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Buy or build?

Without doubt, the most existing, talked about, judged and analyzed sub-sector in the iGaming world over the past Debate was initially launched following the Sporting bet a acquisition of Paradise pokerwinner in October 2004, and was accelerated by the £ 4.6bn IPO of Party Gaming in June 2005, projecting the company into the FTSE100.  Not bad for a piece of software and some heavy marketing that enabled poker fans worldwide to practice, learn, enjoy and occasionally win at their hobby in their home or at work.
      These two high profile deals have been complemented across virtually the entire range of online gambling companies that have bolted-on poker products to their existing range  of sports books and casinos.  Most tellingly companies outside of the iGaming industry have also looked to generate incremental revenues from the online poker phenomenon, with white-label agreements and licensing deals for Internet portals and online media companies looking to monetize their database of content consumers.

      Clearly, the growth of online poker has been spearheaded by some aggressive marketing by the key players such as Party Gaming (with an estimated +50% market share), Sportingbet and PokerRoom (now part of Austrian company BetandWin).  This has been compounded by the cross-sale of operators’ existing customers that bet and gamble on sports and casino games.  However, as with any fast-growing and embryonic industry, two major questions must now be asked; is the industry a bubble and, if not, where do the industry operators go next to best source high value customers?


      In this article, we do not intend to spend time debating the first issue.  Suffice to say that we firmly believe that the online poker market is far from saturation (although no one has really suggested this), and neither is growth unsustainable nor unattractive.  This view is based on statistics that, although patchy, point to a situation where Internet and, specifically broadband  usage is growing rapidly across the developed world.  Furthermore, less than 5% of offline poker players have ventured online, prompting Global Betting & Gaming consultants to estimate average annual growth for online poker of +18% between 2005 and 2010.
      These growth pointers are plenty enough for us to view the online poker industry as offering exceptional levels of upside in the coming years.  We don not intend to quantify this growth ourselves, but are happy to view the market as one of significant potential growth of the leading operators.  The key question therefore is how the operators should focus their attention on expanding their databases of players, offering superior returns for private or Plc shareholders?

Statistics

Although the number of acquisitions within the online poker sector is limited, our analysis of recent deals and flotation makes interesting reading when evaluating the merits of acquisitive and organic growth.
      On a purely historic basis, it would be simple to suggest companies can add the most significant value by focusing on consumer marketing and growing their databases organically.  The statistics show that Sportingbet acquired Paradise Poker for $ 476 per registered player ($ 3,540 per active customer), whereas its cost per acquisition (CPA) in 2005 for Paradise was just $ 139.  Furthermore, Empire purchased the operations of Club Dice/Noble Poker for an estimated $ 534 per registered real money player, relative to its 2005 CPA of $230.

      It is also worth nothing that investors acquired shares in Party Gaming at its flotation in June 2005 that valued each existing registered customer (poker and casino) at $ 1,017.  This is relative to our estimated CPA in 2006 of $ 111 (Party’s CPA also includes retention costs as Party has been coy in splitting out its actual figure).  Excapsa’s recent float valued each customer at $ 221, in comparison to its 2005 CP of $ 166.
      Clearly, the gap between flotation/ acquisition values and CPA has narrowed considerably since the Sportingmobilebet and Party Gaming Corporate activity.  Furthermore, while we have no details on CPA figures, it is interesting to note that the proposed acquisition of Ongame (PokerRoom, HoldemPoker etc) values each registered customer at just $ 124.  This largely reflects the high level of registered customers on the owned and white-label network, but the value per active real money player ($ 2,595) is also at a discount to that of Sportingbet’s Paradise acquisition ($ 3,539) and Party’s valuation at float ($ 19,106) per active real money player).
      We believe that these statistics reflect a shifting trend to superior value acquisitions in the sector.  We also contend that the trend is opposite in the CPA for online poker operators.  This, therefore, partially drives our views that, despite the perceived costs of organic vs acquisitive value per player, the most cost effective way for companies to expand their online poker database is most likely to be via acquisition.

