Smarkets Blog

N.B. The following piece was penned for the FT Alphablog. You can find a link here.

At long last, Betfair is IPOing. This means they won’t be talking for a while – they’re undoubtedly going through the standard quiet period – but as someone who’s been following them for years, I thought I’d lend my thoughts.

Betfair was founded 10 years ago at the height of the dotcom boom by an investment banker and a professional gambler. They were the first company to coalesce the idea of backing as well as laying horses in one marketplace — Microsoft Access powered, no less. They merged a year later with a similiar peer to peer betting site called Flutter which was founded by some Americans, and Betfair was off to the races growing at an amazing pace.

The Betfair IPO is great validation of the UK tech scene. Joining the ranks of MySQL, Skype, QXL and ARM, Betfair shows that Europe produces billion dollar tech companies. There is much to celebrate about Betfair coming to market, and it is also validation that great billion dollar companies can come from the betting industry.

There have been a lot articles about the IPO itself, but since the betting industry tends not to be very transparent or well understood, I thought I’d highlight the top risks and strengths in my opinion of the Betfair IPO.

Key Strengths:

• Strong revenue growth: Betfair is a revenue generating machine, pure and simple. Their latest reported figure was £340 million in revenue with a profit of £17.8 million. Their revenues have been increasing around 20-30% a year since they were founded.
• Global presence: Betfair has offices in the UK, Malta, Australia, USA and Romania and customers from many, many more countries. This will give them stability as the legal status of betting changes in different countries and decreases the risk of Betfair. Betfair pulled out of France because of its disadvantageous licensing structure.
• Large user base: They have three million accounts. While this is a lot less than Facebook or LinkedIn, it’s a user base that has cash and spends lots of it. The lifetime value of a betting customer can be anywhere from hundreds of pounds to several thousand pounds.
• Product/market fit: Betfair is a platform for everyone: casual punters, large betting syndicates, bookmakers, hedgers and traders. It works well combining the needs of different customers into one website which drives Betfair’s substantial liquidity.
• Diversified revenue stream: Betfair’s dependency on horse racing and sports betting revenues has been lessened by offering poker, casino and arcarde products. Standard betting accounts for roughly two thirds of the company’s revenue.
• Transparency: One of the things I’ve always admired about Betfair is their stance on transparency and licensing. Betfair has only taken customers from countries that allow online betting. Most other betting companies don’t go down this path. I think this corporate value will serve them well in the future.
• US market: There are a lot of signs from Congressman Barney Frank and others that point to the US liberalising its stance on online gambling. This will be a boon for companies like Betfair, who are well positioned to take advantage of the change.

As you can see the bankers will have an easy time selling the strengths of this tech giant. However, there are key risks, which haven’t been discussed in as much detail.

• Slow innovation: Aside from a few cosmetic tweaks, reliability improvements and the Starting Price feature, Betfair hasn’t innovated much over the last few years. For a company that boasts several hundred developers, it should be able to release more major new features. Betfair gets very little traffic from organic search and has no social features apart from a forum.
• Outdated tech platform: Betfair’s website can be quite slow at times. If you look under the hood, there’s a tangled web of javascript libraries, iframes, caching servers and images. Over the years, it has grown into a technical server farm behemoth that is difficult to upgrade and maintain.
• Tax on top traders: About a year ago Betfair introduced a “Premium Charge” on their most successful traders, taxing their profits up to 20%. This runs contrary to typical volume rebate schemes where the more one trades, the smaller the transaction costs one incurs. The company claims the tax is to offset the cost of bringing new punters to the platform, but appears to outsiders as a clear move to increase revenue taking advantage of Betfair’s position as a monopoly.
• Expensive transaction costs: Betfair takes 5% of traders’ winnings. If a trader bets £100 and wins £1000, Betfair will charge £50 for the transaction. This is very expensive in a world of $8 online stock executions. As betting exchanges become more financial in nature, these transaction costs will shrink substantially.
• Market Size and Competition: As Greg Wood from the Guardian wrote recently, horse racing liquidity has hit a ceiling. Will Betfair be able to maintain the revenue growth? With high costs and a smaller profit margin than Paddy Power, Betfair has found itself in a bit of “grow or die” situation. It will need to find ways to entice more customers to join its platform and spend their betting dollars with them. Betfair is looking to new sports – particularly football – and overseas markets like the US, China and India as opportunities for growth.
• Headcount: Betfair has a tech team close to 500 people. While there is strength in numbers at times, the most successful tech projects in history started with small, nimble teams. The more tech people involved on a product, the less agile a company can be. Adapting to changing tech trends can be a crucial ingredient to remaining competitive in today’s internet startup world.

The impending Betfair IPO is an exciting time for the betting industry, the UK tech scene and for the founders Ed Wray and Andrew Black. They have been truly disruptive in an old industry. It’s something to celebrate and my hat is off to them for building a valuable company.