US Edition Playtech
302.75p -11.25
Questor says HOLD
Last week's profit warning from gambling software group Playtech was very disappointing. The shares are now almost 25pc below their March 22 recommendation price.
Management now has a credibility issue to resolve, so Questor does not advise investors to put new money into the shares – even though they are trading at a significant discount to peers on reduced earnings expectations.
Playtech provides software and managed services for online gaming platforms. Questor first recommended the company after it released an impressive set of first-quarter numbers. At the time, Questor argued that gambling was not a recession-proof business, but one that appeared to be holding up well.
The company had also entered a joint venture with William Hill, called William Hill Online (WHO). Playtech owns 29pc of the venture and also receives royalty payments from the operation. This business looks good and it still has solid prospects. In fact, it could turn out to be Europe's premier gaming platform. However, the warning was an unwelcome surprise – and it may take the share price some time to recover. Last week, Playtech said full-year earnings would be lower than market expectations "owing to the slower-than-anticipated start to WHO and the general challenging economic environment impacting some of our licensees".
William Hill responded to the warning with a statement of its own – just one minute later. "The board of William Hill confirms that William Hill Online is making good progress during an extensive integration period and in difficult trading conditions," it said. "William Hill remains comfortable with the market consensus for the online business in 2009."
In what one analyst called a case of "expectation mismanagement" it appears that William Hill's management had been more cautious in its expectations than Playtech's. Or, to put it another way, Playtech's management have been too bullish in guidance they have given to analysts.
Of course, nothing is black and white – things had been going very well for Playtech. That's why Questor recommended the shares in the first place. The company had a rosy first quarter and it is true companies change their earnings expectations all the time as the world changes. Playtech also insists that it is a passive shareholders and it was acting on information provided to it by William Hill.
One other part of the profit warning related to revenues from third-party licensees. This revenue stream is difficult for anyone to predict – even management. It is also difficult to assess how much of the earnings miss is down to high expectations for WHO and how much was down to third-party licences. This means visibility is not good.
There are some positives. The company's deal with Betfair should also kick in from the fourth quarter of the year. The company also continues to expand – alongside the profit warnings was news of a strategic partnership with the Serbian State Lottery.
Ultimately, the WHO business has great potential and it is reassuring that William Hill is the majority stakeholder. Indeed, Questor expects to hear positive news about the venture from William Hill when it issues its earnings statement next week.
On reduced forecasts, Playtech shares are now trading on a December 2009 earnings multiple of 9.5 times – a significant discount to peer PartyGaming, which trades on an earnings multiple of 18.5 times. The credibility issue caused by management guidance probably means that this lowly rating is deserved.
Of course, Questor is very aware of the old stock market adage that profits warnings come in threes, so will be monitoring the situation closely, but the WHO business looks like a good venture, despite Playtech's management's Pollyanna view of near-term trading. That's why the shares are not an outright sell. The stance on the shares is cut to hold from buy. If you want exposure to this venture, then buy William Hill shares not Playtech.
Rolls-Royce
408p +32.75p
Questor says BUY
Shares in Rolls-Royce started sliding after Questor named them as one of the tips of the year.
Questor has said a number of times over the last six months that the market was being over negative and the company had better prospects than it was being given credit for. Yesterday, the company justified that view with an excellent set of interim figures. The shares are now up 17pc since January 5.
The most important news was the substantial increase in its order book during a time of economic malaise – which rose by £2bn to a record £57.5bn. The company was, however, cautious on the market outlook,
The group also had net cash in excess of £1bn at the end of the period, so its balance sheet remains robust. Despite the difficult environment for the aerospace industry the company continues to win new orders. The oil and gas industry also saw strong sales in the first half.
The company also confirmed that it expected to meet its forecast for revenue to grow and profits to be unchanged in 2009. It also increased its dividend pay-out by 5pc to 6p a share.
The shares are trading on a December 2009 earnings multiple of 12 times and yielding 3.6pc. Buy.