COMMENT
The Online Gaming Party Continues

By Ed Bowsher (TMFArkle)
January 27, 2006

Wow! This morning's fourth-quarter trading statements from PartyGaming (LSE: PRTY) and Neteller (LSE: NLR) were impressive. Fourth-quarter revenue at PartyGaming soared 65% year on year to $320m (£179m), beating market expectations by around $30m. That revenue should translate into chunky profits as PartyGaming achieved a 60% pre-tax margin in 2004. (The margin is expected to be a little lower in 2005)

What's more, 230,000 new poker players signed up to the PartyGaming site during the quarter, a record number. PartyGaming is also excited about its new blackjack game, which has got off to a strong start since its launch in October. Two new games will be launched this year and PartyGaming plans further expansion into other territories.

Non-US expansion is a smart move for PartyGaming as bears worry that anti-gambling laws might drive PartyGaming out of the market. Chairman Richard Segal told journalists this morning that diversification could be speeded up via acquisitions.

And there appears to be plenty of room for growth in the global online gaming market. GBGC, a gambling consultancy, expects the global online market to grow from $12bn in 2005 to $15.2bn this year. That's around 5.5% of the total worldwide gambling market, so there is scope for the online gaming sector as a whole to win more market share.

So why don't I own shares in PartyGaming?

My first worry is barriers to entry. 60% pre-tax margins are bound to attract more competitors. True, PartyGaming's great strength is that it has more players than any other site, which means that punters can easily find people to play against. But an aggressive well-funded competitor could surely win significant market share through discounting and heavy advertising?

And as my colleague, David Kuo, pointed out in this article, the craze for internet poker may not last. Given that background, a price/earnings ratio of 16 for this year doesn't look especially cheap to me.

So what about Neteller?

The e-wallet company said today that revenue for 2005 should be slightly ahead of market expectations, and 2006 has got off to a strong start.

Neteller is arguably a lower risk investment than PartyGaming. The company's supporters say we don't know which online gaming companies will be the market leaders in five years' time, but there's a good chance that gamblers will want to pay the dominant sites via an e-wallet. That's a reasonably persuasive argument, but as with PartyGaming, I worry that the barriers to entry aren't that high.

Neteller also hopes to grow by becoming an internet bank, and is currently trading on a price/earnings ratio of 17.

If you told me I had to pick one of today's gambling shares, it would be Neteller because I think the risk looks a little lower. But I'm not going to buy either. There are too many uncertainties for me.

More: A Safer Online Gamble | PartyGaming: Growth, Value or Income?