At the races: Tony Harris, the finance director of Arena Leisure, speaks to Stockopedia

For Tony Harris, the economic downturn had a relatively muted impact on listed race course operator Arena Leisure (LON:ARE), thanks to the hardy nature of UK race goers. For the company’s finance director, more concerning is the parlous state of the racing levy – the tax on bookies that is channelled back into racecourses – which is receding fast as operators move offshore. Nevertheless, Harris is confident that Arena is well placed to flourish, regardless of how the industry settles its funding problems and last week reported interim revenues broadly flat at £30.1m while pre-tax profits soared by 25% to £2.0m. With the recent opening of a major new hotel complex at Arena’s course at Lingfield Park, combined with rising revenues from broadcasting rights, Harris is now eyeing even more portfolio upgrades and expansion.

Tony, could you just give us a summary of the Arena Leisure business and the proportion of UK racing that you host?

Arena Leisure is a UK stockmarket listed company that has horse racing very much at its heart. We own and operate seven race courses. There are 60 race courses in the UK but on our seven we stage more than a quarter of all the UK’s racing fixtures. We can do that because we own three out of the four UK all-weather tracks, including Lingfield, Southwell and Wolverhampton, with the Jockey Club owning the fourth at Kempton. It is really not unusual for an all-weather track to race 100 times a year as opposed to a turf track where obviously the grass needs to recover and so they may only race up to 30 times in a year.

Arena as a business, which is seen as very much at the commercial end of the horse race course business, has had a strategy over the last few years of developing our operational business. We have done that through a number of initiatives, particularly bringing our own catering operation in-house. We’ve done that now for three years very successfully and it’s growing very, very well. We are also exploiting some of the real estate opportunities on our 1,000 acres of land where we have been successful in obtaining planning permission for hotels at Lingfield Park, Wolverhampton and at Doncaster. At Wolverhampton we have planning permission for a casino.

Wolverhampton and Doncaster are projects still to be built out but the exciting news in this half year was we opened the Lingfield Park Marriott Hotel on May 10. That was a £30m investment, £26m going into the hotel itself and £4m into the race course. We would expect that to generate a 10% return on investment as it reaches stabilisation, and that’s going to be towards the end of 2012 and into 2013.

The operating business has been impacted by the economic downturn although it has still been relatively resilient. It has been resilient because race goers are loyal followers and they have continued to spend and come racing, which has been great. In addition, our income streams, both through the levy on bookmakers and through our media rights income, have increased, particularly in the first half of this year. We contract out media rights in two ways; one, into High Street bookmakers’ shops in the UK but also internationally through our associate company, At The Races.

What has been impacted in the industry in the last couple of years has been private and corporate hospitality, which we’ve seen drop off from highs of 2007 down to a low in 2009. It’s really pleasing to see that business come back in the first half of the year. Private corporate hospitality numbers are up 13% year-on-year for the first six months of this year and that is a trend which I think we’ll see continue through the second half of the year.

The second half of the year is much more important in that market for two reasons; one, the summer season, particularly at race courses like Royal Windsor. Royal Windsor figures through July have been encouraging, 14% up on average attendance, 7% on private corporate hospitality. But the big event in the Arena calendar is the St Ledger at Doncaster. That’s the oldest classic race in the racing calendar; it dates back to 1776. We’ll get 30,000 people come on the Saturday of the St Ledger Festival and 60,000 people come in total over the four days. So that’s the biggest event in the second half of the year. Certainly when that’s completed and we issue our third quarter interim management statement, we have really good clarity of where the year’s going to come out. We tend to be quite cautious at this stage about the second half of the year but at this stage, ‘cautiously optimistic’ I would say.

How much of an impact does that weather have on the business?

Arena’s pretty resilient because of our all-weather tracks. We had 11 abandonments but British Racing likes to get some racing on during the bad weather period and there aren’t many places they can put it because there aren’t many all-weather tracks, so we tend to pick up almost as much as we lose. So we picked up extra fixtures, which the racing authorities put on in order to get some racing going through that bad weather period. So the profit impact was negligible for us.

Can you tell me about the horse racing levy? Who pays it to who and why? Why is it being reduced and what are the consequences of that?

