Fitch Ratings has revised Entain plc's (Entain) Outlook to Stable from Positive, and affirmed the Long-Term Issuer Default Rating (IDR) at 'BB'.
Fitch has also affirmed its senior secured instrument rating at 'BB+' with a Recovery Rating of 'RR2'. A full list of ratings is detailed below.
The Outlook revision to Stable reflects our expectation that Entain would fund its growth strategy with debt, resulting in higher than previously forecast leverage, rather than deleveraging towards its medium-term target. Our rating case assumes debt-funded acquisition of SuperSport.
The 'BB' rating encapsulates Entain's strong business profile, its retail and digital offerings, diversification, sound profit margins and good cash-generation ability. However, Entain's financial flexibility is somewhat limited, driven by low fixed charge cover ratios, expected drawings under its revolving credit facility RCF to part-fund M&A and some refinancing risks on its GBP400 million Ladbrokes notes due in 2023, along with its EUR1.125 billion term loan B (TLB) due in March 2024.
The future rating trajectory will depend on Entain's ability to maintain financial discipline while balancing its external growth strategy. A material unmitigated cash impact from an HMRC investigation, further regulatory settlements or fines or a larger-than-expected regulatory impact would be negative for the rating.
Key Rating Drivers
Acquisitions Drive up Net Leverage: We expect Entain's net adjusted debt / EBITDAR at around 4.0x during the next two years, which is in line with its current rating. This follows materially higher acquisition spend - around GBP1 billion in 2022 - than expected under the previous rating case. However, the latest acquisitions are EBITDA-accretive and will help improve the group's geographic diversity.
Financial Discipline Key to Rating: We expect Entain to operate near their 3.0x leverage soft cap to support its growth ambitions. Our rating case incorporates continued bolt-on M&As, earn-outs and continued investments in the US amounting to around GBP640 million over 2023-2025, in addition to around GBP700 million capex, and some dividends. Larger acquisitions, higher capex or friendlier shareholder policies could be negative for the rating.
Manageable Execution Risks: We see limited execution risks around integration of bolt-on M&As, given Entain's successful record with acquisitions. Execution risk around the HMRC investigation remains; therefore, an unmitigated large regulatory impact would be negative for the rating.
Post-pandemic Normalisation: Fitch forecasts incorporate around a 5% decline in online revenue in 2022, which is more than compensated by post-pandemic recovery in retail revenue. We assume a slower decline in 2H22, following a 7% reduction in 1H22, due to the Netherlands closure impact tailing off from 4Q. Subsequently we expect low- to mid-single-digit growth for its existing online business, with regulation supressing its structural growth. We expect revenue from the retail segment to reach around 90% of pre-pandemic levels by end-2022 and then remain broadly flat. This, combined with recent acquisitions, underpins mid-single-digit growth in revenue to 2025.
Sound Profitability: We forecast EBITDAR to exceed GBP1 billion in 2024, up from around GBP0.9 billion in 2022. We continue to expect good profitability, mapping to 'bbb' metrics, with an average EBITDAR margin of 22% to 2025. Our forecasts incorporate 200bp lower gross margin for the online segment, which is partly offset by recovery in retail operations in 2022. We also expect some operating cost pressure in retail, reflecting higher labour and energy costs, while margin improvement would be aided by Entain's cost-saving programme, under which it expects GBP20 million incremental EBITDA savings in 2023. Average free cash flow (FCF) margin of around 4.5% over 2023-2025 is sound, albeit slightly lower than under the previous rating case due to larger debt and higher interest rates.
UK Gambling Act Review Uncertainty: Our rating case incorporates a 17% reduction in online revenue from the UK (around GBP1 billion revenue in 2021). This will shave around GBP45 million off EBITDA by 2023 against 2021, mainly from implementation of responsible gaming measures ahead of the delayed UK Gambling Act review. This compares with an GBP118 million negative impact from the fixed-odds betting terminal maximum GBP2 stake introduction in 2019. The outcome from UK Gambling Act review is yet to be seen; a materially higher-than-expected EBITDA impact could be negative for the IDR but is deemed an event risk.
Strong Business Profile: Entain is one of the world's leading gaming operators, albeit smaller than Flutter following its merger with The Stars Group in 2020. Entain benefits from its proprietary technology, multiple leading brands that provide betting and gaming services across over 30 regulated markets in Europe, Latin America and Australia, and its commitment to operating solely in regulated markets by end-2023. Its retail presence provides a competitive advantage by granting higher visibility to its online operations, which drive the growth of the business.
Diversification Helps: Diversification into growing and regulating markets should help reduce reliance on and regulatory impact from Entain's main online markets - the UK, Australia, and Italy, which contributed around 70% of revenue in 1H22. We expect Entain to continue investing in its 50:50 joint venture with MGM Resorts International in the US and have assumed around GBP300 million investment but no dividend inflow over the rating horizon. We anticipate US operations to turn profitable in 2024. This is neutral to funds from operations (FFO) under our Corporate Rating Criteria.
