Assignment 2, Step 7
My company is GVC Holdings PLC and to be honest, it feels like I got a particularly hard company to use for this assignment. As this company has proprietary technology that it uses in its subsidiary companies, which offer online gambling and related services rather than a specific product.
I am basing this step of the assignment on a subsidiary company of GVC Holdings PLC being, Ladbrokes.
Ladbrokes do not charge a subscription fee or a membership fee for their platform – they simply make profit off poor bets and internal investments and other strategies. Using minimum spends and limiting betting win amounts, they use incentives e.g. bet match offers, bet back tools, or deposit match offers to keep punters using their platform and betting.
Because of this, I do not have much of a product mix to work with, as I would like. However, I will be using made up numbers for this part of the assignment to demonstrate my understanding, knowing that this does not reflect accurately what the actual numbers would be for this company.
Simplified product mix decision: contribution margins
Contribution Margin is the difference between the Sales Revenue and the Variable Costs.
Variable costs are the costs to make the product and the selling price is what people purchase the item or product/service for.
I have assumed for this exercise that the selling price of racing betting is $10 with variable costs of $5 therefore the contribution margin would be $5.
I have assumed for this exercise that the selling price of sports betting is $17 with variable costs of $10 therefore the contribution margin would be $7.
I have assumed for this exercise that the selling price of novelty betting is $25 with variable costs of $30 therefore the contribution margin would be negative $5.
It is important to note that any product that has a negative contribution margin should be immediately removed from the product mix decision.
These services are betting platforms for real life sports, racing and novelty events that happen on a regular basis, a market constraint at present for this company could be the covid-19 pandemic due to a potential lack of sporting events.
A potential resource constraint could be a lack of employees who are able to work from home resulting in a lack of development of their incentives and online technology.
With all of the types of betting – the punter is limited to betting on the number of horses on the track or the number of teams on the field so the betting circumstances are not unlimited and this could change the contribution model.
Providing the punters with a variety of betting options provides a variety of interest for the punters to keep them coming back, much like their betting incentives, so this would be why they offer a large range of things to bet on.
Assignment 2, Step 8
Please see in a separate excel spreadsheet – the ratios tab.
Commentary on spreadsheet ratios tab
So when undertaking this task of the assignment, this is the step that I feared the most, however, excitingly I was able to follow allow with Maria’s video step by step and feel like I understood and followed all of the deductions she made regarding each line of her example and I was able to link my ratios tab with the original financial statements and the restated financial statements to complete the step. My company was GVC Holdings PLC, which I have found to be difficult that they always seem to be making a loss (even though they have positive annual report statements about growth). I comment on the ratios as below:
GVC Holdings PLC have a negative Profit Margin for all four years – the profit margin is a measure for every dollar of sale, how much are we turning into profit (the higher the positive number the better), it did improve from its 2016 -0.2% back to zero for two years, however, in 2019 it was back to -0.1%.
GVC Holding’s return on assets was improving from its -7.6% in 2016 figure it but went back down to -5.2% in 2019 which tells us that for every dollar of asset, they are not turning it into a great percentage of profit.
From these negative profitability ratios, GVC Holdings PLC doesn’t appear to be in great shape and further analysis is needed on the other ratios we have worked out.
Under the liquidity ratios, the Days of Inventory could not be worked out as GVC Holdings PLC does not have inventory, it is a service based company that deals with proprietary technology mainly online services so I have noted a N/A in the spreadsheet to represent this. Which was a shame as this was a formula I could easily comprehend telling us how long it takes to turn inventory into sales, expressed by:
(average) inventory
(average) daily costs of sale
The next line of the spreadsheet was Total Asset Turnover Ratio, which tells us how efficiently the company is utilising assets to generate sales. These numbers on the spreadsheet appear to be giving a positive indication being above zero for a nice change.
I note that for the Current Ratio, which reflects on liquidity (do we have enough cash and short term assets to cover short term liability) – there was a jump from -44 to -71 from the 2016 year to the 2017 year, I noted that in 2016, the company acquired bwin.party with no large acquisitions occurring in 2017. In 2018, the company acquired Ladbrokes Coral, which would have impacted on the availability of short-term cash and assets.
I did find the next set of ratios/figures to be the most interesting as they reflect on how the company is geared (are they more funded by debt or equity).
The Equity Ratio tells the reader that this company is mainly funded by equity as its ratio’s are high and its Debt/Equity Ratio is negative rather high numbers as well.
The market ratios were all zero for GVC Holdings PLC in this exercise as they have been making losses and even in the 2019 Annual Report, the Earnings Per Share were noted as zero. In the spreadsheet the Price Earnings Ratio has an error against the formula as you cannot divide a number by zero and I wanted to show that I knew the formula however the numbers are zero. I hope this is correct anyway.
The ratios based on the restated financial statements had return on equity as positive return for shareholders in 2016, 2017 and 2018 but a negative return in 2019.
