OUTLOOK: Online Gaming Pioneers Cash in Again

Another day, another online gaming group comes to market. The latest company to try its hand at the roulette wheel of the London Stock Exchange is Cassava Enterprises, owner of the 888.com online casino and poker site. Like PartyGaming before it, the company is hugely profitable, encouraging its sponsors to believe it can command a valuation of in excess of pounds 700m. This will enrich Cassava’s two main shareholders beyond the dreams of avarice, but does it promise to do likewise for stock market investors?

London is fast becoming the listing centre of the world for internet gaming. Four are already quoted here including the market leader in online poker, PartyGaming, and there are at least another three lining up to join them. Unfortunately this has less to do with London’s innate attractions as a listing centre, and much more to do with the fact that online gaming is illegal in the United States, where these companies derive the vast bulk of their clients and revenues.

Online gaming may for the time being amount to a licence to print money, but you have to wonder how long it can remain so. As things stand, the US authorities seem to tolerate the existence of these mainly Gibraltar- registered companies, but the danger of a clampdown, say by making it illegal for credit card companies to make payments to online gaming sites, are all too real. Alternatively, US lawmakers may decide to make the activity overtly legal.

This would pose almost as big a threat to the Gibraltar-based upstarts as a regulatory crackdown, since it would reduce barriers to entry to virtually nothing. Even PartyGaming would struggle to survive in the ensuing free for all. To date, regulatory risk has largely kept established gaming and software players, particularly those based in the US, out of the market. Returns would fast be competed down to far less appealing levels if these risks were removed.

Perhaps as significant, the cost of customer acquisition is already rising steeply. Most industry analysts expect the size of the online market to grow exponentially with rising levels of broadband penetration, yet customer retention remains extraordinarily low, with perhaps as little as 5 per cent of customers still returning after six months. This would suggest that most people try the delights of the online gaming rooms once or twice, but then become bored or retire hurt. In other words, this is largely a transitory market likely to reach its high water mark much more quickly than exponents suggest.

With nearly all these online gaming floats the purpose is not to raise more money for expansion, but to allow early investors and founders to get their cash out while the boom lasts. This should always make potential new investors highly suspicious. If prospects are as good as they are painted, why are the founders so keen to flog off the sun-lit upside? PartyGaming shares have risen strongly since they were floated a couple of months back, so there’s plainly an appetite for these companies. Yet it’s best not to be around when the music stops. As with the candyfloss paper of the dot.coms, you’ll be able to pick the shares up for a fraction of the price a couple of years from now.