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Gambling on government

Created:

15 September 2009

Written by:

John Hughman

When PartyGaming floated in 2005, investors couldn't get enough of the internet-poker trailblazer. The company's initial public offering was three times oversubscribed, helping propel the gambling website into the FTSE 100 within months.

PartyGaming was one of several internet gaming firms to hit the market at this time, as the internet opened up a whole new world of gambling opportunity. But while many investors were attracted to the industry's huge growth potential, many fund managers refused to back the deal because of worries over the illegality of such activities in the US. With the benefit of hindsight, they had every reason to be concerned. The Unlawful Internet Gambling Enforcement Act (UIGEA) was passed in October 2006 and, as our very own Mr Bearbull wrote at the time, "rarely has the value of an industry crumbled so fast."

Regulation beats prohibition

Even today, nearly three years after the law was passed, the UK's betting companies are still paying the price for their short-lived time at the table with the vice-crazed US consumer. PartyGaming, for one, has agreed a $105m settlement with the US Department of Justice in April, while 888 Holdings and Sportingbet have yet to confirm the outcome of their discussions.

For PartyGaming at least, the conclusion of a near three-year period of legal wrangling comes as something of a relief. With all the damage inflicted, say analysts, those online gaming operators that have reached deals can now set about rebuilding their businesses. In particular, they can turn their attention to the consolidation of what remains an extremely fragmented industry, now they know how much of their once-bulging cash piles they have left to spend on acquisitions.

Having been burned once, online gaming operators are unsurprisingly adopting a much more cautious approach to geographic expansion, focusing their businesses in countries where clear regulation of internet gambling is being put in place. Outside of the long-liberalised UK, the wider European market is slowly opening up, as markets that were once tightly controlled by state monopolies begin to welcome new providers.

Europe opens up...

In Italy, for example, which was one of the first countries to regulate, there was a 186 per cent jump in expenditure on online gaming in the first three months of 2009, and the government there is looking to extend its licensing programme. In March this year, France proposed new laws to regulate online gaming in order to tackle - and tax - the illegal gambling that is rife in the country. And regulation is set to follow in the Baltic and other Eastern European states. "There is positive momentum in the regulated market," said Mor Weizer, chief executive of Playtech, whose poker revenues jumped 24 per cent at the half year thanks to its role in the launch of Italy's first poker network.

Even in the US, less hard-line senators like Barney Frank are pushing hard to overcome a law described by the Massachusetts politician as "one of the stupidest things I ever saw." He is pushing for a modification of the UIGEA which would allow selective licensing of internet gaming sites, and the industry is watching closely. "The US presents a great opportunity if and when it regulates," said Mr Weizer. "We look forward to working there and continue to monitor the situation." That's a view supported by Geetanjali Sharma, leisure analyst at Noble Group. "The US is still a grey area, but if they regulate, we're likely to see another crazy boom."

...but monopolies fight back

Yet while the US government's enthusiasm for outright prohibition isn't shared by European lawmakers, the industry remains a legal minefield. This week's European Court of Justice preliminary ruling against Bwin in Portugal highlights the confusing contradictions that still exist between state and European law. In essence, state monopolies such as Portugal's Santa Casa da Misericordia de Lisboa are allowed to defend their position on the basis of protecting citizens from fraud.

Sigrid Ligné, Secretary General of the European Gaming and Betting Association, doesn't agree that state-monopolies are any better placed to counter fraud than private online businesses, based on the results of a benchmarking exercise. "A few assumptions were made that could be seen as anti-online," she said, arguing that a restriction of online gaming could in fact prevent the operation of good controls, monitoring and standards. "There is a demand for choice that monopolies do not satisfy. Rules that restrict growing demand will force customers to go elsewhere. That's what we've seen in the US."

In the meantime, it seems that governments are prepared to go to tremendous lengths to protect lucrative state-backed monopolies and the online gaming industry can expect little help from the EU. "It is the last market in Europe that is so segmented and subject to protectionism. We are optimistic that it cannot stay like this," said Ms Ligné. Although, as Ladbrokes' chief executive Chris Bell said after the company's latest results, efforts to expand the wider European gaming market are likely to be "a long hard slog". Indeed, regulatory harmony of online gaming certainly seems a long way off.

Counters to clicks

Despite the teething problems encountered by the online gaming business, moves by large high-street bookmakers suggest that the internet is still seen as the future of the industry. Private equity owned Gala Coral, which runs 2,000 bookmakers, 148 bingo halls and 27 casinos in the UK, has said that it wants to reduce its debt pile so that it can invest more heavily in its Eurobet internet business. The UK's other large high-street chains are devoting more resources to the internet too. After a disastrous attempt to develop its own web platform, William Hill Online's deal with Playtech is turning around the fortunes of the group's internet business.

In fact, both William Hill and Ladbrokes recently announced plans to relocate their online sports books to Gibraltar, arguing that operating out of the tax haven was the only way to remain competitive given the UK government's unwillingness to reduce the tax rate. Of course, that's unlikely to sit well with a government keen to clamp down on offshore tax avoidance, but according to analysts there seems little it can do. "The thing they're still holding against the government is the shops - they still employ more than 16,000 people in the UK," said Noble's Mr Sharma.

According to Paddy Power finance director Jack Massey, physical stores still have an important role to play. "A multi-channel strategy brings significant benefits," said Mr Massey, as Paddy Power continues its expansion into the UK high street. "Online gets a boost in areas where there are shops," he said. Meanwhile, other companies, such as NetPlay TV, are taking live gambling onto the airwaves. The company 's supercasino.com already operates via Sky's platform and it has just signed a five-year airtime deal with UK broadcaster Five. "No one really knows what the potential of TV gaming it, but our metrics are moving in the right direction. TV adds an element of trust," said managing director Gavin Whyte.

Not so recession proof

The impetus to expand has been brought into stark focus by the economic downturn. Far from being the recession-proof industry that many had thought, gambling has been nearly as susceptible to a pull-back in discretionary spending as other consumer-facing sectors. High street bookies Ladbrokes and William Hill have both reported lower betting activity And if that wasn't enough to contend with, results haven't gone the bookies way either - and neither has the weather, with several key race events called off early in the year. Of course, bookies shouldn't be judged on a few bad results as the law of probabilities means that the punters won't always win.

Revenues from activities such as poker, bingo and casino aren't quite so vulnerable to the hand of fate. Poker, in particular, works by taking a small proportion of each players' staked amounts known as a rake, and has no exposure to gambling outcomes. But poker revenues reported by the UK's largest online operators have also been under particular pressure as gambling dollars switch into casino games. Poker remains hugely popular, but the industry is finding it harder to keep casual gamblers spending.

The effect has been to accelerate the level of business-to-business activity undertaken by providers looking to reduce their exposure to volatile consumer business. PartyGaming and 888, in particular, have been refocusing their business to take advantage of brand owners looking to launch gambling offerings. 888 has said that it wants to to acquire to accelerate growth of its recently rebranded Dragonfish business-to-business offering - "not because we can't build it but because we are in land-grabbing mode".