More reasons to avoid internet gambling stocks

Sportingbet’s chairman was arrested in the US last week on claims of violating state gambling laws. Yet another reason to avoid the online gambling sector.

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Talk about bad timing. Just after our cover story on vice stocks headed off to press, the long-running train-wreck in the online gambling sector juddered forward once more.

Sportingbet's chairman Peter Dicks was arrested in the US last week on claims of violating state gambling laws. This follows the arrest of BetonSports chief executive David Carruthers and several others back in July, on federal racketeering, tax evasion, conspiracy and fraud charges.

The latest incident reinforces our view that investors are too blas about the risks in the online gambling sector. As we said at the time of Carruthers's arrest: "Refusing to accept reality and chasing a losing streak is a classic sign of problem gambling.' But it seems that some people never learn...

The gambling companies claim that they operate in a legal grey area. The law that the US Department of Justice is using against them was passed in 1961 and (obviously) doesn't mention the internet, although it does cover telephone betting.

For some reason, this ambiguity is supposed to be reassuring. We can't agree with that. Unclear laws and the risk of arbitrary actions from governments don't make for a good environment in which to do business.

After the BetonSports palaver, many took the view that the arrests were not part of a crackdown on the whole sector. They pointed to founder Gary Kaplan's less-than-pristine past, and to the fact that the company took sports bets over the telephone, something that is definitely illegal in the US. Optimists felt that this was a company-specific case.

But Sportingbet also takes bets on sports events, and has in the past done so over the telephone. This made it particularly vulnerable in the event that the US authorities decided to go after another gambling firm. The fact that Sportingbet's chief exec Nigel Payne, together with Carruthers, has been outspoken in calling for the legalisation and regulation of online gambling in the US also made it a likely target.

Reassuring noises are now being made about the latest arrest. Some point out that PartyGaming and 888 do not offer sports or telephone betting, but only online casino games such as roulette and poker. Others note that there is no sign of concerted federal action against the gambling companies Dicks's arrest was requested by Louisiana State, not the Department of Justice.

Nevertheless, the risks remain high. The Goodblatte/Leach bill coming before the Senate this month would tighten the law against online gambling. It's widely thought that it's unlikely to pass, but the gaming company directors thought they were unlikely to be arrested. It's clear that there is considerable opposition to the online companies, not just from moralising lawmakers, but also from traditional casinos whose business the online sites are taking. And casinos have powerful lobbyists on Capitol Hill.

What's more, the Department of Justice will have realised that it doesn't actually need new laws and successful prosecutions to hurt the gambling companies. BetonSports has been effectively shut down without anyone being found guilty and the incident hammered its rivals' share. They wobbled again after Dicks's arrest.

Another incident like this, legally justified or not, and shareholders might wonder if the American market is worth the risk to their investment. Directors might wonder if it's worth the risk of a spell in the penitentiary. Some already have admitted that they don't like the idea of travelling to the US at present.

And losing America would be a big blow. PartyGaming gets over 75% of its revenues from the US, while 888 relies on it for over 50%. To be fair, both are diversifying and their non-US operations are growing fast. But it would still be a big hit if the US revenues vanished.

Hence, Partygaming trades on 10.5 times forecast earnings, 888 on 10.7, Sportingbet on 11 before its suspension. Some think that's overly cheap.

Given the risks, we have to disagree. But if you'd like to know about some vice stocks we think you should buy into, take a look at our latest issue. Subscribers can access it online by going to our Latest Issue page: Latest issue

If you're not a subscriber yet, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.

Turning to the stock markets...

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The FTSE 100 closed 21 points higher at 5,879. Miners were among the main losers, with Vedanta Resources down 3% to £13.21. For a more detailed report, see: London market close

Over in continental Europe, the Paris Cac-40 closed 13 points higher at 5,073. The German Dax-30 rose 21 points to 5,795.

Across the Atlantic, US stocks made gains as comments from various Federal Reserve members reassured investors that the US central bank may be worried about inflation, but it is also monitoring the economic slowdown. The Dow Jones Industrial Average rose 60 points to close at 11,392, while the S&P 500 gained 4 points to 1,298. The tech-heavy Nasdaq rose 10 to 2,165.

Over in Asia, Japanese stocks fell sharply as data on machinery orders in July was worse than expected - plunging by the most in nearly 20 years. The Nikkei 225 fell 286 points to 15,794 on fears that economic growth is stumbling.

Oil prices were lower in New York this morning, with crude trading at around $66.05 a barrel. Brent crude was also down, trading at around $63.15.

Meanwhile, spot gold headed lower, plunging below $600 an ounce for the first time in more than two months, as the oil price retreated. This morning it was trading at around $598 an ounce.

And in the UK this morning, casino operator Stanley Leisure says it has agreed a £693m takeover by Malaysian gaming group Genting.

And our two recommended articles for today...

Why coal is making a serious comeback - In the UK, it's largely viewed as a relic of the 1980s. But soaring oil and gas prices mean that coal is making a comeback, says Nick Louth in the Daily Reckoning - and now it's cleaning up its act too. To find out why coal could solve the energy crisis - and how to invest in it - read: Why coal is making a serious comeback

Why the gold price is set to double - Veteran gold commentator Paul van Eeden believes that the price of base metals will be battered by a US slowdown. But the good news is that a US slump will see the price of gold soar. To find out why, see: Why the gold price is set to double

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