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Kevin Smith

Q&A: Andrew P. Lee, Dresdner Kleinwort Wasserstein

12 August 2002

The lingering effects of a sluggish global economy have been felt by the interactive gaming industry. Institutional investors have long been attracted to the gambling industry, but analyst Andrew Lee points out that there are major risks, as well as plenty of rewards, involved when investing in the industry.

"As far as the market is concerned, [I-gaming stocks] aren't wholly attractive, and I think that is wrong. It is a misunderstood market when you talk about U.K. and European investors. It is a huge market, which they understand, but what they don't understand are the intricacies of the legislation and the regulation."

Lee, a vice president of equities research for Dresdner Kleinwort Wasserstein, feels that major investors know very little about the sector and fail to do the necessary research on companies and the intricacies of an industry that often change from country to country.

Lee will discuss these and several other investment-related issues concerning interactive gambling at the European I-Gaming Congress and Expo show to be held in October in Barcelona. For a warm-up IGN, caught up with Lee to discuss the challenges the industry faces when trying to secure new investors and how an educated investor can make the most out of the industry.

IGN: What do you see as some of the bigger challenges from an investor's standpoint when looking at the interactive gaming industry?

Lee:When you are talking about institutions investing in these kinds of stocks there are a lot of hurdles.

As far as the market is concerned, they aren't wholly attractive, and I think that is wrong. It is a misunderstood market when you talk about U.K. and European investors. It is a huge market, which they understand, but what they don't understand are the intricacies of the legislation and the regulation.

There are a number of issues as far as online or interactive gaming is concerned. For them to employ the time in researching this market properly, it isn't worth it for them.

If you are looking at the venture capital side of things it is a different matter, You could get private funding and try and consolidate the market; those opportunities are out there. But most of the institutions are looking at publicly traded companies, and right now Sportingbet is the only one.

IGN: Do you feel there are too many issues right now for investors to deal with before going into the sector or is it a good time to invest?

Lee: It is difficult for investors to employ the time that it takes to research what is a very gray area as far as the U.S regulations are concerned.

News flow is always negative. Newspapers like to get a hold of negative stories and they very rarely put in the positive ones because it is just boring news. There is a continuous flow of bad news, whether it be credit card news or legislation being passed banning gambling. When Nevada passed its bill to move forward with Internet gambling there was no publicity on that because it was pretty boring.

"You have a credit card issue, which everyone over exaggerates; it is an issue for the industry but for some operators, it isn't necessarily an issue. For European, and U.K. investors in particular, you know that the European consumer doesn't gamble nearly as much as in the U.S."

You have a credit card issue, which everyone over exaggerates; it is an issue for the industry but for some operators, it isn't necessarily an issue. For European, and U.K. investors in particular, you know that the European consumer doesn't gamble nearly as much as in the U.S.

So when you are valuing these companies, they benchmark them against U.K. gamblers. U.K. punters probably bet at the most 25 percent of the value that U.S. punters do. In addition, they have multiple accounts, where Americans only have one or two.

The typical U.S. gambler is worth at least 10 times more than a U.K. customer. But the U.K. investor is going to place the U.S. customer at the same value as the U.K. one and then discount it because of the risk, and that is where the problem lies for this industry.

IGN: And of course not only is there a gray area in the U.S., there are certain issues and constrains within Europe from jurisdiction to jurisdiction.

Lee: That is the problem with Europe. It is quite expensive to tap into and not really all that lucrative for the reasons I just said. But to tap the customer in Europe, which has about the same population as the U.S., you have 16 different languages and 16 different soccer leagues. You have to put in the local hygiene factors to target your customers, which obviously makes it far more difficult having to put on Italian football, English football, French football and German football when the U.S. just has the NFL for 300 million people.

IGN: You mentioned earlier the consolidation of the industry. Do you see that as something that will continue to happen in the next one to three years throughout Europe?

Lee: From a global perspective I think it will. My understanding is that it has sped up quite significantly. The smaller operators are really struggling and they will either be acquired or fall out of the market. The smaller guys will have to team up with partners because it is proven that this is a good model for the Internet.

