The environment within which we operate

 

Regulatory environment

The South African regulatory environment continues to become more complex with the ongoing introduction of new legislation rulings, practices and policies. Gaming legislation remains the group's primary compliance focus although this regulatory framework is well entrenched and remains relatively stable.

The main regulatory areas of concern are potential amendments to smoking legislation, the National Gambling Policy, provincial gaming taxes and the recent amendments to the BBBEE Codes of Good Practice. The total ban on smoking in public places has had a significant short-term impact on gaming win in other countries where it has been implemented, although the impact in South Africa may not be as severe due to the strict smoking restrictions that are already in place. The DTI published the National Gambling Policy as approved by cabinet in April 2016, which includes the intention to increase the number of casino licences from 40 to 41. The additional licence intended for the North West province was proclaimed in the Government Gazette on 10 June 2016 but remains subject to legal challenge by CASA. The Gauteng provincial government published a revision of the casino tax regime for comment in January 2016 where the current fixed rate of 9% would be replaced with a sliding scale with a maximum marginal rate of 15%. CASA has submitted an objection to the proposed increase due to, among others, its procedural illegality, gross unfairness and excessive nature. The amendments to the BBBEE Codes of Good Practice are important particularly in the context of various gambling boards seeking to impose the achievement of defined levels of empowerment, as measured against the codes, as a licence condition.

Proposed amendments to the National Liquor Act and the Financial Intelligence Centre Act may also impose more onerous and/or impractical obligations on the group. The liquor amendments include restrictions to whom alcohol may be sold, the restriction of trading hours and restrictions regarding where licenced premises may be located, and the imposition of vicarious liability on licensees. The FICA amendments include stricter requirements for concluding single transactions and the introduction of the concept of 'prominent influential persons/public officials'.

The gaming industry in South Africa is highly regulated, both at national and provincial level, and thus, unlike the hotel industry, has high barriers to entry. The National Gambling Act sets the broad framework for the licensing and regulation of gambling in South Africa, and each province has its own legislation relating to casinos, gambling and wagering. The National Gambling Act currently limits the number of casino licences that may be granted to 41 for South Africa as a whole. The table below sets out details in respect of the number of casino licences in South Africa which are authorised to be issued, have been issued and are available to be issued:

  Province Authorised
to be issued
  Issued   Tsogo   Available  
  Gauteng 7   7   3    
  Eastern Cape 5   4   2   1  
  Western Cape 5   5(1)   3    
  Mpumalanga 4   3   2   1  
  Limpopo 3   3      
  Northern Cape 3   3      
  Free State 4   4   1   1(2)  
  North West 5(3)   4     1  
  KwaZulu-Natal 5   5   3    
  Total 41(3)   38   14   4  
Notes
(1) The Western Cape provincial government is considering the relocation of an existing Western Cape casino licence to the Cape Metropole
(2) One of the existing licences will lapse upon the issue of the one available licence
(3) DTI intends to permit the award of an additional licence

The approval of an additional casino licence in the North West province potentially increases the risk of additional licences in other provinces, although assurances that this is a once-off special situation due to the loss of the Marula licence to the North West province due to the change of provincial boundaries have been given by the Minister of Trade and Industry, Mr Rob Davies.

The approval by the Gauteng Gambling Board of Sun International's application to relocate its Marula licence to Menlyn in Pretoria potentially increases the likelihood of the relocation of other casino licences.

With the exception of the group's Eastern Cape-based licences, casino licences are issued for an indefinite period, subject to payment to the relevant provincial board of the applicable annual licence fees and continued suitability and compliance with licensing conditions.

Economic environment

Disposable income growth, ongoing urbanisation, significant middle-class growth, developed infrastructure and an operating environment conducive to business have historically been long-term structural drivers of growth in South Africa and have increased the consumer base and spending power of the population. Disposable income in South Africa has grown strongly since 2000 and millions of South Africans have entered higher LSM brackets.

Global economic conditions following the financial crisis remain weak although they appear to be improving and sentiment-driven shocks continue to fuel significant volatility. Uncertainty impacts global fund flows to emerging markets which, exacerbated by lower commodity prices and South African-specific political, social and economic issues, have resulted in significant Rand weakness. The Rand weakness has the dual impact of driving local inflation and exerting upward pressures on interest rates, which reduces economic growth. Business confidence remains at very low levels, particularly due to political uncertainty, low levels of economic growth, constraints in electricity supply, and high levels of household debt. Above-inflationary increases in municipal rates, electricity and water, in addition to the costs of mitigating the supply constraints, have had an impact on both businesses and the consumer, although the low levels of economic growth have somewhat mitigated the electricity supply shortages.

