“Our future…is to let the world play for real. Greater than just gaming, our vision is to redefine digital entertainment.” So began “Our Future,” the first document produced by bwin.party Digital Entertainment (BPTY.L) after the merger of bwin and PartyGamingin early 2011. According to the new company, the merger “created a clear market leader” and was “a defining moment – not just for bwin.party but for the industry as a whole.”
The optimism expressed by new co-CEO’s Jim Ryan and Norbert Teufelberger was shared by investors. The share prices of both bwin and PartyGaming jumped around 20 percent after the merger was announced on July 29, 2010; at day’s end, bwin was worth some $1.7 billion and PartyGaming nearly $2 billion, putting the combined company’s valuation around $3.7 billion.
Of course, there were some observers skeptical of the merger’s potential, notably several contributors here at CalvinAyre.com. Even before the merger was announced, our own Calvin Ayre called the proposed deal a “mutual destruction dance.” In an eerily prophetic prediction, Ayre wrote that “after two years of distraction and the loss of many of both companies’ top talents, what is left will not be as powerful in the industry as any of the existing entities are now on a standalone basis…The merger details will distract the new entity for two years or so, allowing other, more focused companies to grab market share.”
In January 2011, just before the merger closed, Steven Stradbrooke noted some “inconvenient truths” about the pending marriage, arguing that “we strongly suspect the average shareholder will be left holding the bag.” Stradbrooke pointed out bwin’s failure to sign a non-prosecution deal with the US Department of Justice; its subsidiary Ongame had done business in the US pre-UIGEA, though bwin.party was expected to ditch Ongame after the merger. (We’re still waiting.) In another poignant prediction, he noted that “poker will present [bwin.party] with its greatest challenges.” Stradbrooke closed by pointing out the ballooning pay packages for executives, ostensibly justified by “the behemoth now under their control.”
To be fair, we weren’t alone in our skepticism. The euphoria following the merger announcement was short-lived; indeed, PartyGaming stock would never again surpass its closing price of 309.5 pence reached hours after details of the tie-up were released. The market’s sentiment toward the proposed union turned sharply; by the time the merger was approved by shareholders in late January 2011, both stocks had fallen by over one-third. The institution of a sports betting tax in Germany in April knocked the stock down further; within three days, after a downgrade to “sell” from UBS, BPTY had lost another one-third of its value. By August 2011 – less than seven months after the merger was officially consummated – the combined entity was worth less than either of its predecessors. The stock would rebound through the spring of 2012, but its struggles returned; after a weak first-half trading update and the PokerStars settlement with the US DOJ, BPTY hit an all-time low of 93.2 pence earlier this month. After disappointing first-half earnings released Friday, BPTY closed at 94.70 pence; its market cap of about $1.27 billion is barely one-third the combined value of bwin and PartyGaming after their merger announcement.
The failure of the bwin/PartyGaming merger has validated many of the arguments made on this site, notably Ayre’s much-discussed screed against public iGaming companies written in October 2011. In that article, Ayre argued that public companies were, simply by virtue of being publicly traded – and thus publicly regulated – incapable of taking the risks required to be a nimble, innovative iGaming leader. Most notably, as Ayre and other contributors on this site have noted repeatedly, publicly traded companies are essentially shut out from the Asian market, the fastest-growing and most profitable market in all of iGaming. In an earlier piece, Ayre had criticized the consistent deference shown towards publicly traded online gambling companies, despite that many private companies were outperforming their public counterparts, in large part due to their avoidance of the restrictions created by public ownership and regulation.
Indeed, looking back at the bwin.party merger, the failure to understand these key effects of public ownership clearly led to many of the combined company’s current problems. Those effects, of course, are nothing new. Even after the 20 percent jump after the merger was announced, PartyGaming’s roughly $2 billion valuation was still a far cry from the $8.5 billion market cap the company saw on the day of its initial public offering in 2005. The decision to go public most notably forced Party’s withdrawal from the US market in 2006 after the passage of the UIGEA, while privately held PokerStars – which would cancel its own proposed IPO – and Full Tilt Poker went on to dominate the American market.
PartyGaming’s decision to merge with bwin showed that the company had clearly not learned its lessons from its 2006 exit from the US, which caused a one-day, 70 percent drop in its share price. In “Our Future,” which explained the company’s post-merger strategy, bwin.party was oblivious to the risks of combination, while professing a seemingly naïve belief in the powers bestowed by a merger. “The transition to regulated markets means that the game is changing and scale and breadth are no longer just an advantage, they are a necessity for long-term success,” the company wrote. Several industry analysts agreed. Warwick Bartlett, CEO of Global Betting and Gaming Consultants told Bloomberg, “Both companies will probably be able to get better economies of scale in marketing,” while Gianmarco Bonacina of Italy’s Equita SIM SpA argued “the combination will protect” the combined entities from market share losses in Europe to PokerStars and then-untarnished Full Tilt.
