Online gambling: a safe bet?

Many online gambling firms are prospering as punters stay at home during the recession. And now that PartyGaming has reached agreement with the US authorities, the trade can breathe a little more easily. Eoin Gleeson examines the industry, and picks the best bet in the sector.

By Eoin Gleeson

published 17 April 2009

in Features

A landmark US deal for online gambling was finally struck this week. Forgotten FTSE darling PartyGaming seems to have managed, at last, to bury the hatchet with the American authorities. Two years after being effectively banned from the US market, and facing prosecution for flouting American anti-gaming legislation, the Gibraltar-based company has decided to cut its losses. The firm has now admitted several law violations to the US Department of Justice and agreed to pay a $105m fine in return for not being prosecuted.

So, why a sudden deal? A change in mood from the US authorities may have helped it was the Bush regime that imposed the original online gambling ban. A cartel of congressman, led by civil-rights activist Barney Frank, has been agitating to dismantle the anti-gambling laws passed by the previous administration. The agreement with PartyGaming was also struck just a couple of weeks after the European Commission complained that the USban was discriminatory and even a breach of World Trade rules.

In the end, pragmatism may have won. "The US's real motive in passing its King Canute-like anti-gambling legislation was entirely protectionist," says Alistair Osborne in the Daily Telegraph. It was all about making sure the big, established casinos on the Las Vegas strip weren't overtaken by the nifty online newcomers. But Las Vegas has recently hit the wall with gambling revenues falling sharply. So some of its biggest operators, such as Harrah, the group that owns Caesars Palace, are now thought to fancy a move into online gambling, says Matthew Goodman in The Times. And a settlement with PartyGaming could be a big step towards full legalisation. The American authorities also seem to have concluded, as they did with Big Tobacco, that it's better to regulate and tax the vice industry than to pursue a ban that is unpopular and difficult to enforce.

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For now, though, the latest deal creates little more than breathing space for the likes of PartyGaming and rivals such as 888.com. Online firms are at least now free to raise capital to pay for advanced software. They can also merge to expand their customer bases. But although free to operate in Europe, PartyGaming has been struggling to fight off competition from smaller players who have managed to sidestep the US ban. Income from online poker responsible for more than half its revenue last year suffered a 1% fall in average daily takings over the last quarter.

PartyGaming has also poured a small fortune into advertising to keep, let alone win, customers. It is increasingly apparent that online gamblers will need to scale up to reduce costs if they are going to survive. But pulling off a big acquisition, ban or no ban, will be tough. Credit is hard to come by and the City may need some persuading before funding any firm tainted by the American ban in a downturn.

Lastly, although a step forward, PartyGaming's settlement doesn't allow it to take bets in the States it just removes the threat of prosecution that has been tailing the firm. The company has also had to admit that some of its activities were "contrary to US law" hardly great PR. And as Collins Stewart analyst Paul Leyland told the FT, the $104m fine 1.6 times PartyGaming's net cash will seriously dent cash flow until the last instalment is paid in 2012.

No gambling business is recession-proof, but Playtech is robust: it operates in 45 countries and is expanding into sports betting. A 29% stake in William Hill is also paying off handsomely, with the average daily income from the group 40% higher in the first eight weeks of 2009 compared with 2008. That helped lift pre-tax profits to €41.45m last year from €26.85m the year before. "This diversification should hold it in good stead," according to Gary White in The Daily Telegraph. It also has a strong pipeline of new potential licensees, with a large number of online gambling groups buying up its software to broaden the range of games they offer.

Eoin came to MoneyWeek in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.