Inconvenient truths about the Pwin merger

pwin-merger-document-studyOn Friday, Jan. 28, PartyGaming and Bwin will hold extraordinary general meetings at which their respective shareholders will decide whether to approve the merger of the two companies. If, after studying the 478-page disclosure document released just before Christmas, 75% of each group believes it’s in their best interests, the merger will go ahead. After our own study of the documents, we agree that there is much for shareholders to consider.

We’ll start with what Donald Rumsfeld would call ‘known knowns’. Right off the bat, the wedding planners (“outside costs” relating directly to the merger process) are expected to turn in a €25m bill. Following the ceremony, the new company will base itself in Gibraltar, a jurisdiction that just raised its tax rate ten-fold, although the gaming sector (for the moment, at least) still won’t be subject to VAT.

VAT figures prominently in one of the ‘known unknowns’ facing the new entity, an ongoing court case with Austrian tax authorities that could end up costing the company €130m. However, Pwin are so confident of prevailing that they don’t include the contested arrears in financial statements. Pwin do concede they might take a hit if internal contracts between its subsidiaries were put under the taxman’s microscope and subsequently perceived not to be sufficiently ‘arm’s length.’

pwin-ongame-gets-the-chopAs far as synergies go, Pwin expects some €42m in cost savings. Some of this will come from Bwin decommissioning its servers in Kahnawake, but the savings may not stop there. Bwin subsidiary Ongame holds a license in Kahnawake that expires July 31, and Bwin may choose to shut Ongame altogether. The merger docs stress the need for “rationalizing each product vertical onto a single platform, terminating contracts for the provision of duplicate third-party software and relocating a number of technology development roles to lower-cost locations.”

Cost savings may not be the only reason to scuttle Ongame. Pwin covets a return to the lucrative US market at some future date, but while PartyGaming signed a non-prosecution deal with the US Dept. of Justice, Bwin never bothered to do so. Bwin’s bosses apparently believe the issue is a matter of scale, and since they didn’t do nearly as much business with US customers pre-UIGEA as PartyGaming, they feel they shouldn’t have too much to worry about. At any rate, much of that pre-UIGEA business could be blamed on Bwin’s March 2006 acquisition of then US-facing Ongame. So if they ditch Ongame, might that also ditch the scarlet letter sewn to Bwin’s chest? (Leaving aside the equally illegal status of the current German market, from which Bwin currently derives over 25% of its revenues.)

Even with Ongame out of the picture, poker will present Pwin with its greatest challenges. Affiliates contribute 60% of PartyGaming’s poker revenues, 18% of Bwin’s; both companies have plenty of revenue-draining rakeback deals in place. The channel is dominated by privately-held competition (PokerStars, Full Tilt), yet Pwin’s optimistic forecast is for its current B2B partners to follow them en masse to Gibraltar. We shall see.

keith-richards-pwin-layoffPartyGaming employs some 350 software development people; Bwin has an in-house IT staff of 750. Like Keith Richards, a good chunk of these people haven’t yet been informed that they expired some time ago. In addition to layoffs, more staff will depart due to the inevitable culture clashes that result when you force two very different families to live under the same roof. Other companies in the industry will benefit greatly from having this many talented managers, techies and creative types flooding into the job market, but these other companies won’t be able to absorb all Pwin’s cuts.

Not all staff levels will be shrinking at Pwin. The board will feature some additional faces, and the returning characters will be getting a significant bump in compensation. Some Bwin board members that formerly received an annual fee of €32k now stand to collect £130k from Pwin. Pwin’s COO will see his pay packet grow from £246K to £428k + bonus. Manfred Bodner isn’t getting his salary doubled, but perhaps Pwin’s new Non-Executive Director expects to be preoccupied by other matters, such as supervising the planned expansion of his Bar Italia restaurant chain.

These execs will likely justify the pay rise as a reflection of the sheer immensity of the behemoth now under their control, and because by helping to create this behemoth, they believe they have brought increased value to the shareholders. It’s not surprising that they would think this way. An international three-year KPMG study of the 700 most expensive shareholder deals found that 82% of the execs involved believed their own deals had been successful. But perception isn’t always reality — the same KPMG study found that 83% of those deals had verifiably failed to increase shareholder value. So what do the numbers reveal about the Pwin deal?

pwin-merger-perception-realityBwin and PartyGaming announced their intention to merge on July 29. Based on that day’s closing share prices, Bwin stock had fallen 39% by the end of 2010, while Party fell 50%. Of course, the July 29 announcement sent both stocks soaring, meaning they had farther to fall, so let’s recalculate using figures from the week before the announcement. Under that scenario, Bwin’s stock fell 25% and Party’s dropped 13%. Those figures may seem a little less harsh, until you realize that the broader index of each company’s respective stock exchange gained 15% (Viennese ATX) and 16% (FTSE 250) during the same period.

Undoubtedly, when it’s all said and done, the people at the top of the Pwin pyramid driving this deal expect to emerge with fists full of cash. We strongly suspect that the average shareholder will be left holding the bag. Not for nothing do the merger docs note the possibility of the ‘failure to realize the anticipated benefits of the Merger.’