The most cost-effective way for companies to expand
their online poker database is most likely via acquisition

CPA trend

Although CPA statistics vary across operators and separate segments of the online betting and gaming markets, we believe that the most interesting trend is in online poker.  While sportsbooks and casino sites have seen a broadly flat to decreasing CPA over the past couple of years (888 in FY05 saw a 5% decline,  World Gaming was down by 6% to just $101, 32Red decreased by6 16% ), poker has seen a material uplift.  This relates principally to a focus on the sector in such a growth market, but even short-term shifts suggest that consumer marketing may becoming less cost effective.
      Party Gaming’s CPA (including costs of player retention) of $111 per new real-money player in 2005 reflects an increase of 91% over 2004 when it expensed just $ 38m of customer acquisition and retention costs, relative to $ 100m in 2005.  Elsewhere, Paradise Poker’s CPA has grown from $139 in the 12 months to July 2005, to $ 166 in the first quarter of 2006and up to $ 199 in the second quarter.  Excapsa’s figures are limited, but imply a 19% uplift  in its CPA from 2004 to 2005.


      It is our view that these figures will continue to rise as the industry becomes more competitive and the online operators look beyond the low-hanging fruit (computer – savvy offline poker players) to targeting competitors’ databases and providi8ng superior offers in a crowded market to entice new players.
      Although, prima facie, the acquisition of customers is currently higher for operators buying rather than attracting clients via marketing, we believe that this may reverse in the future as smaller operators in a fragmented market are willing to sell their database of players in return for a cash sum or equity in a larger operator that has the scale to drive internal growth.  There are also a number of other factors that highlight the strengths of acquisitive over organic growth.
     


Other factors

The benefits of an acquisition are numerous and further drive our view that acquisitive growth should generally offer superior value and returns for operators relative to ongoing organic growth.
      Firstly, for smaller companies, the acquisition route may be critical as it provides instant liquidity into their existing database.  Specifically with poker, a broad base of players is vital to attracting and retaining customers and given the time constraints of organically building depth in a customer base, it may be that attrition rates (players leaving to more liquid sites) exceed the number of incoming players.

      Furthermore, the opportunity cost of not being able to offer a liquid poker offering to existing sports betting or gaming clients may prove detrimental to operators’ player numbers, particularly in a market where most major operators are able to offer consumers a shared purse across all of its products.  We see the complete product offering as a critical success factor in the online gambling industry.  Therefore, a swift and effective addition of a poker product via acquisition (or, indeed, via a licensing deal with a poker aggregator) provides the ideal operating model at a stroke.  The cross-sale of consumers across products should, in our view, play a key role in companies improving their retention rates.
      Other reasons for acquiring over building a database may involve strategic initiatives, such as completing an acquisition to ensure that a company has full control and ownership of its software (as opposed to the licensing route ).  An acquisition may also allow a company to rapidly enter a new geographic market, providing the base and impetus from which it can proceed to develop its broader product and customer base in that region.
      On the downside, the integration costs relation to software, staff and corporate cultures may influence the potential returns of an acquisition.  Clearly, these issues are mitigated if the target company continues to be operated as a separate business.  However, this would negate the synergistic upside associated with combined marketing campaigns and software development.
      Any acquisition comes with transaction risks, as well as management time and costs associated with the deal and integration .  However, we believe that these risks should ordinarily (assuming sensible a acquisition multiples) be outweighed by the upside of delivering potentially lucrative returns to shareholders.  Clearly, there are wrong deals and expensive deals that may be done, but we could contest that the acquisition of customers should normally be more cost effective and offer superior returns that the sole use of marketing-led organic growth.

Conclusions

Online poker should continue to offer online gambling operators a rich pot of revenues as the market expands globally with the increased shift of players online, compounded by the rapid roll-out of broadband networks worldwide.
      We believe that the most attractive route for growth in this sub-sector is, increasingly, to expand via acquisition.  Aside from the number of strategic rationales for acquisitive growth, we estimate that the rising CPA in a maturing market should prompt operators to look to acquisitions.

      Recent deals have been sensibly priced and we view the fragmented market as ripe for further corporate activity.  The combination of instantly increasing product coverage, liquidity and geographic spread should prove compelling to operators, particularly as incremental marketing increasingly attracts reduced-value players (causal ,low-spend players with high attrition).  The opportunity to acquire a data base of existing  players with potentially higher levels of spend and retention (i.e. customer value) should not be missed.

 

 

 

 
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