South African Gaming Sector - STANLIB Stand Point By Jessica Brownhill

2016 | 01www.stanlib.com

STANLIB is an Authorised Financial Services Provider

THE SOUTH AFRICAN GAMING SECTORPRIOR TO THE EARLY 2000’S, LEGAL GLOBAL GAMING WAS PRIMARILY A NICHE INDUSTRY, LIMITED TO CERTAIN REGIONS IN THE UNITED STATES, AUSTRALIA AND MALAYSIA. It is now estimated that the global gaming industry generates about $124 billion per annum.

Since being legalised in 1994, the South African

gaming industry has grown significantly and now produces gross revenues of R24 billion per annum. The bulk of this revenue is generated in Gauteng (42%), the Western Cape (16%) and Kwa-Zulu Natal (19%), with casinos being the dominant gaming node (R17.2 billion). The South African gaming industry appears to be reasonably mature, with gross gaming revenue as a % of GDP

similar to other developed nations like North America and Europe at 0.6%. The casino gaming segment has been relatively defensive in recent years, with gross gaming revenues increasing each year from 2002 (earliest data available), despite the recession (2008-2010).

SOUTH AFRICAN GAMING INDUSTRY GROSS GAMING REVENUES

Source: National Gambling Board South Africa, National Gambling Statistics

R millions

-

5 000

10 000

15 000

20 000

25 000

30 000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Casinos Betting Bingo Limited Payout Machines

GAMING REVENUE

Source: National Gambling Board South Africa

42%

16%

19%

4%

2% 7%

1% 7%

2%

Gauteng

Western Cape

KZN

Mpumalanga

Limpopo

North West

Northern Cape

Eastern Cape

Free State

Provincial Gross Gaming Revenue Gross Gaming Revenue by gaming mode

84%

10%1% 5%

Casinos 72%

Betting 14%

Bingo 5%

Limited Payout Machines

9%

2010

2015

Percentage

BY JESSICA BROWNHILL, EQUITY ANALYST, STANLIB



LEGAL FORMS OF GAMING IN SOUTH AFRICA INCLUDE:1. Traditional casinos that are

land based only, as online casinos are illegal in this country.

2. Betting is predominantly in horse racing. Sports betting has driven growth in recent years. This segment is however highly volatile, as it is largely driven by interna-tional sporting events like the FIFA World Cup. Betting could be perceived to have a slight regulatory advantage as it is the only gaming cate-gory where online betting is permitted.

3. Bingo is the smallest and fastest growing gaming segment, albeit off a low base. 60% of the local bingo market consists of Electron-ic Bingo Terminals (EBTs) as opposed to traditional bingo.

4. Limited payout machines (LPMs) are located in bars, clubs and restaurants. These machines are restricted by maximum bets of R5 and maximum payouts of R500. The LPM market has experienced significant growth since the first site in Mpumalanga in 2003, largely driven by the roll out of new machines. Currently only about 6000 LPM machines (of the 50 000 regulatory limit) have been rolled out in eight provinces across South Africa.

GAMING BUSINESS MODEL

VOLUMESWealth

ConfidenceGDP

COSTSStaff

OperatingGaming Tax

PROFITABILITY MIX

Hotel: 10-20%

Food & Beverage: 10-20%

Gaming: 70- 80%

CAPEX INTENSIVE

Source: STANLIB

High fixe

d co

sts Slots and Tables

GAMING: Footfall

HOTEL: Occupancies and Supply

DRIVERS AND RISKS (GRAPHICALLY)

Risks

Source: STANLIB

REGULATORY RISKS

LICENSES• Ability to retain, obtain

and relocate licenses: Although limited licenses create barriers of

entry and protect local gaming companies, they

can also limit the companies ability to

execute their strategy and create value for

shareholders• One potential additional

license in Northwest province (Could impact

Sun City’s turnaround strategy)

IMPACT OF POTENTIAL BANS ON PUBLIC

SMOKING• Casinos typically

generate 60% of gaming revenues in smoking

sections• Impact would be dependent on stringency

of smoking laws

ONLINE GAMING• Legalisation of online

gaming in South Africa poses a long term risk to

the casino industry• Markets in Europe where online gaming is legal have experienced double digit

growth

TAX LEGISLATION CHANGES

• Gaming taxes and levies represent

significant operating expenses

(17-23% of revenue)• KZN and Western Cape

have had gambling tax increases in recent

years while Gauteng has remained unchanged

• Potential increase in Gauteng taxes from 9%

to a tiered scale (max 15%) could impact

margins

The casino gaming segment has been relatively defensive in recent years, with gross gaming revenues increasing each year from 2002 (earliest data available), despite the recession (2008-2010).



