Gambling on Poker

By Pimm Fox Published: August 11, 2005 ONLINE GAMING and the action in Las Vegas have one thing in common: money, lots of it. And while the boom in Internet gambling has hit the U.S., analysts — and players — say this is only the first deal, so pull up a chair and ante up. The global Internet gambling market generated $7 billion to $10 billion in revenue in 2004, according to various estimates, with about 2,500 web sites offering poker, bingo, sports betting and online-casino games. For investors, the choices are PartyGaming, Sportingbet, William Hill and Hilton Group — which owns Ladbrokes, a large British bookmaker. The market may soon consolidate, but with an estimated compound annual growth rate of 22%, online gambling could be worth some $24 billion by 2009, according to investment firm Christiansen Capital Associates, which specializes in the Internet-gaming business. The caveats include U.S., U.K. and EU regulations, as well as intense competition for players. "The legality of accepting online bets from the U.S. is unclear," say ABN Amro's Simon Larkin and Nick Thomas. But Simon Champion of Deutsche Bank says the legal issues are exaggerated. PartyGaming, owner of the PartyPoker web site, recorded more than $600 million in revenue and net income of $349 million in its most recent fiscal year. Oh, and it also paid out $343 million in dividends, and had free cash flow of $408 million. The company — based in Gibraltar to avoid the possible ire of U.S. authorities — only recently had its initial public offering in London. PartyGaming's market value is around $12 billion, and it's expected to be included in the FTSE 100 index Sept. 16. Deutsche Bank's Champion, who has a Buy recommendation on the shares, which have risen 44% since the IPO, says that PartyGaming could be criticized for depending on the U.S. — where there is uncertainty about the legality of online gambling — for about 87% of its business. "But," he continues, "they have done it better than anyone else, and their strategy going forward — of moving into Europe with poker and other products — could push revenue even higher." He adds: "How many companies do you come across that literally have a market cap of $13 billion and capital expenditure of $25 million, and no debt?" Champion says that PartyGaming's cash flow can be reinvested in acquisitions or dividends. And the recent IPO gives it the currency to go shopping to consolidate its No. 1 poker-web site position. Deutsche Bank estimates 2005 revenue of $992 million, and free cash flow of $503 million. The shares trade at around 170 pence, or about 20 times estimated '05 net, and Champion has a price target of 175p. If you would rather bet on the players than be one, then Sportingbet is a company to watch. Based in the U.K., the online gambling site is the home of sports betting for just about any activity you can imagine. The web site offers real-time odds for baseball, rugby, soccer, boxing and greyhound racing. The company posted revenue of £1.4 billion in 2004 and net income of £5 million, but the numbers don't tell a complete story, because in 2004 Sportingbet purchased Paradise Poker, the No. 4 online-poker web site. The company's customer mix is more international than Party Gaming's, with approximately 27% of the sports-betting punters coming from Europe and 34% from the U.S. About a third of its gross comes from sports betting, a third from poker and a third from casino and other online games, according to Deutsche Bank, which has a Buy recommendation on the shares. At 365p, the shares are trading at a substantial discount to fair value, based on discounted future cash-flow estimates. Sportingbet's move into the world of online poker with the purchase of Paradise is crucial to its growth, and Champion reckons that the company's shared-purse feature, which allows customers to bet from a single account across an array of gambling products, is a spur to more revenue. The company is moving to snap up competitors, and said last week that it would pay $33 million for ISC Entertainment, an online bookmaker and casino operator. Bridgewell Securities says that the purchase of ISC Entertainment could "support the share price of Empire Online, which partners with PartyGaming, and is regarded by some as a likely takeout candidate for PartyGaming." The more traditional gaming companies, such as William Hill and Hilton Group's Ladbrokes division, are also possible winners in this round of gaming excitement. William Hill is the largest operator of U.K. betting shops, and has telephone-betting operations and online betting and casinos for poker, roulette, slots and arcade games. The company, which acquired Stanley Leisure for £534 million earlier this year, also has video and audio links to global sporting events. In 2004, William Hill posted revenue of £8.29 billion and net income of £148 million. But ABN Amro says that earnings should grow 11% in the second half of 2005, and the shares could trade as high as 600p, compared with around 575p currently. ABN Amro suggests that there is real value in the shares if they drop to around 475p to 500p. Hilton's Ladbrokes is undervalued, says Deutsche Bank's Champion, and estimates that strong cash flow from the e-gaming business — plus asset sales — could prompt the hotel company to return capital to shareholders. In 2004, Hilton derived about 60% of its operating profit (£21.3 million) from gaming operations and about 40% from the hotel business. The Ladbrokes e-gaming and betting shops have benefited from more favorable U.K. tax rules and introduction of fixed-odds betting terminals. The company has said it wants to acquire a major bricks-and-mortar gaming license, and has reported that it would return to shareholders a large portion of the proceeds from the sale of some hotel properties. None of the company's online gaming operations take bets from Americans, but that shouldn't stop investors from spinning the wheel on Hilton's stock, which trades at 290p, or a relatively modest multiple of about 13 times estimated 2005 earnings. SmartMoney.com