UK Gambling Market: A Good Investment?

Glynn Davis - Tue 27 Feb, 2007

In spite of the US ban in online gaming, the outlook for UK gambling is a bright one with the market forecast to grow by over 30% in the next four years says Glynn Davis of The Fleet Street Letter. Read on to find out the runners and riders for tomorrows punter...

It’s probably not too much of an exaggeration to say
that only the proverbial trip to the moon would have
insulated you from the recent hysteria surrounding
the granting of a ‘Super Casino’ licence to the city
of Manchester.

This whole episode must surely have been driven by the
headline-grabbing interests of certain newspapers,
because even when this licence is combined with the
other 17 new smaller regional casino licences that are
also due to be issued this year (following the
introduction of the long-awaited new Gambling Act this
September) the impact on overall gambling activity in
the UK is still likely to be only marginal.

We base this on a market fact uncovered by researchers
Mintel. The 140 odd existing UK casinos accounted for
only 8% of the £715m total net expenditure (stakes
minus prizes) in the UK gambling market in 2005.

In contrast ‘betting’ - in high street bookmaking shops
and over the internet - is the ‘flutter’ of choice for
UK adults and accounts for 38% of the market with a
value of around £3.6bn. What’s more, it has enjoyed
phenomenal growth. Betting business was up 113% between
2001 and 2005 increasing market share from only 24% at
the start of this period.

After this sector comes The National Lottery. This
accounts for another 25% of gambling expenditure,
although its influence is waning as it has experienced
a 5.6% fall in value since 2001. But this decline
cannot detract from the influence the Lottery has
had in kick-starting mainstream interest in gambling
in the UK.

It has contributed greatly to the 36% growth the
overall gambling market has enjoyed between 2001 and
2005, seeing net expenditure rise from £6.9bn to
£9.4bn. And the predictions are there’s more to come.
It is forecast to break through the £10bn barrier
for the first time this year - with net expenditure
hitting £10.4bn.

During this period and in addition to the impact of the
Lottery, the gambling market has benefited from other
developments too. These include lower betting shop
taxation, the introduction of Fixed Odds Betting
Terminals (FOBTs) into these shops, the gradual
expansion of the casinos market and the relaxation of
restrictions on advertising of gambling services. The
latter has certainly proved beneficial to the UK’s
bingo halls which have enjoyed a 52% growth rate in net
expenditure over the 2001 to 2005 period.

However, dark clouds loom over the bingo industry as
the smoking bans to be introduced in England and Wales
later this year, are predicted to hit it hard. Early
evidence of this was the recent decision by Rank to
close nine of its Mecca Bingo clubs, which will leave
it with 103 outlets, the second largest operator in the
market after Gala Coral with 175 clubs.

Much more positive to the gambling industry has been
the major broadening of the channels through which
gambling services are now accessible. This includes the
nascent channels of TV and the mobile phone but it is
the internet that is having by far the greatest impact
on UK gambling - significantly more than the impact a
few additional casinos are likely to have.

Mintel found the proportion of UK adults gambling
online has doubled over the past four years and
this trend looks unlikely to slow down judging by  
the most recent trends. When you consider these
gamblers represent only 2% of the adult population
(equating to one million people) and that only 4.5%
of the population has access to the internet then
the opportunity for future growth looks to be
very impressive.

The future looks even rosier when you consider that
online gambling is heavily-skewed towards younger
consumers - with levels peaking among men aged 25 to
34-years-old. As these customers mature they represent
a sizeable market that the online operators can target
on which to grow their businesses.

The one downside of betting online - and in
bookmaking shops - is that it provides the lowest level
of margin compared with other forms of gambling when
using the calculation of prizes distributed versus
stakes received.

This would show that a hefty 92% of the stakes
received by betting operators are returned as prizes.
This compares with an average of 80% for gaming
machines, 83% for casinos, 75% for bingo operators, 50%
for the National Lottery, and a miserly 25% for
football pools providers.

The latter’s poor return to punters might be a
contributory factor of its continued deterioration in
popularity, with net expenditure having fallen by
almost 28% between 2001 and 2005, giving it a market
share of only 1%.

However, when this margin calculation is applied to
online gambling it overlooks the fact that the internet
benefits massively from its significantly lower
operating costs, when compared with pretty much all
the other forms of gambling, especially costly
bookmaking shops.

But even this superior business model could not protect
it from the bombshell that hit it last October. An
unexpected vote in the US Senate passed the ‘Unlawful
Internet Gambling Enforcement Act’ and in one fell
swoop outlawed online gambling in the US.

This caused mayhem in the markets and the shares of the
online operators have fallen dramatically since this
shock announcement. All the major players now have
valuations of a fraction of those they enjoyed at their
peak: Sportingbet has been among the hardest hit and
its shares are currently 90% off their 12-month high;
PartyGaming are over 70% lower; and 888 are nearly 60%
below their peak.