The underlying operations of the group remain highly geared towards the South African consumer (in gaming) and the corporate market (in hotels). The weakening of the Rand mainly impacts the capital cost of gaming machines and the translation of the income statement of the hotels outside South Africa. We do not believe that the contraction in the supply of unsecured lending has impacted growth in the casino gambling industry as it remains entertainment spend from upper/middle-income consumers. The main beneficiary of the easy credit was retail sales, mainly for clothes and furniture in lower-income segments.

The factors noted above mainly impact the group indirectly due to their impact on the consumer, corporate and government markets and have manifested in significant monthly trading volatility. Growth for the past 30 months was relatively weak, except for the last quarter of F’16, where double-digit revenue growth was experienced, although this may be Tsogo Sun specific.

Industry

Gaming
A gaming industry has existed in South Africa since it was partially legalised in the independent homelands during the 1970s. Following the introduction of the current regulatory framework in South Africa during the late 1990s, the industry has been formalised and operates in line with global best practice. The formalisation of the industry has provided substantial benefits to the country through the collection of taxes and levies, the development of gaming and entertainment complexes, hotels and tourism infrastructure, the creation of employment, CSI initiatives and transformation. Gaming taxes and levies vary by province on either fixed or sliding scales and average 21% of gaming win including VAT on gaming win.

The casino market reflected double-digit growth until 2008 when the impact of the global recession slowed growth. The industry proved to be resilient and although growth slowed to low single digits it never went significantly negative. Growth from 2010 has lagged nominal GDP but is expected to accelerate when economic conditions improve.

The South African formal gaming market is made up of casinos, the national lottery, sports betting, limited payout machines and bingo, and generates annual revenues of approximately R25 billion. Casino gaming accounts for approximately 70% of the gaming market and Tsogo Sun has a revenue share of 46% in the six provinces in which it operates. As a result of their geographic distribution, casinos in South Africa mainly compete with providers of other leisure and entertainment activities for patronage, such as shopping centres, restaurants and sporting and concert venues, rather than with other casinos. They operate in different markets, each with its own catchment area. The table below sets out the group's estimate of its share of the total casino gaming win per province:

    For the year ended
31 March 2016
 
    Total casino
gaming win
Rm
  Group share
of total
casino
gaming win
%
 
  Gauteng 7 422   52  
  KwaZulu-Natal 3 434   59  
  Western Cape 2 893   17(1)  
  Eastern Cape 1 219   25  
  Mpumalanga 743   82  
  Free State 499   25  
  Other 1 886    
  Total 18 094   41  
Notes
(1) The group’s effective share of the Western Cape’s casino gaming win will increase to 34% following the acquisition of 20% of the SunWest and Worcester casinos

Online gaming remains illegal in South Africa and there is no indication as to when enabling legislation will be implemented. There was no discernible impact from the banning of online gaming and it is not considered a significant risk. Limited payout machines and bingo continue to show double-digit growth as they are rolled out by province but to date appear to have had limited impact on casinos as they are targeted at a different segment of gambler. The proliferation of both licenced outlets and illegal sites could negatively impact the gaming industry through negative perceptions created by widespread access to gambling. What would be of concern to the casino industry is if the roll out was on an uncontrolled basis and resulted in large bingo sites within casino catchment areas and if the maximum bet and maximum payout limits for limited payout machines were substantially increased.

Hotels
Following the first democratic elections in 1994 the demand for hotel rooms grew rapidly and rooms sold by the group grew by more than 6% per annum between 1994 and 1999. The market responded to the increased demand through the construction of new hotels but demand growth continued to exceed the growth in supply until 2008 with occupancies and average room rates continuing to rise. During 2008, the impact of the global recession constrained demand but construction of new hotels continued until the FIFA World Cup in 2010 as the projects were already in progress. Market occupancies fell from 72% in 2007 to 53% in 2011 due to the combination of constrained demand and increased supply. Demand has subsequently grown, and with little growth in hotel supply, market occupancies have been recovering since 2011 and are now at 64% for F'16. The fiscal austerity measures implemented by government remain in place and the revised visa requirements for unabridged birth certificates for minors and for the collection of biometric data and in-person applications constrained growth during the year, despite the exceptional value offered to international travellers due to the weakening of the Rand. An interministerial committee announced a commitment to the relaxation of the regulations in October 2015 but implementation of the recommendations remains in progress. The impact on the group is not significant as inbound travel is not a large segment of the group's business. We anticipate that demand will continue to grow and that additional supply will again be added to the market when market occupancies approach 70%.

