ESG: STAKEHOLDER RISKS  Spotlight on Woolworths Limited  

 

 

 

Authored  by  Mark  Barraclough    

Is Australia’s most valuable brand gambling with shareholder value?

The case for reform:

Woolworths’  current  heavy  investment  in  high  loss  poker  machines  is  potentially  risky  business  due  to  the  high  social  cost  of  the  industry,  particularly  as  it  relates  to  problem  gambling.  

The  implications  of  a  large  and  growing  investment  in  electronic  gaming  machines  that  cause  significant  social  harm  could  range  from  political  or  community  obstacles  to  brand  contamination  of  not  only  the  Woolworths  brand  but  also  related  potentially  more  vulnerable  brands  such  as  Dan  Murphy’s,  BWS  and  Thomas  Dux.  

To  date,  self-­‐regulation  by  WOW  appears  to  have  failed  to  the  extent  that  it  is  not  transparent  or  demonstrably  effective.  The  reforms  called  for  by  the  Productivity  Commission,  independent  experts,  multiple  politicians,  advocacy  groups  such  as  GetUp  and  individual  customers  and  shareholders  go  beyond  where  WOW  is  currently  willing  to  go.  This  is  why  GetUp  members  who  are  also  WOW  shareholders  have  called  for  engagement,  disclosure  and  reform  by  calling  for  an  Extraordinary  General  Meeting  of  WOW.  These  calls  for  reform  have  been  public,  sustained  and  of  significant  national  profile  and  pose  a  legitimate  threat  to  business  as  usual  by  management  and  the  board.    

To  date,  WOW  has  not  disputed  shareholder  claims  that  problem  gamblers’  contributions  to  gaming  revenues  are  estimated  at  least  40%  of  total  gaming  revenues,  a  statistic  that  highlights  how  a  good  deal  more  needs  to  be  done  to  reduce  the  harm  being  caused  by  high  velocity  poker  machines.  

GetUp  questions  whether  the  lack  of  transparency,  oversight  and  engagement  on  such  an  important  issue  of  social  justice  is  indicative  of  wider  issues  within  WOW’s  strategic  capability  to  prioritise  and  execute  decisions  based  on  its  shareholders’  interests.  In  an  effort  to  chase  further  profits  to  maintain  shareholder  value,  Woolworths  through  its  investment  in  ALH  is  diving  even  deeper  into  the  poker  machine  business  without  addressing  the  risks  these  operations  pose  to  its  core  operations.    

This  report  will  show  that  Woolworths  has  a  significant  stake  in  the  gambling  industry  –earning  a  conservative  estimate  of  approximately  $92  million  in  EBIT  from  its  poker  machine  interests  in  FY11.  An  August  2nd,  2012  report  by  Citi  Group  put  that  number  at  $139  million.    

There  are  many  instances  of  companies  embracing  pro-­‐social  reforms  especially  when  those  reforms  are  backed  by  membership  or  stakeholder  alliances  with  vocal  and  impactful  industry,  political  and  community  groups  with  a  longstanding  commitment  to  change.  Embracing  responsible  social  reform  can  lead  to  the  passage  of  legislative  reform  that  would  serve  a  greater  good  and  apply  to  competitors,  especially  if  the  EGM  reaches  a  national  profile  where  it  could  act  as  a  catalyst  for  even  further  public  support  for  reform.  

The  below  report  was  commissioned  by  GetUp  and  written  by  independent  ESG  analyst  Mark  Barraclough,  formerly  of  MSCI  and  RiskMetrics.    The  report  lays  out  the  growing  stakeholder  risks  incurred  by  WOW’s  ongoing  gambling  interests  specifically  as  they  relate  to  electronic  gaming  machines.  

 

Scope of Report:

• Growing  Stakeholder  Risk  Over  Gambling  Interests:    With  pro  poker  machine  reform  organisations  frustrated  by  the  Gillard  Government’s  watering  down  of  poker  machine  reform  legislation,  social  activist  organisations  such  as  Getup  have  turned  attention  to  the  largest  operator  of  poker  machines  in  Australia,  Woolworths  Limited  (Woolworths).  