A lot of other models for the Internet have failed. You can't buy goods for 15 quid and sell them for 10 quid and expect to make money, which is what everyone else has done.

In setting odds, you can't loss-lead. You can't give 2-to-1 odds to Dallas and then give the punter 2-to-1 on Miami because then everyone will put a million pounds on each side and win.

In addition to that, you have no distribution cost and no fulfillment costs; you've got nothing. That is the scalable model that the Internet was always supposed to be, so by putting one sports book with another, you immediately strip out all the cost base.

Everything you need is in call centers, which are a minimal cost compared to other overheads for e-commerce. When you think of all the synergies that you get, you don't need an extra odds compiler. Apart from all the financial synergies you also get a better margin because obviously the more customers you got the easier it is to balance the book.

IGN: Does more and more consolidation mean there is less of a need for investors?

Lee: It is very difficult to say because I am not really sure where they are going to find the funds in the current market to go through with the consolidation.

I can see a lot of merging. I don't know how prevalent the idea of white labeling is but there seems to be a bit of that going on in Europe. I am not sure how prevalent that is among U.S. companies, but the sports books do an awful lot of it.

IGN: We are already starting to see that with P2P betting exchanges.

Lee: Yes, although I think it will be difficult for the exchanges to ramp up and compete in that market. It is going to be a winner-take-all in the exchange market. A lot of companies will try and enter the P2P market and a lot of them will fail. For liquidity reasons it will be tough for them to compete. The problem that everyone else is going to encounter is getting the volume. There will probably be a few sites that will win out, but it is even more so in the exchange sector.

IGN: Do you think, which has about 90 percent of the market, is in a good position for long-term security.

Lee: Correct. Even if the High Street bookmakers get into it, Betfair is in good shape. William Hill has started to have a go at it for kind of legal reasons. But even if William Hill is to succeed and the government was to take it away, or say Betfair couldn't trade on a license yet, they will just move offshore.

Their credibility is somewhat undermined on horseracing because the trainers are placing bets against their horses and cleaning up.

IGN: But that has been an issue since day 1 of the P2P sector. There has always been a worry that someone could come in on the losing side of a bet because they have insider knowledge.

Lee: Right, but the worse it gets, the fewer people will use the site on horseracing. But it is big enough on soccer and it is going to be big enough on all the other sports that it has the critical mass and the liquidity it needs to succeed. The bookies are using it at the moment to keep their books balanced.

Betfair's threat right now is losing more horse racing customers and losing the wholesalers who are placing money on the site. Probably about 80 percent at least of their trade comes from William Hill, Ladbrokes and Coral. Those are the wholesalers laying off bets. They could all set up their own exchange, in which case Betfair would lose out, but I don't think they have enough liquidity at the moment.

If their punter base was all new retail punters, they would have doubled the size of the U.K. horseracing market in a year, and that is just not possible.

IGN: Do you have a sense of to what degree consolidation will take place in the industry?

Lee: It has always been our opinion that there will be potentially four or five, big global players on the sports betting side, and they will probably clean up. And it is even more the case in P2P; it will be a fewer number that gets to share the pie.

IGN: Having said that, do you have a projected time frame for when you'll see those four to five emerge as the leaders?

Lee: We will have to wait and see how long it takes in America for the regulatory situation to clear up. Obviously once that opens up, there will be a whole flood. But I think a lot of them will just acquire sites. There is no difference in the gambling market from individual marketing to customers and actually taking over someone's customer base. It is the same means. I can see MGM coming in and cleaning up a few books. I think William Hill and Ladbrokes will do particularly well in Europe and they will start taking bets from U.S. customers in the near future and will do reasonably well in Asia because the Asians love betting on European soccer.

I think there will be a few big European players and there will be a few U.S. brands too, but it doesn't look like the U.S. regulatory situation is going to clear up for at least another four years or so. We will probably see four or five big players until then, and then a couple of the U.K. ones will fall out I would imagine.

Q&A: Andrew P. Lee, Dresdner Kleinwort Wasserstein is republished from
Kevin Smith
Kevin Smith