The Back End of Betting

Published in Company Comment on 3 November 2010

Playtech reports improved trading.

Investors in betting companies will be comforted by Tuesday's trading update from Playtech (LSE: PTEC) which indicated that after the seasonal summer slowdown and aftermath of the World Cup, September was a stronger month, with the trend continuing into October. Playtech itself reported gross income up 30%.

Back End

Playtech provides the back-end software platform and gaming applications for the remote gaming industry, partnering with consumer-facing betting operators such as Ladbrokes (LSE: LAD) and William Hill (LSE: WMH).

Its core system provides operators with a full range of games across a variety of platforms. The punter has just one account but can play at poker, bingo, casino and sport betting, online or via TV broadcast, mobile or gaming terminals.

This segmentation between the customer-facing operators -- which include traditional bookies, new online entrants such as Betfair (LSE: BET) and Partygaming (LSE: PRTY), and media companies such as Virgin Media (LSE: VMED) and Sky (LSE: BSY) -- is perhaps a sign of the growing maturity of the online gaming industry.

Model

Playtech's model of how the industry will operate is that gaming operators should be primarily marketing companies. They would retain their core capabilities (such as making the sport book in the case of traditional bookies, say) but outsource peripheral games and back-end systems.

The rise in the number of operators, and their perceived need to offer a full range of games so as to retain fickle punters who switch readily between sports betting, poker, casino, etc, are major factors behind this development. Playtech's 700-strong development team provides a scale of games development that each operator would be hard-pressed to match across the full spectrum of games.

This strategy requires competing operators to be happy sharing the same platform provider and games developer. The fact that Playtech serves William Hill Online (in which it has a 29.9% stake), provides the technology for Ladbrokes' gaming machines, and also delivers Betfair's casino game is some proof that pudding can be eaten.

The product range has been deliberately built through a string of acquisitions, including GTS (a game developer), Virtue Fusion (bingo) and P2P (Sportsbook), plus a partnership with Scientific Games in the US (lottery and games terminals).

The reality does not quite live up to the model yet, though, with casino representing 67% of Playtech's revenues in the last quarter, and poker and bingo together another 27%.

There is some anticipation of consolidation in the sector, but Playtech's broad product span and relationships mean it holds some strong cards.

Growth

Playtech's revenues are mainly royalties calculated as a percentage of the operators' revenues. With largely fixed costs it is thus highly operationally geared, and profits depend very much on the underlying betting and gaming market.

There has been a sea change in attitudes to gambling, with new technology spurring growth amongst new demographic groups. The industry is traditionally held to be relatively recession-proof, but online gambling has not been around long enough to rely on that assumption.

Since the US clamped down on internet gambling in 2006, the industry has generally favoured regulated markets where governments have laid down specific legislation. Regulation has generally led to market growth, such as in the UK, Italy and France (although Playtech is suffering from the curtailment of casino operations in France).

So it's good news for Playtech that the Head of the European Commission recently called on governments to recognise the reality of online gambling; the new government in the Netherlands is considering legislation, and the German government lost a case in the ECJ where it sought to protect its state gaming monopoly.

Corporate Governance

Playtech has just been named as AIM's International Company of the Year and plans to move to the main market, which its £1bn plus market capitalisation more than justifies, albeit with 40% in former owners' hands.

Strange, then, that it has lacked a permanent CFO since October 2008 and had only two executive directors since the COO stepped down in March (with a director who previously served as CFO acting as interim CFO). The process of finding a permanent candidate was "in its later stages" at the half year, but only "making progress" at the third quarter.

Valuation

The company expects EBITDA for the nine months to 30 September to be not less than €77.7m, and that it will meet its expectations for the full year. That attaches some weight to brokers' consensus forecasts for full year pre-tax profits of €82.8m against €70.3m in 2009, putting the shares on a prospective PE of 13.1 and yield of 3.8%.

That's not cheap in the current climate, but not too pricey for a company that generates cash, has decent prospects for growth, is well-positioned for any fall out in the sector, and whose shares are down 20% since April.

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