How does a company attract investors and plan a long-term strategy when it’s threatened by the US Department of Justice (DoJ) and a rash of lobbyists determined to impede its ability to do business? Fairly easily if it is online gambling company PartyGaming, whose strategy is proving to be a winning hand – multiple winning hands, in fact.
Founded by Ruth Parasol, a US lawyer who made her fortune from telephone sex lines with her father Richard Parasol, PartyGaming provides a spread of branded online gambling products, such as PartyPoker, StarluckCasino and PartyBingo. The brands, which dominate the worldwide online gambling market, are enormously successful. Last year, this Gibraltar-based business collected sales of more than $600 mn with a profit jackpot of almost $372 mn.
Though highly profitable, almost 90 percent of PartyGaming’s revenues come direct from US gamblers. This is an issue for anyone remotely interested in PartyGaming’s long-term business plan, because the DoJ maintains that online gambling is illegal and wants to prosecute PartyGaming, which would deprive it of most of its current sales base.
But with no solid US assets, PartyGaming continues to cut and deal anyway, regardless of prosecution threats. It floated 20.6 percent of its equity on the London Stock Exchange (LSE) in June, completing the largest IPO on the LSE since 2001. And this month PartyGaming becomes part of the UK’s FTSE 100.
Partying on
Julian Harris, a partner at Harris Hagan, a law firm specializing in gaming and leisure, says the DoJ’s allegation that PartyGaming’s operation is illegal is based on an outmoded piece of legislation called the Wire Act, which is designed to prevent cross-state sports betting. ‘[The Wire Act] covers sports betting but it is stretching the point to say it applies to gaming – and it also stretches the point to say it applies outside the US,’ he observes. ‘It’s based on a US view of where the players are. [UK] law is completely different in that gaming takes place where the computer servers are located, and it’s up to other countries if they want to ban their citizens from using them.’
Harris says the DoJ has taken action against similar operators from third world locations such as Costa Rica, slapping on injunctions the moment funds get repatriated. ‘But, politically and diplomatically, that would be very difficult in western jurisdictions,’ he points out. ‘The reality is that the DoJ hasn’t done much – and I don’t think it will.’
To date, institutional investors haven’t been scared off by the DoJ’s claims. The flotation was three times oversubscribed when PartyGaming listed on June 27 and soared 11 percent to reach a market value of over $9 bn on its first day of trading. Richard Singleton, governance director at London-based Foreign & Colonial Investment Trust, says PartyGaming’s IPO looked ripe for the plucking. ‘It was priced to sell – it would have been a dereliction of duty not to buy,’ he observes.
Supported by advisers Dresdner Kleinwort Wasserstein, which also advised Sportingbet, another gaming company, on buying an online poker site last year, PartyGaming floated for 116p ($2.12) and, as IR magazine went to press, it was hovering around the 175p ($3) mark. Sell-side analysts from Deutsche Bank and Citigroup are betting it will rise higher with both placing buys on the stock. Citigroup, for instance, has placed a target price of 185p ($3.24) on the share price.
PartyGaming certainly doesn’t lack for a sell-side fan base. Out of 15 recent research notes (some written pre-IPO and some written shortly afterward) only one – from Arbuthnot Securities – failed to deal a ‘buy’ rating. ‘Arbuthnot’s general premise was that the majority of our business is poker and US-based,’ says Peter Reynolds, PartyGaming’s head of IR. ‘Its basic argument was that we were too US-focused. I did point out we didn’t set out to construct our business this way originally but when the [US] market exploded in 2002, we absorbed the majority of the increase, taking 50 percent of the market.’
Over the long run
What’s spurring the investor optimism behind PartyGaming is hope for continued high growth. Already its revenues have rocketed 90 percent this year to over $222 mn, with operating profits at just under $130 mn, and some experts estimate the online gambling industry will triple in size within five years.
