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Betfair, the online person-to-person betting exchange, is looking to list on the Main Market of the London Stock Exchange on 22nd October.

More than half of Betfair’s major shareholders, board members and management team are planning to sell shares on flotation, although no new shares will be issued as part of the listing. The company is targeting a market capitalisation of between approximately £1.16 billion and £1.48 billion, a level which would put it firmly in the FTSE 250.

Operations

Launched in 2000, Betfair pioneered online person-to-person sports betting by developing a market place which allows customers to bet at odds sought by themselves, or offered by other customers – thus eliminating the need for a traditional bookmaker. Bets are only accepted if the full risk of each can be matched with another customer or a set of customers with the opposite view. Betfair generates revenue on its Betting Exchange by charging a commission (between 2-5%) on a customer’s net winnings. The group also offers a range of other sports betting products, casino games and poker. These businesses together comprise the group’s “Core Betfair” offering. In the year to 30th April 2010, Betfair processed on average more than 5 million transactions per day – more than all European stock exchanges combined.

The firm also owns a 73.5% holding in LMAX, which has developed an exchange platform for online retail financial trading that has evolved from Betfair’s exchange technology. LMAX was originally established by Betfair in 2007 and has invested significant resources since then in developing its proprietary exchange, with a launch expected to take place in the final calendar quarter of 2010.

Betfair also owns Betfair US, which comprises TVG, a licensed US horse racing wagering and television broadcasting business, and a development office in San Francisco. LMX and Betfair US together comprise Betfair’s “Other Investments” segment. In addition, Betfair has a 50% shareholding in Betfair Australia, a joint venture which operates a licensed betting exchange business in Australia.

Business Development

The directors believe that admission will make the company’s international expansion easier by giving it more credibility with foreign regulators. It will also give the company more flexibility to take part in industry consolidation, while helping it incentivise and retain staff. Furthermore, it will provide ongoing flexibility and liquidity for existing shareholders.

Management

Edward Wray, non-executive chairman, is the co-founder of the Betfair Group and was chief executive until 2003, after which he moved to Australia to set up Betfair’s Australian joint venture. He took over as chairman in 2006 and is now based in the UK. Prior to founding Betfair, he spent eight years at J.P. Morgan & Co. as a vice president in the debt capital markets and derivatives area. He has been a director of Betfair since August 1999.

Andrew Black, non-executive director, is also the co-founder of Betfair, having devised the company’s betting exchange model. Black was a professional gambler but also worked in various roles for Serco, the Ministry of Defence, Boxall Asset Management and Track Data Corporation. He has been a director of Betfair since August 1999. Black will retire as a director at the company’s AGM to be held on 6th October 2010.

David Yu, chief-executive officer, joined the Betfair Group as chief technology officer in 2001 and also held the position of chief operating officer prior to his appointment as chief executive officer in 2006. He was previously vice president for Alta Vista’s e-Commerce and International divisions. He has spent almost 20 years working in technology, mainly for internet companies.

Financials

For the year ended 30th April 2010, group revenue rose by 13.2% to £340.9 million. This reflected a combination of growth delivered by the Core Betfair offering, driven by the Betting Exchange, together will the effect of including a full year of TVG’s revenue following its acquisition in January 2009. Pre-tax profit fell from £47.5 million to £17.8 million, primarily as a result of the planned investments made in both Core Betfair and Other Investments. Adjusted EBITDA was £53.5 million.

On the balance sheet, the firm held £150.9 million in cash at the period end, up from £133.4 million 12 months earlier, and no debt. In addition, Betfair held £284 million of customer funds at the same date. Current assets at the year-end exceeded current liabilities by £58.37 million.

Since the year end, Core Betfair has grown strongly, benefiting especially from the 2010 FIFA World Cup. In the three months to 31st July 2010 total Core Betfair revenue grew by 22% to £87 million. The group has also delivered further progress on its growth strategy, including FSA authorisation for the LMAX exchange platform in July 2010, together with an acquisition by Goldman Sachs of a 12.5% shareholding in LMAX. Furthermore, it has also migrated its poker product to the Ongame network in July 2010 as well as its web-based casino product to Playtech in August 2010. Overall, the business has made a positive start to the year with a strong performance in sports and games and a steady performance in poker. The business is continuing to perform in line with the directors’ expectations and they view the outlook for the current financial year with confidence.

Assessment

Betfair has had a very successful existence, and the IPO will make Wray and Black very rich men. However, the potential valuation rumoured seems to be a bit on the high side. Nonetheless, the group should be a much easier sell than Ocado. After all, this online enterprise actually makes money and has revolutionised its industry.

We think that Betfair warrants a premium rating due to its strong market position and formidable balance sheet. But the top price of £1.5 billion would rate the firm at a rather toppy 30 times historic EBITDA. In our opinion a valuation of around £1 billion, or around 20 times EBITDA, would be a reasonable entry price. However, with the issue unlikely to be offered to retail investors you will have to wait until the shares start trading in the secondary market to snap them up. Buy on weakness.