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Investing The Hard Way: European iGaming’s Continued Resilience

TAGs: 888 Holdings, Betsson, bwinparty, Caesars Entertainment, Calvin Ayre, Editorial, investing the hard way, Net Entertainment, Paddy Power, PartyPoker, Playtech, PokerStars, Vince Martin, William Hill

Investing The Hard Way: European iGaming Continued ResilienceI’ve written several times about the extensive challenges facing online gambling operators in Europe. There are severe economic worries, particularly in southern Europe, where near-depression-level unemployment exists in countries such as Italy, Spain, and Greece. There are considerable, oft-changing, and occasionally confusing regulatory impacts. Tax changes, even in mature markets such as Germany and the UK can emerge without warning, knocking down profits and share prices. And there are extensive competitive pressures; in many jurisdictions, there are a theoretically unlimited pool of operators vying for the same customers, forcing increased marketing and promotional spending to acquire new customers and keep existing punters happy. Those pressures have been most notable in poker, as the power of privately held PokerStars has decimated poker revenues at nearly all public operators.

All told, these pressures make investors nervous and keep share prices in the sector rather volatile. Yet over the past two years, European iGaming operators have managed to overcome all these obstacles and post consistent profits and share price gains. Shares of 888 Holdings (888.L) have nearly quintupled; iGaming supplier Playtech (PTEC.L) has better than doubled. A slew of major names – Paddy Power (PAP.L), Net Entertainment (NET-B.ST), Ladbrokes (LAD.L), William Hill (WMH.L) and 32Red (TTR.L) are up 60-80 percent, while even laggard Betsson AB (BETS-B.ST) has outperformed the broad European market.

All told, with one major exception (which most observers can name off-hand, and I’ll discuss shortly), European iGaming operators have performed rather well. And the recent slew of half-year reports released over the past few weeks have shown continued strength in the sector, even in economically challenged Europe. 888 grew total revenue 7 percent in the first half; Ladbrokes increased revenue by more than 6 percent (albeit at the cost of lower profits); Paddy saw a 22 percent gain year-over-year, a rise nearly matched at William Hill.

And yet, somewhat curiously, the last few months have seen some pressure on share prices in the sector. It may be that typical summer doldrums, when stock market volumes usually drop, are leading to an absence of buyers relative to sellers; European markets have generally dipped as well, though not to the extent iGaming shares have. But the seemingly strong group of mid-year updates did little to move share prices among European operators. 888 – despite almost universal analyst praise for its first half – saw its shares trade flat following its announcement, despite an almost 20 percent decline heading into those earnings. Paddy and William Hill shares both fell after their respective first-half releases, despite impressive revenue and profit growth; Ladbrokes shares dropped as well, owing to its profit decline. 

It may also be that the market – in theory, a forward-looking mechanism – is pricing in further difficulty, and/or anticipating that the industry cannot maintain its current growth rates. But, overall, the recent trading in iGaming shares should offer investors an opportunity to buy online gambling stocks at a discount to recent levels. Most companies are reporting not only solid results but substantial optimism for the third quarter and second half; meanwhile, the US looms as an opportunity for several industry players, notably 888 and its self-branded games in New Jersey. 

In looking for the best stocks in the sector, it’s key to focus on those who will outperform their counterparts. Where can companies gain an edge? Earnings in 2013 so far show three major paths to outperformance: 

Mobile. 

Paddy is the undisputed leader in mobile; 43 percent of online revenue in the first half came from mobile customers, according to Paddy’s first-half release. Mobile revenue doubled year-over-year, and was a large contributor to Paddy’s overall revenue growth. Similarly, 888 saw mobile move to 17 percent of revenue in its key UK market, and called it “the fastest growing channel across all products.”  William Hill is continuing its focus on mobile; 14% of revenue came in mobile in the first half, but it is targeting a Paddy-like 40 percent.

It doesn’t take a computer science degree to understand that mobile is the future of iGaming (as, indeed, it is for nearly any type of Internet business). Those companies best executing in the space will have a significant “first-mover advantage” in capturing the incremental revenue that mobile can create: a quick five-pound bet at a sports bar, or the use of a mobile gambling app to kill time on the tube. If a company is not executing well in mobile, investors should ask one simple question: Why not? And then a second question: why would I trust my capital with executives who are falling behind in what is clearly the most important transformation taking place in iGaming right now?

It’s one reason why I have long recommended shares of Paddy, despite occasionally high earnings multiples. Simply put, if a business is not seeing the type of mobile growth seen at Paddy or William Hill, it’s doing something wrong – or, at the least, not doing something right.

Poker. 

In my three-part series on the history of publicly traded poker last month, one trend was unmistakably clear: since the 2006 passage of the UIGEA, publicly traded companies have seen their poker revenues, profits, and market share steadily decline. Despite some gains in Europe in 2007-2008,  the continuing dominance of PokerStars and its subsidiary Full Tilt Poker has made the poker segment an afterthought for most publicly traded operators. The first half saw that trend continue, most notably at Playtech. That company’s iPoker network saw revenue decline 17 percent year-over-year, a drop the company called “in line with market trends.” 

There is one exception: 888. 888 has doubled its poker revenue over the last three years, and saw additional growth in the first half. The company claims to now be number four in market share (ostensibly passing iPoker, and trailing Stars, Tilt, and bwin.Party Digital Entertainment (BPTY.L)) and did so with a reduced amount of bonus spending. 