• This  report  examines  Woolworths’  risk  exposure  over  its  involvement  in  the  poker  machine  business  and  explores  the  potential  risks  to  shareholder  value  should  this  issue  continue  to  gather  momentum.  

 

Recent Developments: Engagement  Becomes  Adversarial  On  the  25th  June  2012  Woolworths’  shareholders  and  Getup  members  submitted  requests  to  hold  an  Extraordinary  General  Meeting  (EGM)  to  vote  on  motions  seeking  to  amend  the  company's  constitution  to  prevent  it  from  owning  or  operating  poker  machines  with  more  than  a  $1  maximum  bet  from  2016.  The  resolution  would  also  impose  a  revenue  limit  of  $120  per  hour  and  restrict  the  use  of  gaming  machines  to  no  more  than  18  hours  a  day  from  2016.  

On  3rd  July  2012  Woolworths  took  the  matter  to  the  Federal  Court  requesting  that  the  motions  be  rolled  into  its  AGM  in  November.  While  the  Federal  Court  decided  to  defer  the  resolutions  until  November,  Woolworths  withdrew  its  request  to  call  off  the  EGM.  

Meanwhile,  GetUp  filed  complaints  with  the  Australian  Stock  Exchange  and  the  Australian  Securities  and  Investments  Commission  arguing  that  Woolworths  has  yet  to  notify  shareholders  of  the  request  for  an  EGM.  

With  engagement  between  Woolworths  and  Getup  becoming  increasingly  adversarial,  there  is  potential  for  this  stakeholder  issue  to  expand  to  more  public  forms  of  agitation  ahead  of  the  EGM  and  beyond.  With  over  600  000  members  across  Australia  and  with  over  80  000  of  its  members  already  signing  a  petition  supporting  the  campaign,  Getup  is  well  positioned  to  pursue  its  agenda.    

Under  these  circumstances,  the  question  is  how  much  could  this  issue  potentially  damage  the  Woolworths  brand,  and  conversely,  could  adopting  the  suggested  reforms  be  financially  justified  purely  from  a  strategic  risk  management  perspective?      

 

 

 

Can Woolworths Carry The Public Debate Over $1 betting limits? If  one  aligns  the  arguments  for  and  against  the  suggested  reforms  the  conclusion  is  no.      

Social  activist  groups  pushing  for  reform  make  a  cogent  case  for  why  lower  betting  limits  are  warranted  and  their  arguments  are  in  line  with  the  Productivity  Commission  Inquiry  into  Gambling  2010  recommendations.    

The  introduction  of  $1  betting  limits  is  also  well  supported  by  a  broad  coalition  of  Church  groups  and  social  welfare  organisations.      

The  logic  behind  the  proposal  to  introduce  lower  betting  limits  is  simple  to  understand.  Currently  many  ‘high  velocity’  poker  machines  allow  gamblers  to  lose  up  to  $1200  an  hour.  Lowering  the  betting  limit  from  $10  per  spin  (or  $5  in  Victoria)  to  $1  per  button  press  will  dramatically  slow  the  process  whereby  problem  gamblers  can  lose  substantial  sums  of  money  and  get  into  a  position  where  they  are  chasing  their  losses.    Once  limited  in  this  way  poker  machines  will  also  not  be  able  to  take  more  than  $120  in  any  given  hour.    

The  Productivity  Commission  Inquiry  into  Gambling  proposed  both  the  introduction  of  $1  betting  limits  and  a  trial  of  mandatory  pre-­‐commitment  technology  as  a  means  to  minimising  the  harm  caused  by  high  velocity  poker  machines.  

From  the  Productivity  Commission  Draft  Report  2010  Chapter  11:  

“There  is  a  strong  case  on  net  social  benefit  grounds  for  a  much  lower  bet  limit:  a  limit  of  around  $1  (which  would  still  be  equivalent  to  an  average  $120  per  hour  of  play  if  the  gambler  plays  quickly)  would  reduce  harm  from  high  intensity  gambling  without  unduly  affecting  recreational  gamblers  (who  typically  bet  at  quite  low  levels).”  