From an IR standpoint, this type of story will naturally attract investors interested in high growth, but value investors also find it appealing, Reynolds points out. ‘We’re a very fast-growing company but we also have a very strong cash flow, which is a strong value pull,’ he explains. ‘When people talk of ‘value’ it means different things to different people.’
Reynolds won’t divulge the current makeup of PartyGaming’s shareholder base. Just back from vacation, he says he’s still doing the math. In the medium term, however, the IR strategy is to sustain earnings growth and continue to build shareholder value. The online gaming market remains fragmented, which often signals market share consolidation on the horizon.
Not everyone on the Street is singing PartyGaming’s praises, however. Graham Neale, equity research director at Killik & Co, didn’t recommend PartyGaming to clients and he’s not convinced the cards are stacked quite the way PartyGaming would like, either. ‘In the short term, PartyGaming could be a profitable trade,’ Neale says. ‘But there are risks. One is that the industry is generating revenue from poker players playing for only a few months, and retention rates on all poker web sites have been poor. Most players are losing money so they’re stopping playing. When an industry is going through a high level of growth, despite the loss of existing customers, you’re achieving revenue growth because new customers are still coming through the front door. But as soon as the rate of new customers slows, you reach the point where the number of people leaving outnumber those entering.’
Justin Urquhart Stewart of Seven Investment Management, a division of Killik & Co, also refuses to talk up the PartyGaming story. ‘The regulatory concern is a big red flag,’ he notes. ‘And these areas are very much open to fraud – much depends on the security of the structures in place. It’s been a bit of a fashion fad and the best of the value may already have been had. It’s certainly a cash cow, but there are definitely distinct risks.’
Trouble ahead?
From a legal standpoint, one of the risks to PartyGaming’s business is the Kyl bill, an anti-gambling bill led by Arizona Republican Senator Jon Kyl. The Arizona senator has already had his bill kicked out of Congress more than once, but he’s persisting.
If passed, the bill would impose stiff penalties on banks or third party intermediaries involved in the transfer of funds to offshore gaming operations. The DoJ has already attempted to crack down on financial players processing transactions in an attempt to block revenues but some transactions still got through via online money transfer services developed for gaming and betting sites.
David Schollenberger, partner and head of gaming at law firm Manches in London, says US politicians will be looking very carefully at what happens in the UK before passing final judgment on legislation designed to deal with online gambling. The UK’s recently passed Gambling Act 2005 makes it the first country to legalize offshore gambling. ‘The Senate will be playing a wait-and-see game, possibly for years and years, until it decides what it wants to do,’ says Schollenberger. ‘Of course, it’s not popular to make [gaming] official but if it sees the UK as a successful model, then Kyl’s bill is likely to fail – again.’
That’s what PartGaming is betting on, too. Reynolds appears at ease with the Kyl lobby and its threats. ‘There have been several attempts [at making online gambling illegal],’ he says. ‘But in the US they already have online gambling with horseracing and there’s online gambling going on in the Indian reservations. Given the similarity of this Kyl bill to the last one, I have to say it has real difficulties. But we’re keeping an eye on it. The World Trade Organization (WTO) has already said there’s an inconsistency between on and offshore operators, because you already have state lotteries and online gaming.’
The WTO’s ruling is an ace PartyGaming wants to hold on to. It is based on a case argued last year by the tiny Caribbean state of Antigua and Barbuda, which claimed US attempts to ban international online gaming were against international trade rules, and unfairly protected US betting interests. Antigua and Barbuda won, though the US has subsequently appealed.
But what about the long arm of the DoJ? Is Reynolds convinced PartyGaming can keep building its pot of winnings while the enforcement agency waits for the right moment to pounce? ‘We have 26 pages in the prospectus devoted to the risks to investors, but we’ve made sure we have the right people on our side,’ says Reynolds. ‘And we’re very comfortable with our board-level and non-board skills. There are lots of challenges, but it’s also hugely exciting – especially with such investor interest.’
