Party Looks Strong, but Challenges Lie Ahead

PartyGaming, the world's largest online poker company, has regained its float price of 116p after a tumultuous two-month period in which its shares dropped more than 100p to 71p before slowly rising again.

PartyGaming's share price began to slip after the company announced in September that revenue growth was slowing. Amid key strategic maneuvers made by the company--such as segregating the players from the four "skin" partners from the PartyPoker.com network--the stock began to slowly recover after bottoming out at 71p on Oct. 9.

The company could have yet another storm or two to weather over the coming months, however. While three of the skin partners made deals with PartyGaming, the group couldn't come to terms with the operator of its largest skin, EmpirePoker. Acquisition talks went sour, and the operator, Empire Online Limited, says it intends to sue PartyGaming.

Empire is seeking damages "caused to it by the conduct of companies within the PartyGaming group," and analysts at investment bank Morgan Stanley have indicated that PartyGaming could be liable for close to £300 million if Empire Online is successful.

A report from Morgan Stanley reads, "On a simplistic basis, we assume that the maximum potential liability is the market capitalization of Empire that was directly eroded as a result of the platform split, plus reputational damage."

The report also notes that Empire's share price fell from 183p to 121p after PartyGaming's separation of the skins, and then to 86p after Empire released a profit warning. Thus, about £290 million of total market capitalization was eroded over the course of 10 days.

Most observers say it's too early to assess whether Empire will be successful with its case. On the one hand, PartyGaming warned in its prospectus that a contract dispute between it and any of its skins could have a material adverse effect if not resolved favorably. The statement prompted Morgan Stanley to note in its report, "It is clear from this statement that it is a risk that Party takes seriously, and we cannot rule out a material adverse effect from the impending litigation."

On the other hand, Empire Online's prospectus contains a statement that lends doubt to whatever success it could have. The company states in its prospectus, "Should the agreement with WPC Productions (the relevant PartyGaming subsidiary) . . . be breached by them, the company would have to sue such parties in the courts of the British Virgin Islands and to enforce any resulting judgment in Gibraltar . . . without any guarantee that any such action would be successful."

The upbeat first quarter financial report released by Sportingbet Plc (SBT.L) last week has also prompted Morgan Stanley to speculate that PartyGaming has been "losing market share to Paradise (Poker) this year," noting that Paradise Poker experienced a 33 percent gain in gross win between May and July of 2005 and August and October of 2005, while PartyPoker attained a gain of only 2 percent in gross win between April and June of 2005 and July through Sept of 2005.

PartyGaming will announce a pre-close trading update on Thursday.