COMMENT
PartyGaming: Growth, Value Or Income?

By David Kuo (TMFDragon)
October 12, 2005

Investors generally like to classify companies according to how they think the business will perform in the future. Income investors, for instance, are interested in shares with the highest dividend yield. Consequently, they want shares that can deliver a steady income stream, and many of these can be found in the FTSE 100.

Growth investors, on the other hand, like to focus on businesses that can grow profits quickly. Normally, they are prepared to pay a higher price for a business today in the belief that the shares will rise as earnings grow. A common characteristic of growth shares is that they rarely pay a dividend because any cash generated is better utilised within the business.

Meanwhile, value investors are, by and large, bargain hunters. They seek out shares that are selling at prices for less money than they are worth. These businesses may have fallen out of favour with the market, so value investors hope to reap the benefits when the shares recover.

In general, most companies fit neatly into one of the three pigeon-holes. But occasionally a company doesn't, and that can throw investors. A good example here is recently-floated PartyGaming (LSE: PRTY), which seems to fit any one of the three categories or none at all! Here's why.

PartyGaming is the dominant player in the online poker arena, with over 50% of the market share. Other players include Sportingbet (LSE: SBT), which owns the unquoted poker site, ParadisePoker, and 888.com (LSE: 888). Globally, Internet poker is estimated to be four times bigger than it was two years ago. Additionally, it is predicted to quadruple again in the next two years. So, as a leading player in a fast-growing industry, PartyGaming should fit the bill of a growth share nicely.

But PartyGaming is quite lowly rated for what is inherently a high-growth company. Generally, growth shares are priced at hefty premiums because earnings are supposed to grow rapidly. But at 70p, its shares are valued at only 9 times earnings, which are well below the market average - they are almost in the realms of value territory.

PartyGaming also pays a hefty dividend, which is unusual for a growth company. Its prospective dividend yield at 6.4% is more than twice that of other FTSE 100 companies. Presently, only Lloyds TSB (LSE: LLOY) and United Utilities (LSE: UU.) are yielding more at 7.5% and 6.8% respectively.

So, is PartyGaming a growth, value or income share?

The brief answer is it's quite hard to tell. But in my view, the Internet has effectively compressed the life cycle of some businesses, such as online poker, from decades into a handful of years. Therefore, the development, growth, shakeout, maturity and decline stages, which use to stretch over decades, are occurring in a matter of years.

In marketing terms, the industry looks as though it is in the shakeout phase, which is usually characterised by increased competition. What's more, existing players will tend to resort to price cutting as a means of boosting volume, but this will inevitably be at the expense of margins. Another feature of the shakeout phase is a shakeout of the weakest competitors either through natural attrition or consolidation.

PartyGaming is likely to survive the shakeout, but its ongoing survival will depend on the popularity of Internet poker. As such, investors will need to ask whether Internet poker is a fad or a sustainable industry. Sometimes, it is hard to tell until the fad is over - does anyone still collect Beanie Babies?