That’s succinctly put. I wish I could answer that as succinctly, but I’ll try. Up until 1964 you could only bet on horse racing on race courses, and in 1964 the law changed and basically High Street bookmakers became legal and you could bet on horse racing off race courses. Of course, that had a major impact on profitability of race courses. In order to compensate racing for that lost income the government introduced a levy of tax on bookmakers to fund a proportion of horse racing and that is the levy scheme that we have today. That levy has typically been, over the last few years, 10% of all bookmakers’ profits on UK horse racing.

What has happened in recent years is a number of things. The model of bookmakers has changed and many have sought to reduce the way that they’re captured for tax. What we’ve seen with the levy is a number of factors; one, betting exchanges, which are not part of the levy net, have increased their proportion of horse race gambling. They have increased it as well as smaller bookmakers have put their business onto betting exchanges and they’re effectively running a business, but they’re not paying levy and they’re not paying tax.

The second impact has been bookmakers moving increasing amounts of their business off-shore. William Hill has just announced that it is moving its telephone betting offshore and last year moved its internet betting to Gibraltar. So that, again, doesn’t get caught by the levy. Then there are some mathematical calculation thresholds in the way the bookmakers pay the levy, which also enable them to avoid or mitigate the amounts that they pay. So the long and the short of it is that the way that the levy is structured today is in disrepair and is no longer appropriate for the way that bookmaking on horse racing works in the current market. So what we’ve seen is the levy reduce considerably. At the margin that has resulted in reduced prize money, and you can see that in our revenues this year, but it hasn’t impacted profits because as prize money reduces as it gets passed through to what is actually paid on races. Now that’s a very emotive subject and over time you could see that there is considerable pressure on race courses to maybe make up the shortfall for some of that prize money. As a group, we will pay what we need to pay and what is fair and reasonable in order to get the field sizes to race in our fixtures.

On the levy funding itself, it covers much of the costs of racing fixtures and what we might see, going forward, and this is the big uncertainty in the market, is either a reduced number of fixtures or reduced funding across fixtures. Now at the moment it is uncertain how the levy and the racing industry is going to deal with that but what I would say is that Arena is particularly well placed to manage the situation because of our mix of fixtures and particularly because of our all-weather. The reason for that is because the majority of the fixtures that we run are profitable for bookmakers and for the levy. In other words, they generate more levy than they consume. Their 10% share is more than they are receiving in prize money and fixture costs.

So in summary, it’s a very concerning situation for the industry as a whole and the levy is undoubtedly in need of reform but whichever way it goes, Arena is certainly well placed to manage the situation.

When it comes to expansion, most companies will look to organic and acquisitive growth. How important is it for you to keep reinvesting in your portfolio and in what ways can you expand the group?

In terms of investing in our existing assets the Lingfield Park Marriott is an excellent example of where we are able to expand the entire leisure and business offering that we have. The truth there is we’re making the race course a 365 day per year asset rather than, in case of the all-weather track, a 100 day per year asset or, in turf track, a 30 day per year asset and we’ll certainly continue to do that building out the planning consent that we have at Wolverhampton and at Doncaster.

At Folkestone, that’s the one race course where there’s opportunity for a residential development and that’s really exciting. Firstly, it will protect the race course. That race course is not particularly profitable; it’s a marginal business at the best of times at the moment. So a redevelopment scheme that incorporates housing will enable part of the profits of that development to be recycled back into a complete regeneration of the race course. So that, if you like, is the quid pro quo for the local community in granting a planning consent. As that process goes through consultation in Shepway, which is the local council, that’s certainly the linkage which is very clearly being made both by us but also by the local authority and residents. So we’re optimistic that that will come to fruition in due course.

Acquisitions are always a bit difficult. We’ve never set out strategy to acquire more race courses. It really becomes a difficult strategy to bring to fruition because race course owners, on the whole, tend to own trophy assets and, therefore, their price expectation tends to be out of kilter with the economic multiples that you’d expect to pay for a leisure business. We have the ability and we have the capability to absorb new race courses and if they came up at the right price we would certainly do it but we don’t set it out as a core strategy.

And what are your expectations for the performance of the business during the second half of the year?

I think we’re really pleased with the way the operational business has progressed. We continue to run a tight operational business and the income streams coming through from At The Races are really bolstering what is a good operational performance which, at the moment, we expect the trend to continue in the second half of the year.