By  comparison,  Woolworths  appears  to  acknowledge  that  there  is  a  “serious  problem”  which  needs  to  be  addressed  and  yet  its  majority  owned  ALH  Group  opposes  lower  betting  limits.  

At  its  annual  general  meeting  in  2011  the  Woolworths  chairman,  James  Strong  stated  :  “We  do  not  deny  that  there  is  a  serious  problem  about  people  who  have  gambling  problems  “.    The  company  also  states  in  public  releases  that  “Woolworths  absolutely  supports  proven  reforms  that  will  genuinely  help  problem  gamblers  without  preventing  responsible  players  enjoying  a  flutter.”      

In  its  submission  responding  to  the  Productivity  Commission  draft  report,  the  ALH  Group  stated  that  its  preferred  outcome  would  be  to  see  further  voluntary  pre-­‐commitment  trials  rolled  out  and  Woolworths  has  stated  it  also  supports  this  initiative.  However,  ALH  Group  is  already  trialling  voluntary  card  based  pre-­‐commitment  at  one  of  its  hotels  in  Queensland  and  reportedly  only    11  %  of  patrons  have  taken  part  in  the  trial.  Voluntary  pre-­‐commitment  has  been  widely  criticised  as  ineffective  because  problem  gamblers  are  unlikely  to  participate,  or  if  they  do,  there  are  a  number  of  ways  they  can  step  around  the  technology  when  it  suits  them.  

Regarding  the  $  1  betting  limit  recommendation,  the  ALH  Group  made  the  following  comment  in  its  response  submission  to  the  Productivity  Commission  draft  report:  

“Even  if  such  policy  measures  could  be  demonstrated  to  have  some  level  of  impact  on  reducing  the  level  of  problem  gambling,  the  benefit  would  be  unlikely  to  be  outweighed  by  the  substantial  detriment  to  recreational  players  and  the  industry  overall  -­‐  thus  imposing  a  social  net  cost.”    

ALH  Group  supplied  no  supporting  evidence  illustrating  what  the  ‘substantial  detriment’  would  be  to  recreational  players,  however  it  did  state  that  such  an  initiative  could  see  a  drop  in  gaming  revenue  of  40%  .  

Another  point  Woolworths  is  making  is  to  emphasise  that  the  company  controls  only  6%  of  the  nation’s  poker  machines.    However,  as  the  largest  operator  of  poker  machines  in  Australia  it  is  difficult  to  see  many  people  agreeing  that  it  is  unreasonable  to  single  Woolworths  out  over  the  issue  of  poker  machine  reform.  

The  fact  is  a  majority  of  the  Australian  population  support  measures  to  reduce  the  harm  being  caused  by  high  velocity  poker  machines  and  this  means  most  people  will  be  sympathetic  to  the  campaign  being  run  by  activist  groups  and  disinclined  to  accept  the  arguments  being  made  by  a  large  corporation  who  profits  from  the  poker  machine  industry.  

A  poll  conducted  by  the  Australian  National  University  in  2011  showed  74%  of  Australians  support  further  initiatives  to  reduce  the  harm  caused  by  poker  machines.  Under  these  circumstances  it  is  difficult  to  see  Woolworths  being  able  to  maintain  its  current  position  and  not  sustain  damage  to  its  brand  as  activist  campaigners  work  to  educate  the  general  public  about  their  involvement  in  the  poker  machine  business.  

*Australian  National  University  Poll  July  2011  

 

The Scope of the Problem. The  Productivity  Commission  Inquiry  into  Gambling  report  of  2010  found*  among  other  things  that:    

Australians  spent  more  than  $19  billion  on  gambling  in  2008-­‐09  and  around  $12  billion  of  this  sum  was  spent  playing  poker  machines.      

Social  costs  stemming  from  problem  gambling  are  estimated  at  $4.7  billion  a  year.  

600,000  Australians  play  poker  machines  on  a  weekly  basis  and  15  per  cent  of  these  regular  gamblers  are  problem  gamblers  and  account  for  40  per  cent  of  expenditure  on  the  pokies.    

One  in  six  people  who  play  the  poker  machines  regularly  have  a  severe  gambling  problem.  

