WORLD GAMING plc - now UK-listed

Baker Tilly's Littlepage: Gaming Stocks Outlook (Transcript)
2005-12-21 13:28 (New York)


Dec. 21 (Bloomberg) -- Jodi Littlepage, an analyst at Baker
Tilly, talked with Bloomberg's Mark Barton in London yesterday
about the outlook for the online gaming industry in 2006,
PartyGaming Plc, Sportingbet Plc and regulation in the U.S.

(This is not a legal transcript. Bloomberg LP cannot
guarantee its accuracy.)

BARTON: Online gaming has captured the imagination of
gamblers. The $8.2 billion market is forecast to grow 22 percent
annually for the next five years. And it captured the interest of
investors too, as PartyGaming, Empire Online, and 888.com join
more than 10 companies holding high profile IPOs.

In fact, some investors are concerned the proliferation of
online gaming sites and the surge in the number of online gaming
IPOs is similar to the Internet boom of 2000, the one that went
bust a year later.

In a moment, Guy Collins joins us with a status report on the
online gaming stocks. But first to Baker Tilly gaming analyst Jodi
Littlepage. She joined me to talk about the surge in popularity of
online gaming. I began by asking her what's been the big theme of
2005?

LITTLEPAGE: There's been some very high profile floats in
2005. Obviously PartyGaming, which was the largest float on the -
on the London Stock Exchange for a couple of decades - decade and
a half I think. And that's kind of been the story. A little bit of
consolidation, but it's really been overshadowed by some very high
profile floats and bugle buckets coming in and investing in these
businesses.

BARTON: PartyGaming's shares came to the market at 116 pence,
and in September - on September the 2nd, of course it did say that
revenue missed forecast, shares fell, shares in a number of its
competitors fell. Was it a company-specific thing? Should we be
overly concerned about its announcement?

LITTLEPAGE: Yeah. I mean you bring up a point that, you know,
is out there in the city right now, and people are very concerned
about the potential growth of poker. And poker does have, you
know, it will flatten out. It is flattening out. If you look at
the PartyGaming perspective, they grew at - their poker business
grew at about 347 percent last year. And then the last quarter
before they floated it only grew at 15 percent. The following
quarter where they released results the market didn't like, it
grew at another 15 percent. So, we've just got to make sure we get
the expectations right for the different products.

BARTON: Do you think the expectations are too high for the
different products? And maybe for the industry as a whole?

LITTLEPAGE: No. It was for poker. Maybe it's now becoming
more realistic, the view of investors, and the view of the markets
for poker. But not sports betting. I think investors are very
realistic. They do respond appropriately to events and news in
industry and company events.

BARTON: Talking about poker, I mean, Christensen Capital
Advisors says online poker grew to one billion in 2004, but it's
going to grow - it's going to slow to 60 percent in '06, and it's
a 30 percent a year later. I mean, quite substantial falls, aren't
they, in growth?

LITTLEPAGE: They are. But if you compare them to the industry
overall, Christensen Capital also say that the industry itself is
going to grow at about 33 percent in 2005. And that's top line
revenues, whereby the equities, the published A companies in this
space, their equity prices grew about 200 percent last year. So,
if 33 percent is the overall industry growth, then anything above
that for poker is still above their peers in the space.

BARTON: And another company that stood out this year was
Sportingbet, and in July it said for the year to July annual
profit rose almost eightfold. Business so far this year is strong
as well. It's doubled in its size by buying Paradise Poker in
November. And strong trading in every division. Is this one of the
companies that stands out for you?

LITTLEPAGE: It does. They're a solid company. They started
out small; they went through a couple difficult periods. They are
exemplary because they have a way of doing M&A transactions that
really add value to their shareholders and to their business. They
deliver to their shareholders what they say they're going to
deliver, and they're very good for the industry because of that.

BARTON: One factor that's overhanging the industry is the
legal aspect between Empire Online and PartyGaming.

LITTLEPAGE: Yeah.

BARTON: Does this affect sentiment in the industry? Is this
hanging over the industry, this suit?

LITTLEPAGE: It is. I mean, I think what the market doesn't
really realize is that Party and Empire were at one stage very,
very closely tied together. Empire used Party's software. So, the
two companies have had a little bit of a falling out over
decisions that they've made, but, you know, I think that's as -
that's as far as the impact really goes in the sector, that, you
know, people will now understand if they're going to go public,
they need to consider certain things, and they need to actually,
you know, behave like publicly traded companies.

BARTON: Online gaming stocks have had a switch back ride
since coming to market earlier this year. Shares of the biggest,
PartyGaming, surged 50 percent from their initial public offering
price of 116 pence on June 27th, to a high of 175 pence a month
later. Investors snapped up the stock as they bet it would deliver
fast revenue and profit growth after sales almost quadrupled in
2004. PartyGaming makes 87 percent of its revenue in the U.S.,
where the Justice Department considers the business illegal.

Well the investors' mood changed abruptly on September the
6th when the company warned that revenue growth was slowing, as
you can see on the screen here, this plunge in the stock wiped 35
percent of its value in a single day, and in shares of
competitors, such as Sportingbet as well, slid further to touch a
low of 71 percent in October, 39 percent below the IPO price
before then rallying on renewed optimism about the business
outlook.