For these quoted operators it was imperative that they
offloaded their US divisions and unshackled themselves
from all their business connections in the country,
which must have been particularly hard since all of
them received by far the majority of their revenues
from US punters.

For example, at the time of its float PartyGaming
generated a massive 88% of its revenues from its US
customer base and Sportingbet had hardly been quiet
about its focus on targeting the large and lucrative US
market. Regardless of the magnitude of its former
revenues Sportingtbet was forced to sell off its entire
US business for the nominal sum of $1.

It was possibly because Sportingbet’s chief executive
had been particularly critical about the US legislation
on gambling that the company’s chairman last year
found himself under arrest when briefly setting foot on
US soil.

He represents one of a growing number of senior online
gambling executives to be arrested by the US
authorities – including the ex-chief executive of
BetonSports - and it is the high likelihood of further
arrests that makes for great uncertainty in the sector.

The big question for investors is whether to
reconsider the online gaming sector or whether it is
still a no-go zone?

For sure, some of the dust has settled as the quoted
companies have extricated themselves from their US
businesses but it is the potential for arrests that
remains the big issue. The recent detention of two of
the founders of online payments firm NETeller has
prompted a new worry for the sector because they are
being charged under a combination of the new Gaming Act
and on money laundering charges.

Unlike the previous arrests the latter could have a
material impact on the gaming companies because if
found guilty of the new charges, then the US Justice
Department would be able to claim back all the money
(from the company as well as the individuals involved)
that had been raised when these companies floated on
the stock market. In the case of NETeller the US
prosecutors have also seized £28m of cash.

If it wasn’t for this negative overhang then the
sector would look reasonably rosy for the major
operators, according to Warwick Bartlett, founder
of Global Betting and Gaming Consultants, who
travels the world advising countries on implementing
gambling legislation.

He says Asia represents a “huge” opportunity once the
penetration of broadband and internet access increases.
Vietnam for instance has a population the size of
Germany (albeit less affluent) and then there are other
territories such as Indonesia, China and Hong Kong
where much opportunity lies.

But even in these new areas there are still some risks
as evidenced by the recent detention of a
representative of online gambling firm Victor Chandler
in Israel, when promoting the company’s online gambling
sites in the Middle East.

Thankfully Europe remains both a safe bet and a still
largely untapped market that is growing at a healthy
clip. Proof of this came from quoted operator 888,
which recently issued a trading statement highlighting
that net gaming revenues (from outside the US) was up a
healthy 28%.

PartyGaming has also made its intentions clear about
attacking non-US markets with the recent release of
early French, Spanish, Russian and Portuguese language
versions of its poker software before it embarks on a
full launch later in the year. The company is also
cranking up its marketing activity in Europe with TV
ads appearing in September, alongside increased online
promotions via viral campaigns on YouTube.

Both Party Gaming and Sportingbet remain serious online
players even now with their smaller ex-US business
models and their shares have moved up from 12-month
lows, in spite of continued selling pressure on their
stock. Bartlett suggests this is partly down to their
founders and senior management’s still holding sizeable
stakes and that this overhang continues to act as a
dampener on their progress.

Their weakened balance sheets are also likely to have
put paid on their earlier aspirations of acting as
consolidators in the gaming market. This is now being
left to stronger established operators such as
Ladbrokes and William Hill, plus potentially big US
gaming groups like MGM and Harrah’s.

These players now consider ‘purified’ online operators,
including 888, Sportech and Betinternet, as targets now
they are rid of US revenues and run ‘clean’ businesses.
Early evidence of this development is the ongoing talks
between 888 and Ladbrokes about a sale of 888’s assets.

The combined advantages of avoiding the US and balance
sheet strength derived from their domestic betting shop
businesses puts both Ladbrokes and William Hill in
strong positions to act as consolidators.

And not having the US Justice Department breathing down
their necks, and looking to arrest their executives
whenever they pass through America, will undoubtedly
provide a serious level of comfort to investors. This
will also have acted as a support for their share
prices after the shock October announcement. At
Friday’s share price of  441.5p Ladbrokes stands close
to its high for the year of 462p, while William Hill’s
share price of 658p is also not far off its 12-month
peak of 681p.

Their well known brand names also act greatly in their
favour, according to Mintel, which found that although
online gamblers frequently use a wide range of websites
for browsing and checking out odds, ultimately they do
their actual betting with a recognised name.

And this trusted brand recognition is not restricted to
the UK, suggests Bartlett, who reckons they are equally
well known overseas. When this is supplemented with the
additional credibility of the British Kitemark featured
on their websites and UK regulation he reckons this
makes them very attractive to overseas gamblers.

What investors in such companies as Ladbrokes and
William Hill - and any other quoted gambling company -
will be hoping for is that their pick at least
maintains its existing share of the gambling industry
pie. The gambling market is forecast to grow by an
impressive 31% by 2011 when it will account for a
chunky £13.6bn of net expenditure. What nobody will
want is to see another US Congress shocker.

Regards,

Glynn Davis
For the Daily Reckoning


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