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Casino Royale

Paul Sullivan

 

I guess the only thing riskier than gambling on the stock market is gambling on gambling stocks on the stock market.

There was a time, not so long ago, when investing in Internet gambling stocks seemed more dashing than dangerous. The TV poker craze was at its height, and online gambling firms were starting to stick their noses up, and even advertise on TV.

Then came Black October, when the U.S. Congress, bowing to pressure from the apparently irresistible Religious Right, tacked a bill making it illegal for banks and credit card companies to cover payments to online gambling sites onto an innocuous sounding bill governing port security and passed it when no one was looking.

It caught the online gambling industry by surprise. As late as September, many analysts were predicting that the lawmakers would not get their act together until the new year.

“It was hugely surprising,” Andrew Lee an analyst at Dresdner Kleinwort Wasserstein told Forbes.com. “It was last-minute, back-door, with no debate and no formal vote.”

Whatever, the weekend passage of the Unlawful Internet Gambling Enforcement Act had a devastating effect on gambling stocks, mostly UK companies listed on the London Stock Exchange. PartyGaming, the Gibraltar-based owner of PartyPoker.com, the world's largest online poker site, lost 57 per cent of its value on the following Monday, and competitor 888Holdings fell 33 per cent.

It's not clear how much money was actually lost, but the industry was worth $12-billion (all figures U.S.) before the ban, and the public companies lost $7-billion in value. But no one in the industry believes the crackdown led to a reduction in gambling. Despite the ban, U.S.-based e-gambling consultant Christiansen Capital Advisors estimates that Internet gambling will be worth $18.376.4-billion in 2007. And U.S. gambling will just go offshore or underground.

Like most things the Americans do, the congressional assault on the right to lose money online has an impact on Canada and Canadians; some original Canadians, some offshore.

Perhaps the biggest winner since the Congress played its hand has been Calvin Ayre, the refugee from the late, unlamented Vancouver Stock Exchange, who hunkered down in Costa Rica and Antigua making untold millions as the head of Bodog Entertainment Group. Bodog and several other privates such as PokerStars, Full Contact Poker and Ultimate Bet stepped into the vacuum left behind by the UK public companies and have seen their traffic increase exponentially. In 2006, Mr. Ayre claimed his take on more than $7-billion wagered was about $300-million.

While Calvin Ayre has the hot hand, other Canadians have a few aces up their sleeves as well, specifically the First Canadians of the Kahnawake reserve south of Montreal, proprietors of Mohawk Internet Technologies. Buttressed by the argument that gambling is one of the ancient traditions of the Mohawk people, reserve Web servers host the top five poker sites in the world. Of course, Canadian law prohibits gambling not run by the government, but no one seems too quick to prompt another Oka-like confrontation.

Meanwhile, a Canadian public company that supplies gambling application software, CryptoLogic, is moving its head office from St. Clair Ave. W. in Toronto to Ireland, listing on London's AIM (Alternate Investment Market) (CRP), as well as the TSX (CRY) and NASDAQ (CRYP). The software development staff is staying in Toronto, but the executive team is getting closer to the action in the UK.

CryptoLogic is an interesting company. Famed criminal lawyer Edward Greenspan resigned from its board last year, ostensibly because he needs to concentrate on defending Conrad Black in his own little disagreement with the U.S. government. CryptoLogic is also the target of a website called CryptoLogicsucks.com, and you can just imagine what it has to say. Yet, CryptoLogic also rates as The Motley Fools' best international stock for 2007!

So let's say you decide that CryptoLogicsucks.com isn't going to rattle your cage. CryptoLogic has been a Motley Fool Hidden Gem for a couple of years. Now, argues Brian Pacambara for the Fool, the company's circumstances, fundamentals and size make it the best bet of all international stocks for 2007.

CryptoLogic argues that it has insulated itself from the congressional ban by moving most of its business to other realms. A few years ago, 70 per cent of its business was U.S.-based; in 2006, according to CFO Stephen Taylor, only 35 per cent of its business came from the U.S.

CryptoLogic has effectively insulated itself against American conservatives. Thanks to several recent agreements with the UK's William Hill and Parbet from Scandinavia, 100 per cent of its licensees' revenue comes from outside the US.

You should have bought CryptoLogic right after the congressional ban, when the stock price plunged 35 per cent, but the stock rallied and now trades about $10 above its 52-week low.

Perhaps the best reason to bet the farm on CryptoLogic is the company's cash position: of a market cap of $300-million, $129.2-million is cash. And it's debt-free, trading at an EV/EBITDA multiple just above 4. So if you believe there are enough punters in Europe and Asia to overcome the loss of the U.S., then your odds favour CryptoLogic.

But what about those forgotten stocks, the UK companies that pulled out of the U.S. after Black October? They seem to be doing just fine, thank-you. For the four weeks ending December 11, 2006 PartyGaming's poker revenues average daily revenue was $920,000, up from $635,000 in October. UBS has upgraded PartyGaming from “reduce” to “neutral”.

Meanwhile, there's a consolidation underway that will take a couple months to shake down. PartyGaming is buying the gaming assets of Empire Online for about $40-million, while Ladbrokes, the biggest London bookie, is rumoured to be on the verge of buying 888 Holdings, another public online company listing on the LSE, for £490-million (British).

All-in-all, this might be a good time to hold 'em, if not fold 'em, and wait out Congress. Industry observers don't think the law is enforceable; private operators, who aren't subject to shareholder nerves, have barely noticed it, and everyone is waiting for the Democrats to follow the European example and regulate online gambling, not try to prohibit it.

Meanwhile, in an amusing switch, Las Vegas Sands announced in December it will establish an online casino for the UK this spring, based in the Channel Islands. “It's hypocrisy and discrimination,” stormed the head of Public Affairs at the European Betting Association. “This proves the U.S. being open to competition is a false claim.”

Surely he's just bluffing…

Paul Sullivan is a longtime Vancouver journalist and president of Sullivan Media. He also writes for The Globe and Mail.

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