Thursday, June 29, 2006

PartyGaming (PYGMF.PK) (LSE: PRTY)

Brief History:
PartyGaming is a brainchild of Ruth Parasol. Ruth is the eldest of three girls, born in 1967 in San Francisco, California to a Swedish born mother and a Polish born Holocaust survivor. She has an unconventional upbringing by her entrepreneurial and self-made millionaire father. By the age of 12, Ruth was attending Grateful Dead concerts and overseeing her father’s household bills, writing cheques and categorising tax deductible business expenses.

Ruth earned a BS in Business from University of San Francisco and a Juris Doctorate from Western State University College of Law in 1992. Ruth started an Internet pornography website in 1994 and exited the business in 1996. In 1997, she launched Starluck Casino Online from the Caribbean on licensed third party software. In 1998, she decided to build her own software with the help of Anurag Dikshit, a computer science graduate from Indian Institute of Technology, who she made a partner. With their own proprietary gaming and processing software, they have greater degree of control over their IT platform and improved their competitive advantage.

After seeing the success of their rival Paradise Poker in 2000, they switched their focus from roulette and blackjack to poker. PartyPoker was launched in 2001 with great publicity stunt. It announced a poker tournament with a first prize of $1M. Vikrant Bhargava and Russ DeLeon, who become partners, joined in 2001.

PartyGaming is the world’s largest online gaming company. It is number one in online poker and online casino. Since launched in 2001, PartyPoker grew rapidly to become clear leader in online poker, a position it has held since 2003. On average, PartyPoker handles around 32 hands of real money poker per second, every hour, every day, every month. Over £45 billion was wagered on the site in 2005. The Group’s secondary poker brands include EmpirePoker, IntertopsPoker, MultiPoker and PokerNOW.

Poker is the largest business segment of PartyGaming, accounting for 88% of its revenue in 2005. The Group essentially acts as the host for customers wanting to play poker against each other and as such takes no principal risk but simply charges players a fee, or “rake”, for every hand of real money poker played (where the pot is greater than $1 and where the hand reaches the flop).

The Group’s online casino business is the largest of its kind in terms of revenue, and it includes PartyCasino, Starluck Casino, PartyBingo and PlanetLuck Casino.

PartyGaming has over 12 million registered players throughout the world. 1.8 million were active players in 2005.

Price/share: $2.10
Current PE: 28.6
Forward PE: 12.5
Price/Sales: 5
ROE: Neg
ROA: 73.6%
TEV: $ 8373.8M
EBITDA – Maintenance Capex: $295.6M
TEV / (EBITDA – Maintenance Capex): 28.3
Free Cash Flow: $297.5M
Price/Free Cash Flow: 28.2

Investment Perspective:
At first glance at the valuation, PartyGaming does not look cheap. However, its potential to grow over the next few years will make investment in PartyGaming a steal.

Online gaming accounted for approximately 5% of the total $258.3 billion of gross gaming in 2005. It is the fastest growing segments of the overall gaming market, having grown at a compound annual growth rate since 1998 of over 50%. Over the next few years, it is estimated that the online gaming sector as a whole will grow at a compound annual growth rate of over 14% reaching 7.7% of the global gaming market by 2010.

Online poker, which is the most important segment of PartyGaming, represented approximately 20% of online gaming revenue. Although smaller than online sports betting (36%) and online casino (25%), online poker has been the fastest growing segment within the online gaming sector in recent years (compound annual growth rate of 158% from 2000 to 2005). GBGC estimated that online poker will grow at over 18% per annum between 2005 and 2010.

The high rate of growth undoubtedly has attracted a number of online poker operators, and provides listings for over 390 online poker sites in operation around the world. The key features which enable PartyGaming to dominate 41% of market share of online poker and make it more than 3 times bigger than its nearest competitor are (1) player liquidity, (2) control of software, (3) payment processing expertise, (4) excellent customer service and (5) Affiliates.

(1) Player liquidity: Players want to be able to find a table playing the game they want at the stakes they want to play for, with plenty of other players to make it interesting and all at the time they want to play. Player liquidity is therefore very important for attracting and retaining customers. Therefore, the larger the site, the better liquidity it will get. PartyPoker, being the biggest online poker site, will therefore have better competitive advantage over its competitors.

(2) Control of software: Being able to upgrade, augment and add new features to software means that an operator can keep pace with changing consumer tastes, stay ahead of the competition and, should they arise, fix problems quickly. PartyGaming has recognised the value in owning and developing its own gaming software and currently has over 200 software engineers based in Hyperabad, India, that deliver systems upgrades and developing new games as well as maintaining the existing systems architecture.

(3) Payment processing: PartyGaming continues to expand the number of ways that customers can pay-in and withdraw funds and now offers 23 different mechanisms, more than any of its competitors.

(4) Excellent customer service: It has established a dedicated customer service function with over 900 representatives that provide a 24/7 service, addressing technical as well as personal account enquiries. It has also established a series of performance targets that its seeks to meet on a daily basis; 80% of all cash out verifications are completed and processed within six hours, 90% of all phone calls are answered within 10 seconds, and 75% of all emails are answered within 30 minutes and 90% are answered within 90 minutes.

(5) Affiliates: PartyGaming has one of the largest affiliate networks with over 5,000 active affiliates in 2005. Customer traffic generated by its affiliate network accounted for 34% of poker revenue.

Despite intense competition in online casino (1050 online casino sites), GBGC has confirmed that PartyGaming’s online casino business is the largest online casino in the world. It is estimated by GBGC that online casino will continue to grow at approximately 9% per annum until 2010.

Insiders Ownerships:
Four founders have over 65% holdings of PartyGaming.

Potential Risks:
The biggest risk for PartyGaming is related to gaming laws. Online gaming laws are not well established and application and enforcement of unfavourable gaming laws, especially in North America, may restrict and jeopardize its growth.

Online gaming is a highly competitive market with over 2,400 sites in operation in 2005. Competition could get worse if US-based operators are to offer online gaming if legal status were clarified.

· Introduction of new games, such as backgammon (PartyGammon) may increase revenue substantially.
· High online gaming growth potential (ranging from 9% for online casino to 18% for online poker) over the next few years.
· If US legal status turned favourable, PartyGaming may enjoy higher valuation.
· 1st Quarter revenue ending March 31, 2006 increased by 54%.
· Websites were launched in French, German, Portuguese, Spanish, Swedish and Russian, with more foreign language versions planned for later in the year.

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