The Return on Net Operating assets (RNOA) for the restated financial statements is interestingly high positive numbers for 2016 and 2017 then is low for 2018 and a negative for 2019. Compared to the ROA figures from the original financial statements, which were all negative numbers with a trend of improving then diving again. We understand from the study guide that the accounting drivers for RNOA are Asset Turnover and Profit Margin which we want quick figures for. Because the firm’s net profit margin has relatively stayed the same ranging from -2 to zero, I do have to wonder if the acquisitions it has made over these four years has effected these numbers as it purchased bwin.party and Ladbrokes Coral within that time period and created and issued a huge amount of shares in that time.
We understand the drivers of past economic profit to be Return on Net Operating Assets (RNOA), Net Operating Assets (NOA) and Cost of Capital. The NOA and the return on these net-operating assets are important to understand the Economic Profit of a firm and we all know the bottom line any firm is concerned with is economic profit, can we afford to stay in business and keep running?
The economic profit of a firm takes into consideration the opportunity cost of the next best alternative that could have been invested in. The economic profit for the spreadsheet is expressed as the formula:
Economic profit = (RNOA – WACC) x NOA
The weighted cost of capital was not something that GVC Holdings PLC has provided a specific figure for in their annual reports so for this exercise in the spreadsheet the figure of 8% was used as instructed in the assignment task not as per the video I followed by Maria, I thought that as my company seemed to have a lot of losses and negative numbers that I would use the lower amount to reflect more accurately. Again, I am hoping this is correct.
Overall, this task of the assignment was interesting to complete and was more straightforward than I originally anticipated. In saying that, I am still not sure if all of my figures are correct but I believe it is on the right track to reflecting, at least a little, some realities of the firm.
Assignment 2, Step 9
This step of the assignment requires the creation of two hypothetical alternative capital investment opportunities; please forgive my lack of imagination with making up my cash flows and investment ideas.
As GVC Holdings PLC provides an online gambling service, I have to think that possible investment opportunities would be steered towards improving their proprietary technology and more incentives to get people using their services.
GVC Holdings PLC is considering developing virtual reality technology for streaming services, in order to make this viable they are considering opening virtual reality viewing on horse races (Option 1) or virtual reality viewing on their poker platform (option 2) as a subscription service to view one of these events live. Currently GVC Holdings does not offer live streaming of their betting events in such a way.
GVC Holdings will be considering offering this virtual reality subscription whilst it is profitable to do so. Market demand would be linked to the novelty of the service, putting GVC Holdings in front of its competition by offering a service on the forefront of technology trends by also adding another service to their portfolio. The timeline allocated to these projects would be 10 years.
The cash flow generated for the virtual reality poker streaming service would be from fans who wish to view live games in a VR space, paying a subscription fee to stream.
The Cash flow generated for the virtual reality horse racing streaming service would be from fans of horse racing and punters who wish to view live races in a VR space from the view of a horse, again paying a subscription fee to stream.
At the end of the period both options could just be closed down if required, with the software being sold for a profit (perhaps $1,000,000 for each). Further cash flow could be made from selling advertising space inside the VR space.
Other potential costs could be obtaining any appropriate licenses necessary for the live events, servers and employee fees for developers, which has been included in the initial investment amount for each project.
The investment would be confirmed on 1 January 2020, leaving the cash flow projected to be collected on 31 December each year in line with the financial year-end for the company using GBP as the currency in line with their main operations.
DISCOUNT RATE IS 8%
Please refer to the excel spreadsheet where the Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, Cumulative Cash Flows have been worked out, showing the above cash flows table in the workings tab of the spreadsheet.
Recommendation
As per the attached spreadsheet, I would be recommending that GVC Holdings PLC choose the VR Streaming Service for the Poker Games option (Option 2) as it had an initial investment lower than the Horse Racing VR Streaming Option (Option 1), it has a shorted payback period of only 4 years and roughly 69 days rather than the 6 years and 14 days of the Option 1, with potential for higher profits, having 115 million rather than the 78 million the Option 1 as per the projected future cash flows in the spreadsheet by Year 10.
The Net Present Value method is the most widely used method and we know that a positive NPV is a sign of a good investment opportunity, which both options do have that positive NPV. The Internal Rate of Return is the rate of return when the rate of return is 0, which again was a high positive for both options. Option 2 is clearly the most beneficial to the firm though, as the IRR should always be higher than the required rate of return, which in the case we assume is equal to the discounted rate of 8% (which both options actually deliver on). This is why other items are apart of the decision e.g. the buyback period and the initial investment amount so even though both are viable options Option 2 adds the most value to the firm and is the stronger choice for increasing wealth faster (as we know a dollar today is worth more than a dollar tomorrow)– Option 2 has a higher percentage and has demonstrated to be the better option for GVC Holdings PLC to proceed with.
Assignment 2, Step 10
I will be adding some peer reviews to this section shortly and reflecting on some feedback that I receive as well. Watch this space.
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