Business model – The environment within which we operate

REGULATORY

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 risk and opportunity are potential amendments to smoking legislation, regulations regarding the maximum number of casino licences granted nationally, Gauteng provincial gaming taxes, amendments to casino licensing conditions, a Gauteng draft request for proposal for new electronic bingo licences, amendments to the Financial Intelligence Centre Act and the relocation of casino licences to the Western Cape metropole.

During May 2018 the Minister of Health published a draft amendment bill prohibiting smoking in public places. 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.

Following the approval by cabinet of the National Gambling Policy in October 2015 the Minister of Trade and Industry published his intention to increase the number of casino licences from 40 to 41 to include an additional licence in the North West province and it was proclaimed in the Government Gazette during June 2016. The additional licence remains subject to legal challenge by CASA.

During May 2018 the Gauteng Department of Economic Development published a revision of the casino tax regime for comment where the current fixed rate of 9% would be replaced with a sliding scale with a maximum marginal rate of 15%. CASA submitted an objection to the proposed increase due to, among others, its procedural illegality, gross unfairness and excessive nature.

Various gaming boards are attempting to impose the achievement of a prescribed contributor status as licence condition. The group remains committed to enhancing its BBBEE credentials in every commercially reasonable way and is currently a level 1 contributor measured against the revised codes of good practice – tourism sector scorecard. The group, however, cannot expose its licences to moving targets due to the uncertainty and the extent to which the levels to be achieved are moved out of the group's control and will continue to challenge the decisions.

During 2018 the Gauteng Gambling Board issued a draft request for proposal for comment for an additional 14 licences of 300 EBTs each. The maximum number of EBT licences is currently not regulated by the National Gambling Act which may result in the uncontrolled proliferation of licences by the provincial gambling boards which would not be good for the EBT industry.

Amendments to the Financial Intelligence Centre Act have imposed more onerous obligations on the group. The FICA amendments include stricter requirements for concluding single transactions and the group will achieve full implementation of the regulator's framework by the March 2019 deadline.

During February 2018 the Western Cape Provincial Treasury published a draft bill and regulations to permit the relocation of two outlying casinos to within the metropole. The group will continue to pursue the opportunity.

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 3 –  
Mpumalanga 4   3 2 1  
Limpopo 3   3 –  
Northern Cape 3   3 –  
Free State 4   4 1 1(1)
North West  5(2) 4 1(2)
KwaZulu-Natal 5   5 3 –  
Total 41(2) 38 14 4  
(1) One of the existing licences will lapse upon the issue of the one available licence
(2) The 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 Morula licence to the North West province due to the change of provincial boundaries) was given by the Minister of Trade and Industry, Mr Rob Davies.

The approval by the Gauteng Gambling Board of Sun International's relocation of its Morula 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.

The National Gambling Act currently limits the number of LPM licences that the provincial gambling boards may issue but does not currently limit the number of EBT licences.

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 have improved with economic growth across both the developed and emerging markets. Global fund flows to emerging markets have been significant but South African-specific political, social and economic issues have constrained investment in the country. The Rand strengthened during the year, particularly following the favourable political developments during December 2017, which eased local inflation. In recent months the Rand has weakened again which may result in an increase in interest rates which would not assist the current weak levels of economic growth. Business confidence during the year prior to December 2017, was at record low levels, particularly due to considerable political uncertainty, low levels of economic growth and high levels of household debt. Although sentiment improved following December 2017, there does not as yet appear to have been a recovery in consumer spending which remains at low levels. 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.

The underlying operations of the group remain highly geared towards the South African consumer (in gaming) and the corporate market (in hotels). The strengthening of the Rand mainly impacts the capital cost of gaming machines and the translation of the income statement of the hotels outside South Africa.

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 and reduced levels of growth over the past five years.

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 was 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 including roads, the creation of employment, CSI initiatives and transformation.

The South African formal gaming market is made up of casinos, sports betting, LPMs and EBTs, and generates annual revenues of approximately R28 billion. In addition the national lottery generates revenues of approximately R3 billion.

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. Gaming taxes and levies vary by province on either fixed or sliding scales and average 22% of gaming win including VAT on gaming win.

Casino gaming accounts for approximately 65% of the gaming market and Tsogo Sun has a revenue share of 47% in the six provinces in which it operates and 43% nationally. 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. Casinos 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 2018
  Total casino
gaming win
Rm
Group share
of total casino
gaming win
%
Gauteng 7 937 49    
KwaZulu-Natal 3 497 58    
Western Cape 2 923 35(1)
Eastern Cape 1 181 22    
Mpumalanga 731 80    
Free State 480 26    
Other 1 847 –    
Total 18 596 43    
(1) The group’s effective share of the Western Cape’s casino gaming win includes 20% of the SunWest and Worcester casinos

Limited payout machines ('LPMs') continue to show double-digit growth and above inflationary growth is expected to continue until the markets mature. LPMs, which are principally located in bars, clubs, hotels, taverns and bookmakers, appear to have had a limited impact on casinos as they are targeted at a different segment of gambler. LPMs account for approximately 11% of the gambling market and growth will be driven by the roll out of additional sites and by the optimisation of individual site locations and machine mix within sites.

Electronic bingo terminals ('EBTs') have shown strong double-digit growth as new licences were issued and sites were rolled out and this is expected to continue until the markets mature. EBTs do appear to have some impact where large bingo sites are located within casino catchment areas as the experience is more similar to a casino main floor experience. EBTs account for approximately 5% of the gambling market and growth will be driven by the roll out of additional sites by province. EBTs are currently not operating in the Western Cape, the Free State and the Northern Cape and have only recently commenced trading in KwaZulu-Natal.

