Peermont investors to bask in Sun deal

The announcement last week that Sun International would buy Peermont Global for R9.4-billion took the market by surprise, but Sun International had for some time had low-key, on-off discussions about buying South Africa's third-largest casino group.

"Sun International had a look at Peermont many years ago. It was always a case of price, and other issues had to be sorted out," said De Wet Schutte, research analyst at Avior Research.

"At various stages they've had talks with Peermont ... the deal has been in the making for a number of years. It was a matter of getting the timing right, also because Sun International has been quite active on the deal-making front over the past two years."

Sun International is the country's second-largest casino and hotel operator after Tsogo Sun. But CEO Graeme Stephens, who has a wealth of investment banking experience, has been bulking up the business, refining its corporate structure and cutting costs since he took the hot seat two years ago.

Sun International is now trying to reduce its exposure to the Western Cape (which represents 27% of its profits), increase its contribution from Gauteng (which has the highest gambling spend in South Africa) and expand in Latin America. It wants fewer, larger, quality assets and plans to dispose of smaller assets over time.

Peermont has had its own challenges since it was bought by a private equity consortium led by the Mineworkers Investment Company (MIC) in 2007 for R7.3-billion and delisted from the JSE. This meant the casino group, which owned Emperors Palace near OR Tambo Airport and 12 other leisure complexes, had to repay a crippling amount taken to make the deal happen.

In 2013, it restructured this debt, swapping from euro-denominated to rand debt to cut costs. Last April, Peermont declared the completion of the restructuring with a huge sigh of relief. Because it's not listed, there is limited insight into Peermont's operations.

But gaming expert Uys Meyer, the CEO of Blue Alpha Asset Management, says he believes the Sun International deal is a great one for Peermont investors.

For years, speculation has swirled that Peermont would be bought. Grand Parade Investments (formed in 1997 as Sun International's primary BEE partner) had looked at Peermont too, but insiders say Grand Parade walked away from the deal.

Sun International, however, will make a snug home for the company. Peermont will slot neatly into Sun International's portfolio, which includes 28 hotels and 12 casinos, including Sun City near Rustenburg.

The price tag on the deal makes it the biggest since Tsogo "merged" with Gold Reef Resorts in 2012 to create a R20-billion giant.

But there is concern that this buyout will create a situation where there are just two heavyweight casino operators, Sun International and Tsogo Sun, which will have far too much pricing power in the industry.

Schutte says South African casinos are based on a monopoly sort of model. "Our casinos are not really earmarked to compete with each other. It's about consolidation in the industry - that typically happens when an industry is mature," said Schutte.

It's an industry driven by discretionary spending, especially from the rich, though the outlook is anything but optimistic. "But as long as the economy grows and more people shift up the LSM ladder, we ought to have continued growth," he said.

There is clearly competition concern about the deal, and one expert says the environment has changed markedly since Tsogo was given the green light to conclude the Gold Reef deal.

Reuben Beelders, chief investment officer at Gryphon Asset Management, says that although the deal effectively reduces the sector to two main players, this is hardly unique in South Africa.

"This is really just a takeover of Emperors Palace," said Beelders. Emperors contributed R872-million to Peermont's ebitda in its latest reporting period, out of a total of R1.2-billion.

Crucially, it seems that the gambling boards won't block it.

Of course, another reason for Sun International to do this deal is that Peermont objected to its plan to "relocate" its licence for its Morula Sun casino from the outskirts of Mabopane to Menlyn in Pretoria. Peermont has now agreed to withdraw this objection. For investors, it's unclear which of the high rollers, Tsogo or Sun International, will be a better bet.

They differ in numerous ways: Tsogo has a much bigger hotel business than Sun International with more than 90 hotels.

By contrast, Sun International has been focusing on becoming an "emerging-market casino operator", consolidating its position in South Africa while selling properties that do not fit.

Also, Sun International is expanding outside Africa, even selling some of its African properties while Tsogo is increasing its African exposure.

"It's all about hanging on to margins in a difficult revenue environment. Our sense is that Sun International still has a bit of room to move whereas Tsogo is a higher-margin business and as it is is an efficient operation," said Schutte.

Sun International's share price is up nearly 40% over the past year with a market cap of R14.9-billion. Tsogo's share price edged up 1% over the past year, yielding a market value of R26.7-billion. The group is committing more than R5-billion to prop up its casino presence in the medium term.

The gaming industry is in a low-growth phase, but there is still money to be made. South Africa's gross gambling revenue - the amounts bet, minus the winnings paid out - will increase 35% to R29.5-billion in the five years to 2018, says a report by PwC published last year. Casino gambling would be the biggest contributor, at R20-billion, said the report.