If it was possible to tear yourself away from a fascinating Cheltenham Gold Cup festival, any half-objective observer would agree that gaming companies had an excellent results season. Whether it was traditional bookies such as Ladbrokes (LAD) and William Hill (WMH), or software and marketing specialists like Playtech (PTEC), the sector has proved to be a one-way bet over the past six months for investors who had an eye for a winner. Several important trends have become apparent which will shape the prospects for the sector over the coming year, with a series of changes in regulation and taxes, particularly in the US, that could potentially open up an important new market.
The American dream
The single most important regulatory change was the decision by the state of New Jersey to license online gaming. The market got very excited about this and companies such as 888 (888), which has partnership deals to provide technological know-how to major US casinos, was a particular beneficiary of the improved sentiment. However, a closer look shows that the measures that New Jersey has endorsed do not mark the start of a great online gaming liberalisation because, fundamentally, without federal laws to impose uniform legislation, the end result will be a patchwork of different jurisdictions and standards. In short, it could prove a logistical nightmare, which is probably why the deals that have been done so far have stopped short of establishing a full independent operation on the ground.
What there have been are mostly technology-based service contracts. The irony is that European companies are well ahead of their US rivals when it comes to online technology. The New Jersey gaming bill allows online gaming, but only if tied to the state's casinos. In addition, online operators will have to pay a higher gambling tax of 15 per cent and the bill has a 10-year sunset clause. Overall, New Jersey looks like it is trying to provide a subsidy for Atlantic City's struggling casinos, but at least the industry has something to be getting on with.
The UK gaming companies best-placed to take advantage of any further changes are probably 888 and William Hill, which has an operation in Nevada. Interestingly, it is small-cap Sportech that may have the most tangible foothold in the market with its concession to run tote horse betting in New Jersey. Sportech's shares made waves after its full-year results when the company, which runs the football pools, won a tax case entitling it to an interest-adjusted VAT rebate of £80m on tax paid for the 'Spot the ball' competition in the 1970s. The windfall potentially pays off the company's debts and gives it the fire-power to break out further from its declining football pools niche, which could include investing in the US.
What price growth?
The growth of mobile betting has been a feature of the past two years, particularly the huge strides made by William Hill in mobile betting. Revenues from punters betting on mobile phones are more than doubling every year and are a big reason for growth in operating profits averaging more than 20 per cent a year. However, what emerged from the results season is the rising cost of acquiring all those additional punters. In short, competition is really beginning to hot up as bookmakers compete for business.
The Cheltenham Gold Cup was a classic example. All the money-back offers if a favourite won made it difficult for punters to lose. For example, Paddy Power lost £6m on a race at Cheltenham after the favourite won and other bets were refunded. Apart from the fact that no bookie ever really loses when the balance of the book is taken into account, the Irish bookie's stated policy is to use big money-back offers as a form of proxy advertising. However, even Paddy Power noted at its recent results that marketing inflation is becoming a real factor in the rising cost of attracting punters.
That could be because many of the markets that punters use online are starting to mature. For example, as specialist sites such as Betfair (BET) have discovered, once everyone who wants to use your service has signed up, any further incremental growth is both difficult and costly to achieve. Bwin.Party described the current situation with even more precision in its recent results: "As a number of markets have matured, the marginal returns from new customer acquisition in a number of those markets have declined, while the costs required to support them in terms of marketing, risk management, IT operations, customer service, affiliate management and legal and regulatory services have not."
In other words, bookies are not far off the point of diminishing returns when it comes to acquiring customers. The value now, and the point of all the money spent on marketing, is to cross-sell other products from across bookies' range of in-play betting markets and casino games to those most likely to stay and use your products. This has helped William Hill maintain such a large gap over its main rivals, albeit at the price of higher costs.
Technology tug
Even though costs are rising, it is now absolutely vital that a company's online offering is up to scratch. The niche that Playtech has built in this particular market is proving to be a formidable asset, despite the persistent doubts over the company's relationship with its major shareholder, Teddi Saggi. The last set of results illustrated the name the company has made for itself - sales jumped from €110m (£72.8m) to finish the year at €317m, with operating profits almost doubling to €131m. And barely a week after Playtech agreed to sell its share of William Hill Online, it inked a deal to overhaul Ladbrokes' IT and online marketing structure. Ladbrokes had been trying to improve the online arm itself, but a slipping timetable for improvement led to a change in policy.
Even a small company such as Sportech (SPO) has been positioning itself in the technology market, spending $12.6m (£7.8m) on eBet Online Inc ('eBet'), a business-to-business online betting operator and service provider for the North American horse racing betting market, which came shortly after gaining an online betting licence in Connecticut.
IC VIEW
Investing in gaming companies will be profitable for some time yet, as the structural changes in the market have allowed all of the main operators to expand organically. However, investors should start to think seriously about whether the online betting boom is entering a tougher phase of development and react accordingly by diversifying their gaming holdings to cover both technology companies, as well as the brown trilby brigade.
