levels will predictably put a dent in OPAP's profitability. But that is where the privatization catalyst comes in: by cutting its main shareholder loose, OPAP will be able to look beyond Greek borders. Apart from its 2003 expansion in Cyprus (where it has 120 agencies now) and its failed bid for the Turkish national lottery Milli Piyango in 2009, OPAP has been notably absent from the international scene.

By allowing companies such as Lottomatica or Intralot (OTCPK:IRLTY), both with extensive international experience, to bid for its 33% stake, the Greek state is deftly boosting OPAP's prospects. Liberated from the constraints of a high dividend payout, OPAP will from now on be able to better allocate capital and to seize growth opportunities. Hence a very interesting page in its history is about to be written, one which should reward handsomely the shareholders who are willing to go for the ride.

Disclosure: I am long OTCPK:GOFPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.