Has internet betting got the upper hand? - Monday 23rd of January 2006

IF the numbers werent mindblowing enough, the colourful past of PartyGaming founder Ruth Parasol was guaranteed to make people sit up and take notice.

The story of a former online porn entrepreneur having the presence of mind to invest her small fortune into building an internet gambling empire was tantalising media fodder.

But the planned £5 billion-plus flotation of PartyGaming on the London Stock Exchange has far bigger implications than merely making Parasol, her husband, Russ DeLeon, and India software designer Anurag Dikshit paper billionaires.

It marks a new phase in an industry which has traditionally kept its business dealings close to its chest. The potential size of PartyGamings valuation has shone a spotlight on the money-making ability of internet gambling. And if the Gibraltar-based company gets a favourable reception from investors, it is expected to kick off a wave of initial public offerings by other internet rivals.

Waiting in the wings is online casino and poker room 888.com, the next company tipped to take the stock market plunge. We will be looking at it [the PartyGaming flotation] very carefully, says John Anderson, chief executive of 888.com. Well be making our decision on whether to float quite soon.

Having access to the public markets could take the fortunes of online gambling to the next stratosphere, providing extra trust-factor to tempt customers and extra capital to expand into new territories and types of games.

Already, the internet jackpot has mushroomed to more than $9.2 billion a year. But with more and more consumers becoming switched onto broadband, that figure is expected to rise to as much as $22.7bn by 2009.

The market potential is quite enormous. Of all the gambling taking place, online is growing the fastest, says Warwick Bartlett, of UK-based Global Betting and Gaming Consultants.

To put things into context, the internet sector is still a minnow among gambling sharks. According to Bartlett, it only represents 3.9% of the $236bn gross win from all forms of gambling worldwide. It is essentially in its infancy and extremely fragmented.

Sportingbet, which is Britains only major quoted online gambling group and claims to be the second largest company in the world in terms of gross profit, believes it has just a 3.5% share of the online market.

But that doesnt stop online operators from saying that the internet side of the business is now holding all of the cards to become a dominant betting force in the world, and sooner rather than later.

Online gambling profits are already 10 times bigger than the betting shops, claims Nigel Payne, chief executive of Sportingbet. Were not as big as the lotteries or all the casinos in the world put together. But within our industry, we have no doubt we will be in time. I think within five years, online gambling will be bigger than the casino industry.

Its a bold statement, but Payne believes the evidence is already stacking up. During the Superbowl [one of the biggest US sporting events of the year[, my business took more bets than all of the Las Vegas casinos put together. My poker business [on the website Paradise Poker] each day has five times the number of tables playing poker than all of the Las Vegas casinos put together.

It appears the betting shops have already read the writing on the wall with both William Hill and Ladbrokes running online businesses.

But Bartlett, whose consultancy has advised Dresdner Kleinwort Wasserstein on the PartyGaming float, believes that the internet has a long road to travel to seriously challenge the land-based casino industry.

He points out that these companies are also charting new territory in Asia and taking advantage of the Chinese governments relaxation of gambling laws in Macau.

But Payne argues that no matter how fast they build, they can never have the same geographic reach of online gaming.

There are about 220 countries around the world. Only five of those 220 actually have betting shops. Most of the rest of the world dont have poker shops, casinos and betting shops. They still gamble but they do it with Luigi behind the bar or a guy with a blackboard around the corner, says Payne.

Once internet penetration comes along, he says experience shows that punters can be easily converted to gamble online in a set up that is by comparison far more regulated than handing money over to a man on the street. And while a London-based online operation can instantly tap the bank accounts or credit cards of people all over the world, a casino based in Macau or Glasgow has to count on tourist traffic or consumers living in the region.

Payne believes a number of factors are also working together to make his job of converting the new generation of gamblers much easier. There has been an increase in the televised nature of events that people gamble on, whether that be boxing or poker games, Payne says.

As people see more of these events on TV, and at the same time there is an increase of internet penetration and an increase in the use of broadband, the ease of doing this in their home is all going in one direction.

Its this potential that has eight-year-old online player Party Gaming expected to achieve a market valuation of £5bn-plus. The Gibraltar-based company will likely sail in to the FTSE-100 if it proceeds with a listing.

But its more than growth prospects that has potential investors excited. The industry benefits from an incredibly low-cost business model and as a result makes big profits.

 

 

 

The majority of operators are based in low-tax environments like the Isle of Man, Gibraltar, Malta, Alderney and Antigua. Their call centre staff can be based in countries with cheap wages; and they dont have any of the expense in terms of capital investment and legions of employees associated with creating Las Vegas-style casinos.

