In his first major decision on competition policy since taking over from Margaret Beckett in July, Peter Mandelson, the Secretary of State for Trade and Industry, said the Ladbroke's purchase "would damage competition and disadvantage punters" by extending its dominant position in the UK betting market.
The decision puts an end to a fierce lobbying battle started in May when Ladbroke agreed to buy the Coral shops from brewing giant Bass.
The deal triggered a wave of protests from a number of politicians and bookmakers, and was referred to the Monopolies and Mergers Commission (MMC) for a full inquiry by Mrs Beckett in March. The MMC delivered its report to the Department of Trade and Industry at the end of July.
Mr Mandelson said he accepted the "unanimous conclusions" of the MMC that the deal would "reduce punters' choice" and "weaken price competition", both at a national and domestic level.
"I accept the conclusion that the merger is against the public interest, with adverse effects on price competition, innovation and choice, to the detriment of punters," he said.
Mr Mandelson added that the takeover was anti-competitive for two reasons. First, Ladbroke, with around 1,900 shops, is already the largest owner of off-racecourse betting shops. The acquisition of Coral would have increased its share of betting shops from 21 per cent of the total to 30 per cent, widening the gap between Ladbroke and its nearest rival, William Hill. William Hill is owned by the Japanese finance house Nomura, which controls around 1,500 shops and 22 per cent of the market. If the deal had gone ahead, more than one in three bets placed outside racecourses would have been controlled by Ladbroke, according to MMC estimates.
Second, the merger of Coral into Ladbroke would have left only two national bookmakers, Ladbroke and William Hill, in the pounds 6bn-a-year UK betting market.
Mr Mandelson said that Ladbroke's proposal to sell up to 301 Coral shops to Tote, the state-owned bookmaker, plus the disposal of both the Coral telephone-betting service and a couple of greyhound tracks, would have done little to enhance competition. He concluded that "the adverse effects of the takeover could only be remedied by requiring Ladbroke to divest the "whole" of Coral. He recommended that Coral be sold to a single buyer, but added that a break-up of the group could be acceptable if it led to "a more robust competitive environment".
Tote will now return to Coral the 133 outlets it bought for pounds 46m earlier this year, as the deal was conditional on the approval of the merger.
Mr Mandelson's decision is a blow to Ladbroke, which had hoped to cut costs by up to pounds 15m and to achieve economies of scale in its betting division by merging the Coral shops into its existing chain. The Coral shops made a pounds 17.1m contribution to the group's profit in the first half of the year.
Peter George, Ladbroke chief executive, said the group was "very disappointed" with the DTI's decision. He claimed that the company had received "supportive initial guidance" from the Office of Fair Trading at the time of the deal.
However, an OFT source said yesterday it had advised Ladbroke that the merger would only be cleared if the MMC used the same criteria with which it judged the 1988 merger of William Hill and Mecca.
One of the key planks of the MMC's case against the deal was that the bookmaking world had changed since 1988 and that the William Hill/Mecca yardsticks no longer applied. In an in-depth view of betting market trends, the MMC argued that the market has shrunk over the past 10 years, with a 12 per cent fall in the number of betting shops.
At the same time, concentration increased to unprecedented levels. According to the MMC (see table), the five largest bookmakers controlled 70 per cent of total betting turnover in 1997, compared with 65 per cent in 1989. The remaining 30 per cent is scattered among a myriad of independent operators which are too small to compete with the big boys and whose share of the market has been declining since the William Hill/Mecca deal.
The plight of smaller bookmakers was also exacerbated by the National Lottery's arrival in 1994. According to government figures, the number of bets has declined by about 10 per cent since the introduction of the weekly lottery draw. This caused a sharp fall in the industry's profitability and accelerated the rate of closure of betting shops, to the bigger players' advantage.
The MMC and the DTI also rejected Ladbroke's argument that the Coral buy complied with "the quarter-mile rule", one of the cornerstones of the MMC's clearance of the William Hill acquisition. The rule requires a bookmaker who buys a shop within a 440-yard radius of one of its existing outlets to have at least one competitor in the same area.
However, the MMC demonstrated that technological changes, the influence of television and a relaxation of gaming taxes have transformed betting from a local activity, centred on the neighbourhood bookie, into a UK- wide business where competition is measured on national terms.
"This evolution of the industry over recent years, and the differing structural effects of the two mergers, mean that the Ladbroke/Coral and Mecca/William Hill mergers are not directly comparable," the DTI concluded.
On the financial side, the decision to force Ladbroke to sell Coral sparked a search for potential buyers. Shares in Ladbroke rose 17.5p to 222p after it reported receiving several approaches from "venture capitalists and other parties".
A spokesman said the company was hopeful of achieving a "good price", although he suggested this might fall short of the pounds 363m paid to Bass given the current economic uncertainty.