Three-­‐quarters  of  problem  gamblers  have  problems  with  poker  machines.  The  number  is  higher  for  women  –  in  9  out  of  10  cases  poker  machines  are  identified  as  the  cause  of  problems  for  women.  

Some  poker  machines  can  be  played  at  extremely  high  intensity  where  a  gambler  can  lose  $1,200  per  hour.  

People  who  have  a  problem  with  gambling  lose  an  average  of  $21,000  a  year.  Problem  gamblers  and  their  families  have  a  significantly  lower  quality  of  life  and  may  suffer  mental  and  physical  health  problems,  find  it  difficult  to  hold  down  a  job,  and  struggle  to  maintain  relationships.    

(*Productivity  Commission  2010,  Gambling,  Report  no.  50,  Canberra;  and  Productivity  Commission  1999,  Australia’s  Gambling  Industries,  Report  no.  10,  AusInfo,  Canberra)  

 

 

What is the poker machine business worth to Woolworths? Through  its  controlling  75%  interest  in  Australian  Leisure  and  Hospitality  Group  (  ALH  Group),  Woolworths  declared  revenues  from  its  Hotels  segment  of  $1.153  billion  in  FY11  and  earnings  before  interest  and  taxation  (EBIT)  of  $184  million.    In  its  2010-­‐11  annual  report  the  company  did  not  disclose  the  percentage  of  revenue,  or  EBIT  figures,  flowing  directly  from  ALH  Group  poker  machines,  however,  it  did  state  that  ‘gaming’  comparable  sales  were  up  3.1%  yoy  in  Victoria.      

Australian  Bureau  of  Statistic  figures  indicate  that  gaming  revenue  in  hotels  equipped  with  gaming  machines  is  in  the  order  of  28  %  of  gross  revenue.    Therefore  it  can  be  estimated  that  Woolworths  received  revenue  of  conservatively  $322  million  from  its  12000  plus  poker  machines  in  FY11.  In  the  absence  of  company  disclosure,  poker  machines  are  estimated  to  contribute  50%  of  hotel  EBIT  which  means  Woolworths  earned  approximately  $92  million  in  EBIT  from  its  poker  machine  interests  in  FY11.*  

With  Woolworths  group  EBIT  in  2010-­‐11  of  $3276.4  million  poker  machine  EBIT  represents  some  2.8%  of  group  EBIT.  

 

Woolworths  FY  2011  Revenue  Group  Revenue  $54.1  b  

Hotel  Segment  Revenue  $1.15b  

   

   

*  This  is  an  estimate  which  takes  into  consideration  the  lower  input  costs  associated  with  poker  machines  when  compared  to  other  hotel  revenue  streams  related  to  the  sale  of  food,  beverages  and  accommodation.  Poker  machine  profits  could  be  higher  than  50%  of  the  hotels  segment  EBIT  and  we  encourage  Woolworths’  investors  to  seek  clarification  from  the  company.  

 

 

Woolworths  FY  2011  EBIT  

Group  EBIT  $3.2  b  

Hotel  Segment  EBIT  $185m  

Woolworths  FY  2011  Group  EBIT  $3.2b  

Est  Poker  machine  EBIT  $92m  

Cost of adopting EGM reforms

Key Points

No  material  impact  until  2016.  

As  the  suggested  changes  would  not  take  effect  until  2016  ALH  Group  would  be  able  to  begin  introducing  new  poker  machines  with  $1  betting  limits  incorporated  into  their  software  code  when  existing  machines  are  turned  over.    

From  the  Productivity  Commission  Inquiry  report:  

“Industry  participants  noted  that,  where  harm  minimisation  policies  require  upgrades  to  gaming  machine  software,  the  compliance  cost  for  industry  is  much  reduced  (in  some  cases,  almost  completely  negated)  if  the  upgrades  follow  the  normal  replacement  cycle  for  EGMs.”  

ALH  Group  is  believed  to  upgrade  software  on  the  majority  of  its  poker  machines  on  a  five  year  cycle  which  means  the  group  has  three  years  to  phase  in  software  upgrades  before  January  2016.  This  potentially  leaves  40%  of  ALH  Group’s  12,000  poker  machines  (4,800  machines)  with  two  years  to  run  before  they  would  be  due  for  an  upgrade.    