As a result of such economies, Party Gaming made pre-tax profits of $371.1m on turnover of $601.6m last year, an incredibly high margin compared with most businesses. In the first three months of this year, it has racked up profits of $125.6m.

Some analysts believe that the valuation of PartyGaming could have been closer to £10bn, if there werent uncertainties over regulatory issues.

The valuation reflected the fact that 88% of sales are generated in the US. Greg Feehely of Altium Capital says: A company with that sort of growth record and potential would float at more than 20 times earnings. It is only being valued at around 10-12 times earnings, because of the risk of the uncertain legal situation in the US.

And thats where the whole business of internet gambling gets really interesting. So far, the real sting of online gambling both in terms of its stock-market valuation potential and its ability to attract customers has been held back by the uncertainty of its legal position in certain geographical territories.

While the share price of Sportingbet has performed well, giving the AIM-listed company a market capitalisation of more than £923m, Payne believes it is still undervalued because of the messy legal position in the US. In a note to clients, broker Morgan Stanley recently said that the shares in Sportingbet could double again in the next two years, but cautioned that the risks were high because prohibition in the US could wipe out two-thirds of its earnings.

So far, Americans have been the most eager to log on and place their bets. They make up 80% of all online poker players and 55% of overall internet gamblers. It is legal to place an online wager on a horse race, but not on any other sports event.

The legality of online poker and casino games is open to interpretation, with the US government saying illegal and online operators arguing that no legislation really exists. Regardless, the American government has been manoeuvring to prevent internet companies based offshore and out of its legal jurisdiction from taking bets from its citizens.

The US Department of Justice has warned media outlets not to take advertising from online betting groups and has pressured banks to refuse to process credit card payments. While these tactics have made advertising difficult, companies have found a way around every obstacle hurled in their way.

These online sites are quite novel at adopting guerilla marketing tactics, says Bartlett. Golden palace.com will tattoo its name on a mans chest and have him streak across the field during a major football game. Last month, it paid $245,000 for a Volkswagen Golf. Why do that? Because it was formerly driven by the new Pope. It stands to get a lot of publicity from that.

I think the US has done all it can possibly do to prevent online gambling and it hasnt succeeded.

Even if the US cemented its position by creating new legislation that outright banned all forms of internet gambling, views are mixed on how effective a prohibition would be. Anderson says he wouldnt do anything illegal, implying that 888.com would have to stop taking bets from the US.

Payne believes it is more likely that the US will choose to properly regulate the industry rather than ban it. Theres no internet product or service in the world that has successfully been prohibited by anybody, he says.

The largest players in the industry hope that countries with unclear positions will follow the UKs example. What would help the situation is if, as in the UK, all the regulations were clarified and written down. Theres too many places where its grey, where there are too many questions, says Anderson, who claims to have 18 million registered users.

The Labour government appears to want the UK to be the worlds hub for internet gambling. Hoping to entice offshore companies to move their operations to British soil, the government rolled out the welcome mat. It gave the green light to all forms of web betting in its new Gambling Act, as long as regulations on age restrictions and the monitoring of prospective collusion or addiction problems are followed.

At first, it tried to limit marketing rights to companies based in the EU, but it is expected to extend that to other properly regulated jurisdictions.

Its a situation that must have infuriated traditional bricks and mortar casino operators. The worlds gambling impresarios from Las Vegas Sands to MGM Mirage and Kerzner International came to Britain two years ago with plans to build a new generation of entertainment palaces. But these dreams were shattered in April when the UK government reduced the number of available supercasino licences from an expected eight to just one. While casino operators still hold out hope that the number will be increased, the move was deeply disappointing.

 

 

 

Anderson says that the UK position has given the online industry more credibility: 888.com has already gone to great lengths to gain consumer confidence by helping to set up e-Cogra. The body uses independent audit firms to make sure that member companies use software that clearly identifies underage users and tracks every single transaction to make sure the games are fair.

But Anderson says that if all countries regulated properly, it would allow 888.com to market more openly in places like the US and at the same time discourage shadier operations. The more regulated you are, the more people trust you and the more money you make, he says.

Once a product reaches mainstream status, the growth potential just keeps on rising. All operators need to do is wait for more people to get connected to the internet.

With this in mind, Anderson agrees with his rival Payne that his industry could indeed overtake the land-based casino giants in the popularity stakes.

There is room for both. Live casinos have a buzz, theyve got bars and entertainment. Theyre exciting holiday destinations. Internet is something you can do at home, he says. But land-based casinos arent in a growth period, certainly not to the same extent as online gambling. Their business is in a more mature phase.

I believe we will overtake the casino industry. Weve got at least five or six years of straight line growth potential.

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