888 ready to de-rate

At the moment, analysts at Panmure Gordon estimate that 888 derives 40 per cent of group revenues from unregulated markets. That represents a major risk based on the trend of countries cracking down on online gambling. The most recent and potentially damaging example is in the UK. Last year, the government introduced a new licensing regime for online gamblers selling to UK-based consumers, which applies irrespective of where the company is registered or domiciled. This subjected a number of companies to a new 15 per cent duty on all online gambling revenues generated from the UK market. A number of companies have estimated the potential cost of this so-called Point of Consumption tax (PoC). For example, William Hill reckons it could take a £60m-£70m profit hit and close sector peer Bwin.Party Digital Entertainment (BPTY) has seen some lines of revenues squeezed in the UK and also Italy where there has also been regulatory upheaval. While brokers are forecasting a drop in earnings this year at 888, the company's bosses have remained tight-lipped on the expected impact and haven't quantified what proportion of profits is under threat from the PoC tax.

The transition to regulated and taxed markets is happening in several other European countries aside from Italy and the UK, including Bulgaria, Hungary, the Netherlands, Portugal and Switzerland. Elsewhere, in countries such as Germany and Greece, regulatory uncertainty persists because laws haven't been enforced or because EU laws prohibit changing the existing regime. Given that 888 derives about two fifths of group revenue from unregulated markets, the City is understandably nervous about what impact new regulation could have. The upcoming British general election could also hold nasty surprises for the gambling industry.

The reason 888 looks attractive to potential buyers could be down to its US foothold. The company has established a business in New Jersey and has signed several lucrative contracts with casino partners in the state. The problem here is the federal system through which US law is enforced: it makes replicating success state-to-state quite difficult. At the time of the interim results last summer, chief executive Brian Mattingley admitted that 888's US business had experienced some "teething problems" and possible "over-regulation". Technical issues with online payments and personal privacy concerns resulted in sluggish trading in New Jersey. But the boss insisted that such problems could be ironed out "over time".

Admittedly, the company has a healthy cash pile, with $60m (£39m) in the bank excluding customer deposits. Bullish supporters of the stock might argue the company has enough cash to offset rising tax costs. The problem here is the company has not quantified the real financial impact of new regulation which will inevitably weigh on cash generation.