Is PartyGaming a Warren Buffet type investment?
“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”-Warren Buffet, lecturing to a group of students at Columbia U. He was 21 years old.
Party Gaming UK:PRTY is the leader in online poker, a rapidly growing sector of the internet gambling industry. The beauty about this stock is it’s low valuation, based on the fear of proposed US internet gambling legislation. It’s currently £1.20 (June 2006) at a P/E of 30 and a forecast p/e of 12 which it will almost certainly achieve. For a company with an estimated 130% eps growth for 2006 (slowing to 12% in 2007 due to the new US laws kicking in) and one where online gambling is rising steadily, it seems like a Prince at a Toad like price.
Does it have a sustainable competitive advantage
Like any investment Warren Buffet makes, he want to understand if it has a sustainable competitive advantage, so I signed up for a poker account and tried out the system. I was impressed with the amount of games in progress at one time and the interface was slick. I enjoyed playing it and there was a definite gambling excitement.
To attract new customers they operate an aggressive affiliate program to drive leads into their website and they also utilise TV advertising and TV sponsorship to drive growth. They are the leading online poker brand on the Internet as far as I can see and have first mover advantage. Ebay crushed all other auction competition and I see no reason why Party Gaming, won’t dominate all online poker competition.
Competitor stocks on the London Markets include 888 Holdings, Rank Group, Sportingbet, Leisure Gaming, BetonSports and Gaming VC – there are none listed on the US markets due to gambling laws. All of these competitors have their differences, but looking at their websites, their lack of focus / volume on Poker and more on Betting Books shows that they are not a serious challenge to PRTY. I would like to go into the Poker competition a bit more, but this article has to end at some point, so if you have any knowledge please add to my blog at the bottom. I don’t really think any of them matter and can be ignored as Party Poker is now the de facto brand on the Internet.
If you want to research the site with an initial free USD50 click here.
However, the US internet gambling legislation cannot be ignored and in the spirit of Warren Buffet’s quote, ‘ a public opinion poll should never be the substitute for research and thought’ I will take an in depth look into this ever present and looming issue.
http://www.gseis.ucla.edu/iclp/alessani.html
http://news.bbc.co.uk/2/hi/business/4723814.stm
http://www.house.gov/list/press/va06_goodlatte/021606.html
http://www.house.gov/goodlatte/internetgambling109.htm
A http://www.house.gov/goodlatte/internetgambling109.htm
http://en.wikipedia.org/wiki/Internet_Gambling_Prohibition_Act
The current situation
Internet gambling is illegal in the US but it is effectively un-enforced.
However, updated Legislation was recently passed by the US Judiciary committee by 25 to 11 votes in May 2006 and will be passed to the House of Representatives to debate and vote upon later this year (update it recently passed the House and is going to the Senate most likely later this year). This updated legislation is important as payments made to internet gambling sites from US jurisdictions are proposed to be made illegal. This may effectively make banks the enforcers of online gambling laws. Coupled with the fact that the user can be prosecuted, if the bill was fully passed it will severely dent party gamings future earnings.
On the other side, the proposed act may generally be difficult to enforce and may have little effect just like the current legislation. However, if it does alter US betting behaviour, I would imagine it would take at least a year for party gamings growth to be affected. The worst scenario is a drop of around 35% in 2007 revenues, then no revenues in 2008 onwards. These estimates are similar to other analysts in the industry.
Critics of the laws say that gambling will be forced underground, similar to what happened during the prohibition of alcohol. I expect a large volume of bets will go underground and gamers will find ways to play, whether on smaller networks or on the largest gambling sites. Industries facilitating payments are also likely to spring up at an alarming rate. Remember the quote in the movie Jurassic Park by Jeff Goldbloom’s character, ‘Life always finds a way’. I expect this will be no different, but more like ‘poker will always find a table’.
Long term, I can’t see governments stopping internet gambling, especially internet poker. I believe prohibition will eventually cease and governments will accept that it is in their best interests to regulate the industry and receive tax for wagers placed within their jurisdiction. But this will be a long way off, my guess, perhaps even 10 years away.
Banning access to the sites will not work as internet communications can be bounced off of other machines in other countries on route to the source gambling site, utilising a sort of peer to peer sub network. However, payments could be stopped to PG through the US banking system. This enforcement route, coupled with individual prosecutions, similar to illegal file sharing prosecutions, would effectively enforce these laws.
The future of PG - excerpts from their annual reports
Europe is expected to be the fastest growing territory for online gaming with gross gaming yield expected to grow by 19% compound between 2005 and 2017. GBGC estimate that the poker segment will grow at over 18% per annum. It is estimated by GBGC that online casino gross gaming yield will continue to grow at approximately 9% per annum until 2010.