Sports betting and horse racing make up approximately 19% of the gambling market and growth in sports betting is strong. The growth in sports betting is driven by the betting on the lottery and other number games, which are subject to challenge from the National Lottery.

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 enforcement of the ban on online gaming and it is not considered a significant risk. However, the group does see it as an opportunity in the event that it is legalised.

Illegal land-based gambling sites are impacting casino, EBT and LPM revenues and impact government through reduced taxes and society through lost employment opportunities, reduced CSI initiatives, reduced economic growth and impaired consumer protection. Closing down illegal operators remains a significant challenge and more effort is required from the dti, SARS, law enforcement agencies and banking institutions in stopping illegal gambling transactions and raiding and closing down illegal land-based sites.

The proliferation of both licensed outlets and illegal sites could negatively impact the gaming industry through negative perceptions created by widespread access to gambling. What remains of concern to both the casino and EBT industry is if the roll out of licensed EBT outlets is on an uncontrolled basis and if the maximum bet and maximum payout limits for LPMs 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 2010 FIFA World CupTM 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 but have stagnated at around 64% from 2016 to 2018.

The fiscal austerity measures implemented by government remain in place, although government business is increasing, albeit off a lower base and at sub-optimal average room rates. The visa requirements for the collection of biometric data and in-person applications, which constrained growth in prior years, has largely been resolved but the unabridged birth certificate issue remains for guests travelling with minors.

International demand, particularly in Cape Town, remained strong until December 2017 but has subsequently been adversely impacted by the water situation in Cape Town and this is expected to adversely impact the market in the short term. In addition, five new hotels opened in Cape Town during the year which will place additional pressure on the market. The value offered to international travellers was adversely impacted by the strengthening of the Rand during the year. Trading in the majority of the rest of the country remains weaker, with little additional hotel supply being added to the market.

Online booking channels such as Airbnb provide access to non-hotel accommodation which adds additional supply to the market that may otherwise have been provided by additional hotels. 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 45 486 rooms available as at 31 March 2018. The group's share of the formal market rooms available is approximately 28% for hotels the group operates and 33% for hotels the group owns, including HPF, 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 operate outside South Africa remained remarkably resilient through the economic downturn mainly due to limited supply of good quality hotels. Trading between the 2015 and 2018 financial years was, however, significantly impacted by the Ebola pandemic, security concerns and more recently a weaker market attributable to the negative impact of lower commodity prices and the resultant weakening of the local currencies. 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 but in the short term tough trading conditions are anticipated. 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.

Technology remains a key business enabler for the group and technology operating models continue to evolve and require ongoing evaluation and investment. The key areas of priority include the ways in which we work and interact with customers (including touch points and adding value to their journey), making resources more productive, and deploying relevant technology more rapidly. Significant emphasis will continue to be placed on analytics, business intelligence and digital platforms.

The technology trends most relevant to our industry include:

  • availability of robust broadband will remain critical and will require ongoing investment. In due course there will be the ability to make hotel rooms 'smart' without the expense of installing additional networks or controllers (e.g. smart thermostat to remotely control the temperature in a room, switching off lights and other energy consuming devices), and mobile operators will be able to provide their services over our Wi-Fi network in both hotels and casinos;
  • the 'mobile everywhere' reality which requires both customers and staff to have real-time access to applications, dashboards and significant volumes of data, including the ability to:
    • track status, preferences, benefits and customer value ensuring they are rewarded equitably;
    • transact with minimal face-to-face human interaction;
    • service customers anywhere and customers to conduct their own self-service at any location, whether onsite or offsite;
    • migrate 'gaming wallets' from a smart card to a smart mobile device utilising technologies such as Bluetooth and NFC;
  • the reintroduction of guest facing hotel kiosks in an effort to either reduce staff or allow the staff to focus on delivering value in other areas;
  • workforce management and planning solutions are coming of age and are being rolled out quite extensively. These are primarily used for scheduling and rostering and make use of big data/artificial intelligence to predict business levels and plan accordingly. Businesses are actively exploring technology solutions to integrate their existing technologies to reduce human input and automate processes;
  • 'agile' deployment of technology which includes the demand to speed up deployment, keep up with the pace of change across all business functions, and provide more regular software updates and upgrades;
  • deriving quality analytics from high volumes of data and utilising machine learning and artificial intelligence to optimise business opportunities;
  • harvesting social media for real-time feedback in order to identify and rectify issues timeously; and
  • adoption of 'cloud' services.

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 previously 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 and uncertainty 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. Recent political developments have been positive but the run up to the 2019 elections may result in further disruption and compromise.

The gaming industry is exposed to anti-gaming sentiment, which increases the risks of excessive taxation and regulation. The reality, however, is that 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. These benefits are, however, not provided by illegal land-based or online gambling sites and more effective policing and prosecution is required to achieve the benefits. In addition, the illegal sites are not regulated and the issues of problem gambling and the proliferation of gambling is not controlled.

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 environmental focus areas are the reduction of consumption through innovative physical property and behavioural changes and the responsible management of the supply chain and waste.

The greater challenges to the industry currently are the rising utility costs and uncertainty of the future supply of energy and particularly of water. The current severe drought and water shortages in the Western Cape is a significant challenge, and while the group's hotels are prepared for water supply interruptions through reverse osmosis plants, boreholes, water treatment plants and sufficient storage capacity, there is no practical solution in the event of no water availability in the region and this risk must be addressed by provincial or national government.