EXPOSURE: PORTFOLIO OF ASSETS

Tsogo Sun Hotel and Gaming Portfolio

GAMING South Africa only South Africa and offshore

GautengMontecasino, Gold Reef City and Silverstar

Kwa-Zulu Natal Suncoast, Golden Horse and Blackrock

Western Cape Garden Route, Caledon and Mykonos

MpumalangaEmnotweni and The Ridge

Eastern CapeHemingways and Queens

Free StateGoldfields

84 South African hotels9 offshore hotels

Nigeria, Kenya, Tanzania, Zambia,Mozambique, the UAE and the Seychelles

Luxury MAIA, Beverly Hills, Palazzo, Sandton Sun,

Sun Coast Towers, 54 on Bath, Intercontinental

Full Service Southern Sun Hotels, Southern Sun Resorts,

Crown Plaza, Holiday Inn

Select ServiceSun Square, Garden Court, Stayeasy

Budget

Sun1

HOTEL

Sun International Hotel, Gaming and Entertainment Portfolio

GautengCarnival City, Morula

and Maslow

Western CapeGrandWest, Golden Valley,

Table Bay and Sunbet

Kwa-Zulu Natal Sibaya

LimpopoMeropa

North WestSun City and Carousel

Northern Cape

Flamingo

Eastern CapeBoardwalk, Fish River

and Wild Coast Sun

Free State Windmill and Naledi Sun

BotswanaAvani Gaborone

LesothoLesotho Sun

NamibiaAvani Windhoek

SwazilandRoyal Swazi and

Ezulwini Sun

Zambia Avani, Victoria Falls and

Royal Livingstone

NigeriaFederal Palace

ChileMonticello

Panama

Ocean Sun Casino

ColombiaSun Nao Casino

SOUTH AFRICA AFRICA LATIN AMERICA

EXPOSURE: SEGMENTAL REVENUE CONTRIBUTION

Casino Assets contribute the largest share of Revenue

9%

7%

4%

63%

4%

13%

Hotel rooms 8%

Food and beverage 6%

Other revenue

4%

South African casino

66%

Nigeriancasino

1%

LATAMcasino

15%

SUN INTERNATIONAL

66%

19%

9% 6%

RSA casino

60%

Hotelrooms

23%

Food andbeverage

11%

Other revenue

6%

TSOGO SUN

2013

2013

2016

2015

Source: National Gambling Board South Africa, National Gambling Statistics

THE SOUTH AFRICAN CASINO GAMBLING INDUSTRY IS DOMINATED BY TWO LISTED PLAYERS, SUN INTERNATIONAL AND TSOGO SUN Tsogo Sun (TSH) is a gaming, hotel and entertainment group. Gaming and entertainment assets include 14 properties in six provinces in South Africa including Montecasino, GoldReef City, Suncoast and Silverstar Casinos. Additional facilities include theatres, cinemas, restaurants, bars, conference and banqueting facilities. Tsogo’s hotel assets includes 90 hotels, ranging from the luxury to budget sector in South Africa, Nigeria, Kenya, Tanzania, Zambia, Mozambique, the United Arab Emirates and the Seychelles.

Sun International (SUI) is a tourism, leisure and gaming group, having interests in 27 resorts, hotels and casinos in 10 countries. 15 of their operations are located in South Africa, nine in Africa and three in Latin America (Chile, Panama and Colombia). Sun international's gambling portfolio includes Grand West, Sun City, Sibaya, Carnival City and the soon to be completed Menlyn Main Casino in Eastern Pretoria (opening in 2017). Sun International has exposure (albeit small as a % of the business) to other gaming nodes through its acquisition of GPI slots (limited payout machines) and Sunbet (Online Sports betting).



TSOGO SUN INVESTMENT CASE• Experienced and proven

management team- Marcel von Aulock (CEO) and Rob Huddy (CFO)

• High quality, well positioned, diversified and well maintained portfolio of assets

• Highly cash generative • UPSIDE RISKS• Hospitality Property Fund

(HPF) REIT structure• TSH entered into a deal

to commit appropriate assets to the REIT, resulting in them holding a controlling stake in HPF. These holdings are now subject to the approvals of the competition authorities

• Increased domestic travel due to constrained consumer and weak rand

• DOWNSIDE RISKS• Heavily exposed to South

African macroeconomic environment and consumer (who is under increasing pressure)

SUN INTERNATIONAL INVESTMENT CASE• SUI has a well diversified

asset base • Geographically: New

Menlyn Main Casino in Eastern Pretoria will increase exposure to Gauteng and expansion into the fast growing Latin American market. Latin America is the fastest growing casino industry after Asia

• Diversified within gaming nodes: GPI slots acquisition provides diversification across gaming nodes into limited payout machines

• Benefits from food and beverage insourcing efficiencies improves SUI’s cost control

• UPSIDE RISK Increased domestic travel due to constrained consumer and weak rand • DOWNSIDE RISKS• Execution risk within the

South American and Menlyn Main expansion plans

• Additional license in North West may impact Sun City

Moat: The ability to keep competitors at bay

Uncertainty: Historical volatility of the company's share price and returns

Stewardship: The competency and track record of the management team

Valuation: The relationship between the current share price and the estimated intrinsic value of the stock

Medium High

Fair Fair

NarrowHigh barriers of entry due to the South African gaming industry being highly

regulated, both at national and provincial level, and significant capital requirements

Buy Buy

Undervalued Undervalued

Recommendation

Tsogo Sun Sun International28.024 8.619R26.93 R88.70

52% 72%

Market capitalisationShare priceFree float

THE FOUR PILLAR INVESTMENT APPROACH SUMMARY

CONCLUSION When considering our four pillar investment framework, share prices appear to be depressed relative to our calculated intrinsic value. We have buy recommendations on both Tsogo Sun and Sun International. The current share prices represent entry points for investors who have a longer-term time horison despite uncertainty around the current macroeconomic environment.

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South African Gaming Sector - STANLIB Stand Point By Jessica Brownhill