PG state they are targeting growth in Europe where broadband penetration is high. They claim competitors will reduce with industry consolidation
PG’s introduction of the first of two new games is on-track for the first half with the second planned for the third quarter of 2006. Multi-lingual and multi-currency versions of PartyPoker are also scheduled for the second half of 2006.
US total revenue growth was 55% over 2004 whilst outside the US it was even higher at 125%. As a result, the percentage of total revenue generated outside the US in 2005 was 16% compared with 11% in the previous year.
Other Shenanigans
Party gaming recently decided (June 2006) to raise money through a bond issue for 370 mill GBP. It was reported that this was to fund the purchase of a UK betting web business. PG likely raised money this way so that it wouldn’t affect this years eps, and it seems like a good move (Note: I don’t think this ever happened, please comment below if it did).
They are raising this to fund a potential acquisition in the UK. Its not definite what they would be buying, but it only makes sense to me to purchase a betting exchange. Why? A betting exchange would allow them to grow their business at a crucial time, when US Internet laws will kick in and limit their revenue. It would also be a good add on to create additional profit from their customer base. News of this would likely create a share price boost. (Update In Sugust 2006 PartyPoker bought the GameBookers, an online betting bookmaker for USD 102.)
EPS Growth and Valuation
One of the most important methods Warren Buffet uses is to forecast future eps growth. With Party Gaming this is very difficult, due to the uncertain legislation facing the internet gambling industry. However, I have forecast future eps values incorporating a 36% reduction in 2007 US revenue and a complete halt by 2008. Note: 2006 and 2007 estimates are roughly in line with analyst forecasts.
| Year |
Eps £ |
EPS % |
Op Margin |
Non US Growth |
Forecast pe - based on price £1.18 |
| 2005 - actual |
0.04 |
|
34% |
|
|
| 2006 - forecast |
0.10 |
135% |
54% |
125% |
12.0 |
| 2007 - forecast |
0.11 |
15% |
54% |
140% |
10.4 |
| 2008 - forecast |
0.09 |
-16% |
44% |
70% |
12.3 |
| 2009 - forecast |
0.12 |
30% |
44% |
30% |
9.5 |
| 2010 - forecast |
0.16 |
30% |
44% |
30% |
7.3 |
As you will see, earnings are likely to drop in 2008, but earnings from the rest of the world will make up for the drop by 2009, unless other worldwide legislation affects these figures. I have also lowered the operating margin in 2008 onwards as I believe PG may start paying tax to sovereign jurisdictions in exchange for operating rights.
Other positive developments for 2006 are two new games and multi lingual language capabilities, for which I have factored in a rise. An interesting point is that PG state that they are not targeting Asia in the short term. I don’t believe that and the truth will be apparent if future language capabilities later this year include Japanese and Chinese, two huge markets, as part of PG’s language and currency offerings. PG may be playing a clever game by trying to convince Asian governments that online gambling won’t be affect them soon due to low Broadband adoption, so to avoid their regulation in the near future, whilst silently building their brand following.
What would Warren say?
Warren loves bad news, and its all been bad news this year for PG. He also loves low valuations, and this one is no exception at a forecast 12 pe next year. Excluding legislation, I think this business has a competitive moat around it and I would be happy owning it for 10 years especially with it’s dividend yield of over 4%, if it had more certainty in earnings growth.
Short term, the price may change like the wind, until there is more clarity on the impact of the legislation in the US. This won’t end the volatility though, as internet gambling laws will constantly be subjected to government scrutiny around the world. What happens if Europe bans them? Why not, as many sites pay no tax. Wouldn’t governments want to license their own government approved sites, so that they can collect a share of the revenue. It’s seems likely.
But PG is such a difficult company to value due to the legislative landscape. It’s seems like a Prince like company at just above Toad like prices. However, the Prince has many powerful enemies and a gun to his head. Revenues are no certainty and as a stock purchase it seems like speculation and not investing, which Warren Buffet, or indeed his mentor Ben Graham, would not approve.
If gamers around the world were able to play poker on the site and legislation didn’t ban the business from countries around the world, it would do well with a reasonable degree of certainty. However, I am worried about the raft of legislation shadowing this stock. Sure, US legislation will take time to affect earnings but I don’t think this is a bet worth taking. Would Warren, a resounding no as earnings cannot be predicted with a reasonable degree of certainty.
As its not a stock Warren Buffet would likely own due to the uncertain earnings growth over the next 10 years, I will not be investing any of my £20,000 pension fund. It is with sadness I say this because I thought I had found a keeper. Time to move on.
Do you believe Warren would think this way. If not why not? Please comment on this blog below.