Depreciating  these  4,800  machines  60%  for  the  three  years  they  are  in  service  and  using  an  initial  value  of  $25,000  per  machine,  gives  a  theoretical  depreciated  value  of  $10,000  on  4800  machines.  Thus  total  cost  of  a  premature  replacement  would  equate  to  a  write  off  of  approximately  $48  million.  However  the  reality  is  the  operator  could  bring  forward  the  software  upgrade  and  not  write  off  the  remaining  value  of  these  poker  machines.  An  Australia  Institute  report  into  the  implementation  cost  concluded  the  likely  cost  of  early  upgrades  would  be  only  $4000  per  machine  giving  a  lower  figure  of  $19.2  million.*  

Adding  to  the  implementation  costs,  there  is  potential  for  some  poker  machine  consumers  to  take  their  business  to  another  establishment  with  higher  betting  limits  and  clearly  lower  betting  limits  are  likely  to  see  a  contraction  in  gaming  revenue.      

Allowing  that  a  higher  proportion  of  problem  gamblers  could  take  their  spending  elsewhere,  and  given  that  problem  gamblers  are  believed  to  contribute  up  to  40%  of  gaming  revenue,  it  is  estimated  that  somewhere  between  20%  to  40%  of  poker  machine  revenue  could  be  lost.  This  would  equate  to  a  spread  of  $64  million  to  $128  million  p.a  based  on  FY  11  estimated  poker  machine  revenue  for  company’s  hotel  segment.  

Offsetting  this  immediate  impact,  the  company  should  be  able  to  attract  patrons  who  are  alienated  by  the  risks  associated  with  high  velocity  machines.  In  other  words,  lower  betting  limits  would  make  the  company’s  poker  machines  more  accessible  to  a  wider  market  and  therefore  any  drop  in  revenue  could  arguably  be  expected  to  recover  over  time.  

Furthermore,  the  company  should  be  able  to  promote  the  introduction  of  $1  maximum  bets.  This  would  have  many  intangible  benefits  in  terms  of  promoting  the  Woolworths  brand  and  resolve  the  company’s  exposure  to  the  poker  reform  debate  over  the  medium  term.  

With  regulators  already  lowering  betting  limits  in  Victoria  to  a  maximum  $5  bet,  there  is  a  risk  that  if  Woolworths  delays  implementing  further  reforms  it  will  miss  the  potential  upside  while  allowing  its  reputation  to  be  tarnished.  

*The  Australia  Institute,  Rubbery  Figures  (January  2012)  

 

Potential Cost of resisting reforms Should  Woolworths  reject  the  suggested  reforms  the  company  is  likely  to  be  exposed  to  a  prolonged  and  concerted  campaign.  Unlike  most  other  participants  in  the  poker  machine  business  Woolworths  is  uniquely  exposed  due  to  the  nature  of  its  core  business.  Woolworths  is  still  predominantly  a  supermarket  operator  where  a  positive  customer  experience  and  strong  brand  image  are  paramount  to  supporting  its  leading  position  in  a  competitive  marketplace.    

Woolworths  Supermarkets  devotes  a  significant  sum  to  advertising  its  brand  each  year  ($145  million  in  2010)  and  toward  presenting  itself  as  a  responsible  and  sustainable  corporate  citizen.  To  this  end  it  is  highly  successful.  The  Woolworths  Supermarkets  brand  is  regarded  as  Australia’s  most  valuable  brand,  valued  at  $7.6  billion  according  to  Brand  Finance.  

On  the  negative  side,  Woolworths  already  attracts  criticism  from  many  quarters  over  issues  such  as  the  concentration  of  ownership  in  grocery  retailing,  impacts  on  corner  store  grocery  retailers  and  the  use  of  its  considerable  purchasing  power  when  negotiating  with  suppliers.  These  issues  can  and  do  have  an  influence  on  the  Woolworths  brand  and  customer  perceptions.  