Well this month Chief Executive Richard Siegel said daily
poker revenue increased 14 percent to $2.7 million for the two
months October and November, compared with the previous quarter,
and daily casino revenue jumped after it introduced Blackjack in
October. The company's got a market value of more than five
billion pounds - that makes it bigger than British Airways in
terms of valuation, and it's been in the FTSE 100 since mid-
September.

Well, Sportingbet, another Internet betting company has seen
a similar trading pattern in its stock. It said in November that
net income surged more than five times to 14 million pounds in the
quarter ended October as sales climbed 35 percent. And other
online gaming stocks which had initial public offerings, including
888.com, which raised 148 million pounds in the sale in September,
and Empire Online, which raised 124 million pounds in June, have
all been part of what has been a volatile sector.

What do you think is going to be the big theme of 2006 in
this industry?

LITTLEPAGE: Consolidation.

BARTON: Yeah.

LITTLEPAGE: Most definitely. Just like other markets. It's
already starting to consolidate. I'm personally working on, you
know, a number of consolidation deals at the minute, whether it be
a public companies that want to buy private companies, or two
companies that want to perhaps go public and decided no, they'll
merge, that sort of thing. You know, as anybody that has a
valuation under 50 million pounds right now feels small in the
industry, and they're thinking I need either to buy a technology
company, or I need to buy an operator. I need to diversify
geographically. And it's easier to do that in this space by
strategically aligning yourself with another business.

BARTON: Will we see smaller companies coming together, or
will we see a case of, you know, the bigger companies swallowing
up the smaller companies? What sort of type of deal will be more
prevalent in 2006?

LITTLEPAGE: To be honest, you've got a bit - a bit of both. I
mean the bigger companies, they don't offer the same - they won't
- they won't pay the same price, you know, for a business. They'll
pay, you know, they're going to really negotiate the small little
company down to the bone. Whereby, you know, smaller companies
they appreciate each other, so long as they can come to terms with
their cultural fit and the prospects of them being together and
the future forecast of their businesses as one. You know, there
might be more value in that for smaller companies. Really it
depends on the culture of the businesses, but the big - the bigger
companies put offers in for most M&A opportunities out there. But
most of those - most of those bids are lower than the smaller
companies will be willing to sell for.

BARTON: A lot of people talk about barriers to entry. Some
say low barriers, some say high barriers. What is the reality in
the Internet gaming industry?

LITTLEPAGE: There's high barriers to entry ...

BARTON: Yeah.

LITTLEPAGE: ... in Internet gaming. Yeah, there aren't a lot
of new - aren't going to be a lot of new entrants into this space
from the operators' perspective. From a technology perspective
there, you know, there are very quite low barriers for the likes
of Microsoft and these very big technology companies that will
eventually move into this space, once the U.S. regulations are
sorted out, there is - there's that risk there, and a lot of
technology companies right now are trying to position themselves
so that they're guarded against that threat. But there is that
threat there.

There's about a dozen primary technology companies in this
space. They provide the technology to the operators, and, you
know, many of the publicly traded companies are actually
operators. So, there's a barrier there, but from an operators'
perspective, your assets, your main asset is your database of your
- of your players. And your players are usually pretty loyal if
you treat them well. So, they won't go away if you treat them
well. But for someone else to come in and grab your - grab your
assets, not very easy.

BARTON: You mentioned U.S. regulation. Will 2006 be a year
where the online gaming market will get closer to being regulated?

LITTLEPAGE: I wouldn't bet that it was going to be regulated
in 2006. Maybe 2007, maybe 2008 sort of thing. I don't know that
it'll happen next year. It's more - it's a political thing in the
states. It's nothing to do with economics or anything.
Economically and financially they know that they should do it, it
would be good for them in every way. But whether it's on the cards
for moving closer towards that in 2006, I wouldn't think so.

BARTON: Is it a factor that should hold us back from
investing in any stocks? No, the whole U.S. legal issue?

LITTLEPAGE: Yeah, I mean they're never going to - it's not
going to be banned altogether. It's going to be regulated at some
juncture. And, you know, the gaming industry has been working
under regulation forever. All these companies are licensed, they
pay their - most companies pay, you know, sort of two to five
percent taxes, depending on where they're at. You know, that we'll
have - now have regulation in the U.K. so they can base themselves
here and pay taxes here.

So, once the U.S. sees the U.K. as a successful jurisdiction
for regulating online gaming, then that'll be a good platform for
them to, you know, perhaps learn, you know, how to - how they can
actually regulate it in their own country.

BARTON: Final question. Share price performance of the
industry next year, is it going to be a good year to buy shares in
these companies?

LITTLEPAGE: Most definitely. Yeah. I think it's a longer
opportunity for investors next year. I think you're going to get a
growth rate that is obviously far superior to other industries,
and much less volatile.

BARTON: Are there any companies that stand out that we should
be keeping our eye on over 2006?

LITTLEPAGE: I think, you know, focus on the companies that
have a little bit of diversification in their - in their - in
their business, so that they either own technology and they're an
operator, or they're geographically diversified, or platform
diversified. Diversification is quite good in this space.

BARTON: That was Baker Tilly gaming analyst Jody Littlepage.
Now here's Guy with an equity outlook for 2006.