Tsogo Sun hotels has a strong presence throughout South Africa and has a broad portfolio of hotels, particularly in urban centres. Of the approximately 150 000 hotel, bed and breakfast and guesthouse rooms available in South Africa, the formal hotels contributing statistics to STR Global make up approximately 30% of the total market, with 45 481 rooms available as at 31 March 2016. The group's share of the formal market rooms available is approximately 30% and the group thus benefits from a significant presence in the South African hospitality industry and is the only hotel group in South Africa with wide distribution across all grading levels.

Trading in the majority of the African cities where Tsogo Sun hotels operates outside South Africa remained remarkably resilient through the economic downturn mainly due to limited supply of good quality hotels. Trading during the 2015 and 2016 financial years was, however, significantly impacted by the Ebola pandemic, security concerns and a weaker market attributable to the negative impact of falling commodity prices. In the medium term it is expected that many African countries will experience strong economic growth which will drive the demand for, and supply of, new hotels. The markets are small and the addition of a new hotel has a more significant impact on the market. It remains challenging and expensive to acquire land and build hotels in many countries in Africa which constrains supply.

Technology

The use of technology is important in both the gaming and hotel businesses to deliver relevant experiences to customers and to drive business efficiencies. Key technology areas are casino management, hotel property management and hotel booking and reservation systems to enable the business, customer relationship management to provide relevant benefits and rewards to customers, business intelligence to drive efficiencies and digital platforms to interact with and provide connectivity to customers.

Relevant technology trends are as follows:
  • online booking volumes of hotel rooms continues to increase although they remain below international norms in South Africa;
  • new booking channels such as Airbnb have emerged that make it easier for smaller operators such as guest houses and private establishments to have access to the market;
  • free broadband wireless access has become the norm;
  • the increased utilisation of mobile devices and business applications makes a mobile-friendly website an imperative;
  • mobile applications continue to evolve and will potentially assist in driving revenue and enhancing customer satisfaction;
  • customer relationship management is increasingly important in encouraging customer loyalty, particularly due to potential gaming advertising restrictions and the Consumer Protection Act;
  • social networking impacts marketing channels and requires transparent and timeous responses and active management;
  • potential exists to leverage off social media platforms to drive revenue; and
  • the importance of data security is increasing due to external threats, increased connectivity and the need to comply with existing and new legislation.

Consumer preferences

In order for gaming and hotel businesses to deliver quality experiences, facilities and services must be relevant to what customers want and are prepared to pay for. Consumer preferences range from the technology preferences noted above to the look and feel of the physical product, the location of buildings, concepts of restaurants and bar offerings, types of entertainment and travel patterns. Public recognition of brands and their associated reputation are important in attracting and retaining customers.

Societal issues

The weak economic environment, along with political factors, continues to fuel disruption which discourages investment and impacts the high unemployment level and low growth rate in South Africa. The impact on labour disruptions in the gaming and hotel businesses in the markets in which the group operates is limited due to the high level of employee engagement and the location of the majority of the properties in urban areas. The group is, however, indirectly impacted through the adverse effect on the economy.

The gaming industry is exposed to anti-gaming sentiment, which increases the risks of excessive taxation and regulation. The reality, however, is that the issues such as problem gambling are well managed and are substantially exceeded by the benefits in the highly regulated industry through significant tax contributions, infrastructure development, creation of employment, wealth distribution to black economic empowered businesses and PDI shareholders and social investment in the communities that are served. The negative impact of casino gaming is also less of a societal issue than the other forms of gaming such as sports betting, limited payout machines, bingo and, in particular, the national lottery due to the ease of access to their sites and lower economic target markets.

Environmental issues

The gaming and hotel businesses pose limited risks to the environment due to the service nature of the industry. Tsogo Sun operates predominantly in urban areas, which further reduces the biodiversity impact. The main environmental impacts of the group are the consumption of energy and water, the production of waste and travel of guests to our properties.

Although customer choices are not yet significantly impacted by environmental performance, behavioural changes are being driven by social responsibility. The greater challenges to the industry currently are the rising utility costs and uncertainty of the future supply of energy and particularly of water.