Immaterial Inflation or Stagflation Pressure: Gaming companies have limited exposure to inflationary pressure on their retail operations (Entain: 30% of 1H22 revenue). They are well-equipped to pass on increased costs to customers. Also, gaming operators have previously demonstrated resilience against economic downturns - gaming expenses tend to account for an insignificant part of household expenses and are less discretionary than some other forms of leisure. Therefore, we do not incorporate deterioration in revenue per customer from factors other than regulatory changes.
Derivation Summary
Entain's business profile is commensurate with a higher rating category, supported by its sound profitability and large scale. Its close peer Flutter Entertainment Plc (BBB-/Negative) is larger and better diversified than Entain, following its merger with The Stars Group. Flutter has a leading position in the US, lower exposure to UK and wider business & customer segment diversification via higher exposure to peer-to-peer platforms, including poker and betting exchange, as well as lottery.
Its peer 888 Holdings Plc (888, BB-/Negative) similarly has strong brands, retail presence in the UK (via acquired William Hill operations) but smaller scale and slightly weaker diversification than Entain.
Entain's expected EBITDAR margin at around 21% over the next two years is solid at the midpoint of 'BBB' rating, and above 888's but slightly below Flutter's, when deconsolidating its US operations for comparability. Entain has weaker profitability than Allwyn International a.s. (previously, SAZKA Group a.s., BB-/Stable), and is more exposed to increasingly stringent regulation of sports betting and online betting, but has better diversification.
Entain's FFO adjusted net leverage is expected at above 4.0x, higher than Flutter's, once the latter deleverages post-Sisal acquisition to around 3.5x by 2024, towards its more conservative net debt/EBITDA target 1.0x-2.0x vs Entain's medium target of 2.0x. Entain's leverage is lower than 888's after the latter's debt-funded acquisition of William Hill International. We expect 888 to deleverage to just below 6.5x by 2024.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
Medium-single digit online revenue decline in 2022, driven by rollout of responsible gaming measures, followed by middle single-digit growth to 2025
UK online revenue to decline 13% in 2022 and further 5% in 2023
Retail reaching 90% of pre-pandemic revenue in 2022, followed by flat trend in 2023-2025
EBITDA margin of 19.3% in 2022, a 70bp decline on 2021's, as an expected 200bp decrease in online gross margin is offset by strong rebound in retail profitability
US operations becoming profitable in 2024, after a one-year lag to management assumptions with no dividends over the rating horizon
Neutral working capital to 2025
Capex at around 5% from revenue to 2025
Investment in US operations of GBP300 million in total over 2022-2024
Dividends of around GBP50 million in 2022 and around GBP100 million-GBP120 million in 2023-2025
Acquisition spend of around GBP1 billion in 2022, followed by an average of around GBP170 million for bolt-on M&As & earnouts per year to 2025
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Continued strong profitability with diversification helping to offset tighter gaming regulation, and realisation of planned synergies resulting in an EBITDAR margin above 22%
FFO-adjusted net leverage trending towards 4.0x or adjusted net debt/EBITDAR trending towards 3.5x on a sustained basis
FFO fixed-charge coverage above 3.0x
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Weaker than forecast profitability due to increased competition or more material impact from regulation leading to an EBITDAR margin at or below 18%
FFO-adjusted net leverage or adjusted net debt/EBITDAR above 4.5x
Maintaining shareholder-friendly financial policies that limit deleveraging prospects
FFO fixed-charge coverage below 2.5x along with a deteriorating liquidity buffer
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: Entain's liquidity was comfortable at end- 2021 with GBP281 million of available cash (net of GBP206 million cash held on behalf of customers that is treated as restricted by Fitch) and GBP590 million available under RCF. The debt documentation includes a springing covenant, which is tested when the facility is 40% drawn, and set at a maximum net debt/EBITDA of 6.0x until July 2023, before reducing to 5.5x until July 2025 and to 5.0x until maturity in 2026.
We expect Entain's financial flexibility to reduce as it draws on its RCF in 2022 to part-fund M&A. We understand that Entain has repaid GBP100 million of Ladbrokes bonds that were due in September 2022, but it is exposed to refinancing of its GBP400 million fixed-rate bonds due in September 2023, along with its EUR1.125 billion TLB due in March 2024 in what will be a higher interest-rate environment.
Generic Approach for Senior Secured Instruments: Fitch rates Entain's senior secured instrument ratings at 'BB+' in accordance with Fitch's Corporates Recovery Ratings and Instrument Ratings Criteria, under which we apply a generic approach to instrument notching for 'BB' rated issuers. Entain's capital structure is characterised by an all-senior debt structure. All debt ranks pari passu, and includes cross-guarantees and share pledges from key group subsidiaries representing at least 75% of group EBITDA.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Entain has an ESG Relevance Score of '4' for Customer Welfare - Fair Messaging, Privacy & Data Security due to increasing regulatory scrutiny on the sector, amid greater awareness around the social implications of gaming addiction and increasing focus on responsible gaming. This factor has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
ENTAIN PLC 