The focus on “scale and breadth” was a curious – and costly – mistake for bwin.party and the analysts who supported the merger. “Scale” – short for “economies of scale” – refers to the savings a company can create on a per-customer basis by expanding its customer base. For instance, it costs substantially more, per unit, to manufacture one hundred cars than it does to manufacture one million cars. But in the online gambling industry, where fixed physical assets are limited to little more than office furniture and servers, the benefits of scale are minimal. bwin.party has repeatedly promised €65 million in cost savings in 2013, with three-quarters of that total realized in 2012. Unfortunately, the savings from so-called “synergies” in the first half of this year appear to have done little to boost the company’s bottom line, as increased gaming taxes and regulatory costs in Europe ate up much of the cost-cutting gains, while a €33 million payment to Spain for back taxes overwhelmed the gain in earnings, even when discounting merger expenses.
Beyond the potential savings from consolidation, “scale” is an odd goal in the iGaming space. As the company itself noted, “Our business is relatively light in terms of physical assets…but it makes intensive use of its intangible assets such as brands, proprietary technology, and know-how.” The problem is that these intangible assets are not scalable. On a per-customer basis, it is not substantially cheaper to market a brand to three million customers as opposed to one million. Likewise, cutting-edge technology and “know-how” aren’t less expensive – or less difficult – to create simply because a company has grown in size. Focusing on “scale” as a key benefit sounds less like a rationale for the merger, and more like a rationalization. bwin.party would claim in “Our Future” that “[we] intend to become larger than the sum of our parts by consolidating our leading position in core markets and by leveraging our assets in new areas to create incremental revenue streams.” But that’s simply not how the online gambling industry works. Putting a Party-branded casino under the same corporate roof as a bwin platform does little – if anything – to make either brand stronger. Likewise, with the exception of poker liquidity, having a presence in Italy is unlikely to strengthen the company’s activities in Germany. Merging two brands – as bwin.party is planning to do with its poker platform – does create cost savings, but it also destroys one of the intangible assets the merger was supposedly intended to “leverage.” Furthermore, as Calvin Ayre noted in advance of the merger, it removes a competitor from the market, potentially increasing share for other providers. Indeed, in an investor call Friday morning, Ryan noted that the transfer of bwin poker customers to the PartyPoker site would result in an initial loss of about 10% of those customers – players likely to take their business to other poker platforms.
This real-world example shows that the pro-merger argument that the bwin-Party combination would “become larger than the sum of our parts” should have been seen as simply ludicrous on its face. The combined entity would certainly benefit from incremental cost savings from infrastructure and support consolidation, but from a revenue standpoint, it’s difficult to see the benefits of combination. Indeed, first half revenues were up just 3 percent over the results of the combined entities in the first half of 2011. This is nothing new; total full-year net revenues for bwin.party for 2011 were almost identical to the combined total for the separate units in 2010, showing that the sum of the parts remains, well, the sum of the parts.
In the meantime, “scale and breadth” can have serious drawbacks, particularly in the iGaming industry. A larger company is a more bureaucratic company, and usually a slower-moving company. Indeed, bwin.party only weeks ago debuted Fast Forward, a fast-fold poker product, more than two years after Full Tilt’s Rush Poker came to market. This came after bwin.party’s poker revenues – by its own admission – were dented in the first half by PokerStars’ Zoom Poker. It is the poker segment that is most troubling bwin.party; the segment has seen revenue decline for the past few years, including an 8 percent drop in the first half of this year, a trend analysts expect to continue. Given the company’s roots in PartyGaming, which dominated the world online poker market almost from the beginning, the steady decline of the poker business is worrisome, but not necessarily surprising. PartyPoker is simply being outmaneuvered and out-innovated by smaller, quicker competitors who are steadily taking share away. The company is attempting to right the ship by re-designing the PartyPoker platform in the second half; but it’s telling that Ryan, on the post-earnings conference call, laid out his company’s goal to be “a clear number two” in poker, essentially ceding dominance of the market to PokerStars.
bwin.party is simply not an innovative, cutting-edge, leading company in the iGaming segment any more; indeed, as I argued earlier this month, the company that created and defined the worldwide poker boom is now just another online casino. Its multi-national reach is a hindrance, not a help, as the stock has been buffeted by regulatory changes in the US, Germany, and even Belgium, while its public status excludes it from the fast-growing Asian market. Neither the bwin nor the PartyGaming brands have been strengthened by the merger, nor has its customer base grown. And it retains an unwieldy co-CEO structure that has repeatedly failed as a governance strategy, something that even fictional characters know. As Oscar on the US version of The Office pointed out sarcastically, “It doesn’t take a genius to know that every organization thrives when it has two leaders…where would Catholicism be without the two popes?”
The merger of bwin and PartyGaming has taken its toll on shareholders – indeed, as Stradbrooke predicted some eighteen months ago, it is the ordinary shareholder left holding the bag. bwin.party has seen its value fall by some two-thirds; it has seen revenue growth stall; and its hopes for a triumphant return to the US market have been seriously damaged by the PokerStars settlement. In return, the company has gotten €65 million in annual savings and predictions of grandeur made in flowery business-school language that, in real terms, make little sense, and in practice, have failed to provide the expected returns. It’s not enough, and it’s not surprising. Bwin and PartyGaming analysts, investors, and executives should have seen this coming.