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Copyright 2005 Economist Newspapers, NA, Incorporated
Economist.Com

June 27, 2005 Monday

HEADLINE: A blue-chip investment?; Online gambling

HIGHLIGHT:
Online poker has fast become a huge business, allowing PartyGaming, the leading poker website, to float its shares in an offering that values the company at nearly $9 billion. But online gambling is controversial-indeed, it is illegal in its biggest market, America. Ironically, this has helped PartyGaming to stay ahead of the pack

BODY:
Big business, but blue-chip too?

ALL good poker players will tell you that the game is only partly about the cards that you are dealt. It is just as much a matter of interpreting the near imperceptible facial tics or equally subtle body language-the "tell"-of your opponents across the table. Amarillo Slim, perhaps the world's most famous professional poker player, summed it up: "Poker is a game of people…It's not the hand I hold, it's the people that I play with." So it is perhaps surprising that a game which relies so heavily on face-to-face action is now so popular online.

PartyGaming, the biggest of the online poker sites, has just netted a fortune for its founders. The Gibraltar-based company launched an initial public offering (IPO) of 23% of the company in London on Monday June 27th, valuing the firm at around 4.6 billion ( $8.4 billion). PartyGaming makes most of its money through hosting online poker games and taking a small cut of the pot that the winning player scoops at the end of each hand. At this it has become hugely successful. In the first quarter of 2005 the company enjoyed revenues of $222m, up 93% on the year before, and an operating profit of $128m, an 81% rise. Its PartyPoker.com subsidiary, which accounts for 92% of revenues, is thought to have grabbed half the worldwide market.

Poker's popularity has grown in recent years for a variety of reasons. From its supposed invention on Mississippi steamers in the mid-19th century until recently, its image improved only slightly-from a game for rogues and cheats in wild west saloon bars to one for mere reprobates played late at night in smoky casinos. But in the past few years, televised tournaments in Britain and America have made stars of the top players. Celebrity endorsement has made the game, if not respectable, at least an acceptably risque vice for some and downright cool for others.

The size of the market and its potential for growth seem impressive. PokerPulse, a website that monitors online poker, reckons that 1.8m gamblers played the game for money on the web during May 2005, some 600,000 more than in September 2004. One estimate puts the number of poker sites operating around the world at some 1,800. Dresdner Kleinwort Wasserstein, the investment bank underwriting PartyGaming's IPO, reckons that the online poker market worldwide is four times bigger than it was two years ago and will grow by the same amount again by 2008, when overall online gambling revenues are forecast to top $18 billion.

The opportunity to play online has drawn players to the game who might otherwise eschew the regular, offline gambling business-and this opportunity has only increased with the spread of fast, broadband internet connections. Old hands may continue to insist that the only way to play is eyeball-to-eyeball, but for many online gamblers, playing from home when it suits them is preferable to the intimidating atmosphere of a casino that might in any case be some distance away (especially in America). Poker online has proved particularly attractive to women and the young, groups that tend to shy away from the typical gambling experience. And poker's advantage over other games, such as blackjack or roulette, is that instead of playing against the casino, with the odds stacked in its favour, you take on other punters.

Indeed, many of the online gambling sites that are thriving at present operate a peer-to-peer model. Another example is Betfair, which allows users to act as bookmakers by setting their own odds and matching them, for a fee, with other users attracted by those odds. However, opponents of online gambling see these sites as little better than those where users bet against the house. Whatever the set-up, they argue, it is considerably easier to lose "virtual" money from a credit card than it is to hand over real cash or chips.

Taking a legal gamble

The immediate future looks bright for those other gamblers-investors-who asked to be dealt in when PartyGaming went public. The firm's IPO was subscribed three times over, and the shares rose by 11% on the first day of trading. But controversy clouded the run-up to the flotation. The firm runs an unforeseeable legal risk as some 90% of its revenues come from punters in America, where the legality of online gambling is questionable. PartyGaming has admitted that the Justice Department considers online gambling illegal, though a recent World Trade Organisation ruling may force America to loosen the rules.

The legal risk may be overstated. It is not clear what America can do to a company that is based in Gibraltar, listed in London and has no offices or servers in America. But Jon Kyl, a Republican senator, is aiming to introduce legislation that would outlaw credit-card payments to offshore gaming firms. American-based online-payments services, such as PayPal, have already refused to handle gambling funds, and online gamblers in Louisiana face fines or prison. If American legislators can find a way to deter American gamblers, it would clobber the revenues of PartyGaming and its competitors. But most analysts think any attempt to stamp out the business completely would prove futile.

In one way, America's ban on internet gambling has been good for PartyGaming and other offshore gambling sites. As punters revealed a taste for going online, America's big gambling companies, such as MGM Mirage, Harrah's Entertainment and Caesar's Entertainment, were deterred by the legal problems from offering web-based services and cashing in on their well-known brands. This left the way clear for foreign firms to clean up.

Founded in 1997, PartyGaming has so far kept the competition in check, including established rivals like Paradise Poker and 888.com. Partly this is a result of clever marketing. At its launch it announced a $1m poker tournament, staged onboard a liner but with qualification rounds held online. Never before had the internet seen such a huge prize, and when the firm set up PartyPoker.com in 2001 it was guaranteed a head start on its rivals. But barriers to entry are low. Some of the cash from PartyGaming's flotation may go towards buying smaller competitors that pose a threat (though the lion's share is expected to end up in the pockets of its four founders).

Can PartyGaming hold on to its lead? Though plenty of investors deem it a good bet, its users are a fickle bunch who may be tempted away to a competitor offering a better deal than the 1-2% of pots that PartyGaming now takes. But perhaps the biggest threat to the market leader would be a further WTO ruling or, ironically, a change of heart in America that led to the legalisation of online gambling there and allowed established firms from the pastime's spiritual home to enter the market.

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