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Is there a future in the industry?
By Robin Chhabra, Leisure Analyst, Evolution Securities

As an analyst following  the online gaming industry I am regularly confronted with the following  remark, “The boom in online gaming stocks is no different to the internet boom and bust at the turn of the century”.  “Not true” I say, “The leading online gaming companies generate substantial profits and cashflow” and I then proceed to reel off an array of impressive performance metrics that have been continually served up by the likes of Sportingbet.  Undeterred, the sceptic attacks with “Ah, but it’s a fad isn’t it?” I’£ be honest with you, for a fleeting moment on 6 September 2005 when PartyGaming warned of slower-than-expected growth, which triggered a wholesale collapse in the value of online gaming shares, I almost agreed.  However, I referred to the cold hard facts, and logic kicked-in again.

  • The global gambling market is huge, worth an estimated US $ 237 bn in 2004 (
    Source: Global Betting and Gaming Consultants)
  • All industry consultants agree that portion of gambling currently conducted online is small-around 4-5% of the overall market.

 

So even if the size of the overall gambling market does not grow – which is in itself a pessimistic scenario – surely even the most hardened skeptics will agree that the general increase in broadbrand penetration, consumers’ rising comfort with transacting online and the emergence of new electronic delivery channels such as wireless (which could unlock the potentially huge Chinese market ) should lead to growth in online gambling for some years to come.  Furthermore, the best gambling operators, online or offline, provide great entertainment and as incomes rise, people spend an increasing amount of their wealth on leisure and entertainment services.  Gambling also provides a valuable source of revenue for Government enabling them to fund vote-winning increases on public services or decreases in personal taxes.  In short, there are several powerful and indisputable macro drivers at work.


      However, I know that Mr Sceptic has not been floored yet.  He (suffice to say in my line of work, it is invariably a he) will try to land one final blow – “the sector will collapse because it is illegal in the US”.  One aspect of the online gaming market that has surprised me has been its sheer resilience in the face of regulatory uncertainty.  For example.  Elliott Spitzwer’s attempts to frustrate the industry by making it difficult for US citizens to fund online gambling transactions led to the emergence of alternative (and hugely successful) payment processors such as Isle of Man based, Neteller.  While the uncertain regulatory environment is bound to create periodic ‘bumps in the road’, this episode highlights the industry’s ability to innovate.  Quite simply, the incentive to deliver inventive solutions is high given that the market is so large and the rewards for success so substantial.  Generally, lawmakers appear to be heading – albeit slowly – towards espousing a system of regulation as opposed to prohibition as they realize that the boundary – less nature of the Internet makes online gambling almost impossible to stop.

      I have painted a rosy outlook but, of course, not all operators will benefit from this relatively positive backdrop.  As in other online industries such as travel, auctions and bookselling, we expect to see most consumers coalescing around a small number of trusted and powerful brands.  The best operators will be those that successful offer a broad range of high quality gambling and gaming product ranging from sports betting, casino, poker, skill gaming and beyond – a one-stop shop- which will enable them to retain customers for longer and earn more money out of them.  Sportingbet is perhaps the best practitioner although PartyGaming’s first steps in cross selling have delivered startling results with 40% of its poker customers availing themselves to its recently launched blackjack offering.  The key here is that PartyGaming’s blackjack customers cost nothing to acquire so the ‘drop through ‘ of customers’ losses to the bottom-line is very high.
      In our view, the winners in this market have already been born and new entrants will struggle.  The financial marketing muscle required to create a brand from scratch is becoming ever more prohinitive especially when you consider that PartyGaming is likely to spend in excess of $ 100m on pure marketing (excluding bonuses) next year.  In this environment, we are not surprised to see an increasing number of casualties who have struggled to reach the required critical mass of customers to justify the fized costs of investment.  New openings appeal to have slowed  dramatically as well.  A shake out of the weakest players is one quality that the online gaming market does indeed share with the internet bust.  The tempering of the stock market’s love affair with online gaming stocks and the dwindling prospects of an IPO windfall for private operators should lead to more orderly and rationally behavior and the days of 100% matching cash bonuses should soon be behind us.  In conclusion.  Mr Sceptic is right not to blindly support all online gaming stocks.  Yes, growth prospects are bright, however the spoils will not be divided equally.

 

 

 
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