However,  unlike  the  above  issues  which  do  not  directly  impact  on  most  Australians,  the  social  problems  associated  with  high  velocity  poker  machines  are  being  felt  across  many  communities.  Curiously,  the  vast  the  majority  of  Australians  do  not  yet  realize  that  Woolworths  is  the  largest  operator  of  poker  machines  in  the  country.  Thus  this  issue  looms  as  a  strategic  risk  to  the  company’s  valued  brand.  

Given  the  scope  of  existing  community  groups  campaigning  for  poker  machine  reforms  and  with  public  opinion  predisposed  toward  poker  machine  reforms,  there  are  some  general  comparisons  that  can  be  made  to  other  stakeholder  campaigns.    Examples  include  the  Franklin  Dam  blockade,  opposition  to  Gunns’  activities  in  Tasmania,  James  Hardie’s  handling  of  asbestos  liabilities  and  the  proposed  reopening  of  the  Jabiluka  uranium  mine  in  Kakadu.  While  these  examples  involve  environmental  concerns  and  problem  gambling  is  clearly  a  social  issue,  the  intensity  of  debate  on  this  issue  in  Australia  over  the  last  year  suggests  that  many  consumers  could  be  willing  to  take  up  this  cause.    While  it  is  not  possible  to  predict  precisely  how  this  issue  will  evolve,  it  is  common  for  activist  groups  to  call  for  consumer  boycotts  and  public  rallies  when  other  forms  of  engagement    fail.    It  would  not  take  a  large  shift  in  consumer  sentiment  to  have  an  impact  on  Woolworths’  supermarket  segment  cashflows.    

The  methodology  of  activist  groups  follows  a  well  trodden  path  which  uses  a  variety  of  strategies  to  draw  the  reluctant  protagonist  into  a  public  debate  where  it  is  vulnerable  to  accusations  of  putting  profit  before  social  responsibility.    The  proposed  EGM  is  a  case  in  point.  Irrespective  of  whether  these  resolutions  are  voted  down,  the  motion  will  have  achieved  the  aim  of  bringing  Woolworths  into  the  spotlight  over  this  issue  and  its  integrity  as  a  socially  responsible  corporation  will  be  questioned.    

The  cost  to  Woolworths  could  be  significant  if  this  issue  evolves  into  one  involving  street  protests  similar  to  those  we  saw  against  the  ANZ  bank  over  its  involvement  in  financing  the  proposed  Gunns  

Pulp  Mill.  Damage  to  the  Woolworths  brand  could  conceivably  outstrip  the  estimated  costs  outlined  in  relation  to  introducing  $1  betting  limits.  

Once  the  momentum  is  behind  a  stakeholder  campaign,  it  is  increasingly  difficult  for  any  company  to  get  its  message  across  to  win  back  support.  A  belated  retreat  is  not  nearly  as  strategic  given  it  can  be  portrayed  as  an  admission  of  guilt.    In  this  way  corporations  can  find  themselves  in  a  corner  as  their  options  become  more  limited.  

At  some  point  the  investment  community  may  begin  to  see  the  financial  repercussions  and  choose  to  sell  shareholdings.  Once  the  market  loses  confidence  in  a  company’s  ability  to  navigate  a  way  out  and  maintain  its  social  license,  the  deterioration  in  shareholder  value  can  be  severe.  

Conclusion As  illustrated  in  this  report,  Woolworths’  involvement  in  poker  machine  gambling  is  a  potential  strategic  business  risk  to  the  organisation.  With  an  increasing  stake  in  an  industry  that  is  receiving  growing  public  scrutiny  and  criticism,  WOW's  brand  is  also  likely  to  be  more  exposed  due  to  an  apparent  inconsistency  between  the  public  facing  family-­‐friendly  brand  and  the  lack  of  a  publicly  available  and  demonstrative  harm  minimisation  strategy  regarding  WOW's  gambling  investments.

For  these  reasons  it  is  likely  that  poker  machine  reform  campaigns  will  continue  to  gain  traction  in  the  media  and  it  can  reasonably  be  expected  that  this  stakeholder  issue  will  continue  to  gather  momentum  until  the  issue  is  addressed  in  a  meaningful  and  demonstrated  way.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Authored  by  by  Mark  Barraclough