Investing in Poker

(Note: An analyst I ain't, so take what follows as exactly what it is, my two cents on possible ways to invest in poker, if you think the boom will last. This isn't a solicitation to buy or sell any of these stocks. Just my two cents. That's it.)

Investing in Poker

While buying a copy of SuperSystem2 is definitely a good poker investment, there are also traditional investment vehicles open to poker fans and anyone else who feels the poker boom is here to stay. So how exactly can the savvy investor cash in on the poker boom, you ask? Good question.

If you believe that the rise in popularity of poker will significantly impact the bottom lines of casinos and the gaming industry in general, there are all sorts of investment possibilities. The most obvious are companies such as Harrah’s, Caesars, MGM, and Mandalay, that own and operate major casinos (many of which are expanding and opening/re-opening poker rooms.) The equation is pretty straightforward: more people playing poker = more casino revenues.

That said, the correlation isn’t necessarily that direct nor that lucrative. Poker rooms really aren’t that profitable overall to casinos and, until recently, had been on the decline, for that very reason. While the poker boom will likely result in more patrons in casinos, they’ll only significantly contribute to the bottom line if they behave like typical tourists (i.e. no marathon 36 hour sessions at the poker table.)

Aside from those issues, gaming stocks in general have been on a tear in the last few years, with many currently nearing 52 week highs, fueled by both merger activity and increased profits. While most P/E ratios are still in the 20-30 range there’s not a tremendous amount of upside, based on their current valuations.

A more direct option to cash on the poker boom is WPT Enterprises, our friends who bring us the World Poker Tour (WPT). Aside from the televised broadcasts of WPT events (which the company licenses the rights to the Travel Channel), WPT Enterprises also collects member casino host fees, sells corporate sponsorships, and hawks branded merchandise. That said, the vast majority of the money they make comes from their licensing agreement with the Travel Channel.

So poker is popular, the WPT is popular, the Travel Channel shows are cool, sounds like a good deal, right? If poker keeps booming then the stock can only go up, right?

Not necessarily. While the present is rosy for WPT Enterprises, it’s hard to imagine the future being much brighter. In their most recent quarter ending October 3, 2004 the company reported $3 million in revenue, with an operating loss of $520,000. Given the fact that the company went public on August 13, 2004, it’s impossible to compare recent results to past financial performance.

That said, it’s difficult to recommend investing in WPT Enterprises, poker boom or no poker boom. Especially since the stock quickly doubled after its IPO. While it’s retraced a bit, trading now at $12/share, it’s still sitting there with a whopping trailing P/E ratio of 437, during what should ostensibly be a boom time. Will televised poker continue to draw record audiences, translating into continued growth in licensing and sponsorship revenues? Maybe, but I personally wouldn’t bet on it, especially until the company proves that it can use its position to expand into other significant, revenue-generating operations.

To be fair, the company is debt free and has over $30 million in the bank, as well as upside potential due to it being the first mover in licensing the television rights to major poker events. If you feel like gambling a bit on future potential, WPT Enterprises wouldn’t be the worst gamble, but I’d definitely wait to try to get in at around $6-8 share.

Okay, fine, you say, so what the hell should I invest in, if I think poker is here to stay and want to take advantage of it? Patience, grasshopper, patience. There are two poker-related stocks that look attractive to me. One is an obvious play and the other is less conspicuous.

CryptoLogic (and its WagerLogic subsidiary) licenses gaming software and services used in various online poker rooms and casinos. The company provides the software backbone that enables the owners of poker sites and casinos to do business. While the bulk of its business comes from licensing casino games, the company is increasingly seeing returns from its online poker operations.

In the most recent quarter ending September 30, 2004 the company reported $15.6 million in revenues, with earnings of $2.9 million. Online poker revenues increased 55% and accounted for 20% of total revenues. CryptoLogic has $77 million in the bank with no debt whatsoever. While shares have been on a bit of a tear in the last year (up over 80%), it’s P/E ratio remains reasonably attractive at 23. The company also pays a .05 dividend, which currently yields 0.9%.

In addition to the positive raw numbers listed above, the company typically signs long-term contracts with poker rooms and casinos, many of which are difficult to replace. While there are other providers of gaming software, switching over is a costly decision, once you’ve established a site and dedicated player base. So not only does the present look pretty bright, but the future as well, with added room for improvement in earnings if poker continues to boom.

So what are the negatives? With any online poker-related company, one can’t forget the quasi-illegal nature of playing poker online in the US right now. Will the US government (as well as state governments) continue to largely turn a blind eye to the millions of US citizens gambling online every day? Probably. But it’s not a guarantee, and while enforcement of such a law prohibiting online gambling would be next to impossible, you do have to consider the damage that would be done to the valuation of publicly-traded gaming stocks if such news came out.

Another less conspicuous play on cashing in on poker is Neteller, which trades on the London Stock Exchange. Like CryptoLogic, Neteller is an infrastructure provider for the online gambling world, supplying the payment processing system that lets all of us gambling fiends deposit and withdraw money from online casinos and poker rooms.

Once a distant second fiddle to PayPal, Neteller suddenly sprang into dominance when PayPal stopped dealing with gambling-related payments. While some sites do have homegrown transaction processing systems, Neteller currently has a hammerlock on providing an online payment system for gambling sites.

In the quarter ending September 30, 2004 the company reported revenue of $21.9 million (up 112% from the comparable period in 2003) and net income of $8.6 million. Gross margins were an impressive 69% and the company ended the quarter with 1,060,167 registered members using its payment system. For the nine months ending September 30, 2004 the company reported $55.0 million in revenues with net income of $20.0 million.

For Neteller, business is obviously pretty good. They’ve got a nice position in a field with few competitors (especially given the strangely puritanical avoidance of the gaming industry by existing transaction processing providers) and can scale up their business with little cost. Plus much of their advertising is done by either word of mouth or by the gaming sites themselves, by dint of offering Neteller as a deposit/withdraw funding option. They also benefit greatly from new poker and casino sites springing up, especially when they all offer promotions competing for new players. Neteller gets paid for each and every transaction they process, so the more transactions (activity that mutltiples when players move money into and out of new sites), the better.

As far as downsides, there are a few. The company’s P/E ratio is in the 80s and it’s within striking distance of its 52 week high, with shares having run up over 90% in the last year. Like other gaming companies, the company’s bottom line would suffer if gambling laws were suddenly forced in certain regions of the world. It’s also slightly difficult to find information on, due to its trading on the LSE, and not exposed to the general investing public and analysts as much as companies such as CryptoLogic and WPT Enterprises.

That said, Neteller is crucial to online gambling and well poised to profit from future growth. Barring a sea change or new entrants into the transaction processing field, Neteller looks like it could definitely be a profitable gaming diamond in the rough.