The poker segment likely creates an opportunity, albeit without the explosive growth in mobile, for an operator willing to focus on the space. The liquidity of the Stars/Full Tilt combination allows for tournament guarantees and a range of games that a smaller site simply cannot provide. But there is room for a service-focused operator that can protect the recreational player and offer an alternative to the Stars behemoth. With iPoker clearly struggling, and bwin.Party facing a transition as it merges platforms, 888 has taken the opportunity to create growth in a space other public operators have seemingly left for dead. With revenues in the space declining, and bonus payments increasing, it seems plausible that several smaller operators will simply shut down or outsource their poker liquidity. A smaller poker market is also a less competitive market, and should provide additional earnings growth for 888 and/or another provider who attempts to re-focus there. With 888 shares down of late, there is an opportunity to buy into a company who, for two years, was one of the two best performing gambling stocks in the entire industry. For other providers, continued declines in poker will provide a headwind towards the overall revenue and profit growth that investors demand to create higher share prices. 

The U.S. 

I’ve expressed my skepticism toward the US iGaming market on more than one occasion. Meanwhile, the fact that online gambling is only regulated in markets that total about 13 million people – less than the population of the Netherlands – validates predictions made here and elsewhere on this site about the slow pace of US regulations.

But there is an opportunity, most notably in New Jersey, the only market of any importance right now (the state has roughly twice the population of Nevada and Delaware combined.) 888 is moving head-first into the market, both on its own and through a partnership with Caesars Entertainment (CZR), the dominant land-based operator in the state. 888’s success in Europe means the company is not reliant on US profits to justify its share price; if 888 succeeds in New Jersey and Nevada (and/or future markets), it will be a boon for shareholders. If not, the share price may fall slightly, but legacy earnings and continued growth on the Continent should provide some downside protection.

And it is the US that provides some of the justification for a surprising, and contrarian stock pick: shares of bwin.Party Digital Entertainment. Now, it is true that I have absolutely skewered bwin.Party in the past, repeatedly recommending investors away from its shares. We have covered the disaster that was the bwinPartyGaming merger, a disaster that was predicted here from the start. And it is true that bwin.Party’s first half was horrific, and a direct result of that merger. The results were so bad that shares fell by nearly 13 percent despite the fact that the company had already warned investors that results would be below expectations.

It is also true, however, that BPTY shares are trading at 110p, near an all-time low. And bwin.Party does have some potential in New Jersey, particularly if PokerStars is kept out of the market. PartyPoker has been gone from the States for some seven years now, but it is likely the brand still has some value and could provide a head start in what are likely to be extensive marketing efforts across the state. The US is a bit of a Hail Mary for bwin.Party; considering its extensive struggles in Europe, its inability to keep pace with competitors, and the consistent decline in poker liquidity the company is already seeing, success in America is far from guaranteed.

But, again, shares appear to have priced in a declining business, and it appears that the company, and CEO Norbert Teufelberger may have finally understood just how damaging the merger has been. Simply put, the management commentary surrounding bwin.Party’s first half was like nothing I have ever seen in some fifteen years working in, reading about, and covering the stock market. In the first-half earnings release, Teufelberger reverted to the same CEO-speak that he has used to gloss over the company’s multi-year string of earnings misses and share price declines. (BPTY stock is down about two-thirds from levels seen in the wake of the 2010 merger announcement.)

But, in the presentation, the company finally admitted what consumers, investors, and competitors have known for some time: bwin.Party is a wounded, flailing company whose post-merger integration efforts have essentially failed. Product director Guy Duncan admitted the company had “a complex management structure” and “a lack of transparency” which made “release cycles slow and complex.” He emphasized the company’s need to be quicker, more flexible, and overhaul its technical processes. For his part, Teufelberger made the surprisingly candid omission that “others have overtaken us”; in a slide on the company’s presentation he noted three key problems. First, a “lack of feature innovation”; second, the “absence of a competitive mobile offer” (as noted above, a key hole for the company); and, finally, “no social hooks.” (Disturbingly, the company is (26) developing a stand-alone social unit, but has apparently not yet thought to integrate that development into its poker and casino products.) 

In a later slide, Teufelberger later was just as candid about the declining poker business; he cited the causes of the company’s declining market share as resulting from a “tired product” with “a lack of innovation and features.” The company is finally refreshing PartyPoker, both for Europe and with an eye toward bringing the new version to the US in hopes of gaining a foothold there. 

All told, bwin.Party’s experience has gone exactly as our own Calvin Ayre predicted in 2010 when the bwin-Party merger was announced. “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,” he wrote. Ayre later added that two years of merger attention would “distract” the new company, “allowing, other, more focused companies to grab market share.” 

bwin.Party's experience has gone exactly as our own Calvin Ayre predicted in 2010 when the bwin-Party merger was announced.

And, indeed, that is exactly what happened, and bwin.Party investors have paid the price with a long, steady decline in the company’s share price. No other iGaming operator in Europe has come close to the destruction of value seen at bwin.Party Digital Entertainment over the past three years. 

But that is in the past. With the company now finally seeing what others have seen – that it has simply failed to execute – bwin.Party and Teufelberger have taken the first step. There’s no guarantee that this seemingly newfound awareness will spark an instant turnaround; it is far easier to destroy a business, and a share price, than it is to rebuild it. But the company is still generating cash, still paying a dividend, and does have at least a modest chance of real success in the U.S. The company’s long-running struggles no doubt pose a risk to shareholders; but there is also the chance for decent returns if the company can stabilize its business, and the low probability of huge returns from a triumphant return to America. At the very least, investors looking at BPTY can ask one question: how much worse can it really get?

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