Tatts Group Limited (ASX: TTS) shares have fallen around 17% so far this year and are currently trading at $3.65.
According to recently released research by listed investment company (LIC) Sandon Capital Investments Ltd (ASX: SNC), Tatts Group's value could be greater than $5.50 a share.
Here's Sandon's investment thesis for Tatts:
- Sandon believes Tatts is trading at a significant discount to the sum-of-its parts.
- Those "parts" are a Wagering business which contributed 28% of financial year (FY) 2015 earnings before interest and tax (EBIT) to the group and a Lotteries business which contributed 60% of FY 2015 group EBIT.
- Sandon argues that the Wagering business has strategic corporate appeal and should be separated from the group.
- Meanwhile, Sandon views the Lotteries business as akin to an infrastructure asset that as a stand-alone company would be valued by the market accordingly.
- The LIC manager has suggested that the best way to unlock value for shareholders is for Tatts to undertake a demerger.
An infrastructure asset in disguise
One of the key points to Sandon's thesis is the similarities between Tatts' Lotteries business and that of an infrastructure business.
For example, Sandon estimates that approximately 75% of Lotteries EBIT comes from licenses that run for at least 35 years. That's akin to the monopoly-like concessions firms such as Transurban Group (ASX: TCL) and Sydney Airport Holdings Ltd (ASX: SYD) enjoy on their respective assets.
Similarly, Sandon suggests that the cash flows from lotteries have low economic sensitivities, are dependable and easily forecastable – much like other infrastructure assets.
Foolish takeaway
The valuation case laid out by Sandon suggests that the market is not valuing Tatts on comparable multiples to infrastructure stocks. A demerger of Tatts is suggested as a way to awaken the market to this apparent valuation discount.
