Playtech plays its cards right

Gaming software provider Playtech is riding high on the back of the boom in online gaming, writes Lindsay Vincent

The internet has touched the lives of most of us. But few industries have shaken the online money tree as effectively as the gaming barons, who lord it over an industry that has captured an estimated 5 per cent of the global gambling market. Analysts estimate the gaming market is worth $350 billion, making it a business that is now as mainstream as Coca-Cola.

Head-turning, if lesser, sums have been made by the handful of enterprises that provide the gaming industry's software. One example is Playtech, a recent graduate from the Alternative Investment Market to the FTSE Mid 250 index. The company's elevation means it will attract attention from the wider investment community, rather than just funds dedicated to a sub-sector of the market. Playtech is a fast-growing, serious business with a big future. Its share price, which has almost doubled from the 2006 flotation price of 257p, reflects this.

Playtech is the global market leader in online software, and its growth has been extraordinary – from zilch to a £1.2 billion market capitalisation in just nine years – as are its profit margins of some 70 per cent. Ordinarily, such margins might appear not just unconscionable but unsustainable. Lip-smacking margins bring forward the 'me too' brigade, while software is only as good as the strange minds that create it. In gaming software, however, things are not always as they seem, and the company is confident its business is sustainable.

For those who find online gaming distasteful, Playtech will confirm their prejudices. Its software supports some of the world's leading gaming sites, many of which operate from the shade of tax-efficient jurisdictions in minor countries. Some gaming firms in these places accept clandestine wagers from US gamblers – but that's an impossibility, apparently, on Playtech's platforms.

Flag of convenience

London's financial markets have become a kind of respectable flag of convenience for foreign firms, and Playtech conforms to the standard image of such companies: it is incorporated in the British Virgin Islands, its head office is in Douglas on the Isle of Man and it has a board of mostly foreign nationals. 'We have a tax bill of just 1 per cent,' says chief executive Mor Weizer, 33, who is not exactly thrilled to be located on a misty island in the Irish Sea. 'A bit boring,' he says.

Playtech's technical centre is in Tallinn, the Estonian capital, where it is the country's second largest information technology firm. Despite establishing an IT academy there, Playtech has been hampered by recruitment difficulties from Estonia's population of just 1.2 million, so the company has recently opened development outposts in India, the Philippines and Bulgaria, which, Weizer says, has a similar culture to Estonia and is cost-effective.

Playtech's list of customers – 59 and growing – include Paddy Power, Party Gaming, BetFred and Victor Chandler. 'We were the last software company to come to the stock market, and 33 of our licensees joined us from competitors,' says Weizer. The largest of these is Boss Media, now owned by G-Tech, one-time aspirant to run the the National Lottery in the UK.

'There are still quite a few significant [potential] licences that are tied up with our competitors,' says Weizer. 'But we still see a lot of organic growth, as our licences are growing faster than the market. There are still many licencees that we can take – there are hundreds of online operators out there. The number of software companies, though, is limited. There are many smaller providers, but only a few top or second-tier providers – say, six to 10.'

Playtech's income derives from an undisclosed percentage of its licensees' gaming revenue. 'I can't say,' Weizer says, 'what that percentage is. Our net margins, however, are 67 per cent.' If this seems excessive, he adds: 'We provide a platform for growth, and we offer opportunities for operators to grow faster than operators of other systems.'

Playtech's range of games is extensive – roulette, blackjack, baccarat and so on – but the most important is poker, where the company's iPoker brand claims global leadership. A key aspect of the game is that gamblers who are registered with, say, Blue Square, VC Bet or Playtech's other licensees share the same table. 'When people enter a site and choose a table, they do not know which sites others at the table have come from.'

He adds: 'It is important in poker to have liquidity in the network. We have 25,000 online players at peak times, playing with stakes from 10 cents to $100. Poker is our fastest-growing game, and we are now seeing inquiries from operators who want access to that liquidity pool. With more than 25 operators already using our platform, this allows for great marketing ideas. We've just finished a 10-day event with $3.5 million in prize money.'

Weizer reveals that each licensee signs a three-year contract, a deterrent to competitors aiming to poach business. 'There are big barriers to entry and no significant competitor has been founded since us. We develop our software in association with our licensees. It is very hard for any competitor to get access to this knowledge. They would have to find a well-established operator and work with them for a few years to develop a knowledge of our systems – a major technical barrier.'

New games

Weizer discloses that Playtech has a pipeline of many new games, including mahjong, which needs no introduction to the largest gaming population on earth, the Chinese. 'We expect to have it in operation by the end of this year. The software has taken time to develop to eliminate the possibility of player collusion. The cost to licensees of adding additional games is marginal, and many of our licensees are still underdeveloped in terms of the number of games they offer.'

The company is also developing person-to-person games, largely for the Asian market, including China, where people play cafe games for prizes and small sums of cash. It is also expanding its land-based video betting game, where a joint venture will introduce 500 machines in Ukraine alone.

While there has been a spate of bullish broker circulars on the company and its prospects, recent turmoil in the stock market has clearly had an impact on short-term expectations for the share price, which has eased from 553p to 492p over the past month or so, but as with gamblers, these broking analysts appreciate the transitory reality of the present.

JPMorgan predicts Playtech revenues will rise from last year's $104 million to $271 million by 2010. At a price of 535p a share, this converts to a price/earnings ratio of 12.6 times estimated earnings per share for 2010.

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