The Business of Poker - Analyze This, Part One
Paul Leyland analyses the gaming sector for Seymour Price, a London based investment firm. Paul was nice enough to sit down with me in on my recent London trip. Only twenty-six, I was impressed how well prepared, and well spoken he was. In part one of my interview with him, Paul discusses the current state of the online poker/gaming industry from his perspective, and gives his thoughts on the state of the union.
Some of what Paul says is a little bit in 'economist speak, but I think the information contained here is really interesting, and to say the least a very valuable perspective. Paul & I covered so much ground, that I am going to make this a two-parter. One week from today, I will run part two of this interview, in which Paul discusses the future of the iGaming industry, and his thoughts on who, and what are next.
John: Firstly, tell me how you got involved in covering this sector?
Paul: As I'm sure you know, the UK from a gaming perspective has had about forty years of regulatory history. The Tory Party, in the mid nineties, kicked off a policy of introducing an act to regulate all forms of gambling, and to an extent, liberalize that which was already in existence. And also bring into fold online gambling. That eventually triggered off an awful lot of market interest. And it just so happened that not a lot of market analysts had the time to read it, or the inclination to understand all the boring politics that went with it.
I was recently out of university doing a history degree, so I got all the political side of things, had the time to read the reports, and formed a rather different view to most people on it, some potential progress. And happily the team I was with at the time thought well ok, then why don't you run with that and have a go at gambling. Originally it was very terrestrial-led. Then it became increasingly clear that the online space was something that was enormously interesting to the terrestrial operations in the UK. It was also a much bigger space than they realized, and a space that was an awful lot different to what they expected to tackle. So from then on, it became clear that looking at both would...one, have an awful lot of market value because it was quite clear that the online space was growing much more quickly than terrestrial. Two, since the online space was growing from a market perspective, without a regulatory framework, you didn't have to rely on an individual government to get it right or wrong. Consequently, there was something of a natural hedge. You could look at terrestrial, you could at online, one or the other or both. All were going to add value to shareholders.
So, it became reasonably clear from probably 2001, or 2002 that looking at both is a good plan. Ironically that's exactly the time when the online space was getting a very very tough time. But thereafter, the market sort of ignored that, or wasn't actually exposed to that because it was incredibly frightened at the time, and it embraced the concept from a top down view which has its benefits, but also has its problems, so.
John: You've been covering gaming then for....
Paul: Four years.
John: So, you entered the business at the same time that the space started, I guess, in its upswing.
Paul: I would say it was about the time when the second wave started kicking off. I think the first wave, sort of mid to late nineties, was relatively easy money. Certainly easy money relative to now. I mean, there were ground breakers from a technological point of view. The marketing side of things was fairly simple. And consequently there was a whole load of people that were doing it, without a vast amount of effort.
Then when PayPal pulled out, and the DOJ (US Department of Justice) leaned on Google, Yahoo, etc., things got a little tough. On top of that people realized that if you had organized yourself properly, you could make a hell of a lot of more money than if it was some sort of organic mushrooming of activity. Then a number of companies evolved, which rapidly gained market share at the expense of other people in a difficult market. And those are the people I think that started to become interesting from an investment point of view.
One or two companies were listed already. Sportingbet being a classic example. That was the early stage where they'd done some acquisitions and started to grow in critical mass when people weren't really noticing the detail. The top line looked quite boring until the year 2002, 2003 when things started to take off. Then that company entered into other issues of its own. Nevertheless, that's when people realized online is a place to be, but you have to get the model right.
Now I think the market has to some extent regressed insofar as until PartyGaming did....its little thing about saying it stopped growing and it doesn't know why. Until that happened, you had a situation where people were looking at the top down saying the online gaming market is all growth at 20% plus that whole you buy any company, you'll do alright.
That had all the seeds of a disaster.
Party has to an extent cleared that out, which is enormously beneficial. And I think the problem now is that fund managers that were once bullish are now enormously skeptical. And it's a question of working through that and demonstrating that the model works. But it only works with good quality businesses. And that's true of any industry whatever.
It's an immature industry that's going through a learning curve and the City (London's financial market) is three or four years behind the learning curve of the industry. But then one would expect that.
John: Right. Do you think the lessons learned from the Internet days are going to be applied or ignored with respect to this sector?
Paul: No. I think that they're quite different because what you're looking at now is an asset pricing issue. What you're looking at now is people recognizing that from a top down perspective, Internet gaming is enormously interesting. They're looking from a bottom up and noticing that individual companies are growing. But combining those two nuggets of detail, they could build a big picture, which is over-optimistic.
They're thinking that the space is exciting. Some companies are growing, therefore the space is growing; therefore all companies will grow, which is never true. And it's a question of working through that. For the Internet bubble what you had was this great new explanation of ideas, none of which was proven. In fact their theory was back everything because most of it'll work and so you'll be ok.
And then actually only a fraction of it worked.
But there was no real way of sitting through, unless you were a transcendent genius, to know which. In the online gaming space you've already got proven models. And that's a crucial difference.
There's already people making money; there's already people growing; there's already people introducing product that works rapidly. So the route to market is quite short. So spotting a good management and a good model is a whole lot easier.
John: So let's talk about management and model. The players in the space now I think, at least from my perspective, quite different from what you're doing and the people that you deal with.
John: I get a lot of calls from the cowboys that see only all the nine billion pound valuations and think ok, I've gotta have some of that.
Paul: So do we. Well, you know, it's only fair to say that there is an extent to which online gaming has become something of a bubble in the market.
Largely diminished by PartyGaming, but let's step back from gaming for one moment. If you have an asset pricing bubble in any sector at any time, it's the cowboys that try to reap it quickly. So, there's no reason why gaming should be any different.
John: Right. So when this announcement came down about Party and them saying, 'hey we may not grow at this Herculean pace', what was the effect that you felt? Was there any kind of tangible reaction you felt right away?
Paul: Well my very very immediate reaction was to call a mate of mine in another brokerage firm and say what price are you being quoted for Party, cause I think mine's wrong.
John: Oh really?
Paul: And a lot of people did that. No one expected 25% like that. But, had the information been handled properly, it wouldn't have been 25%.
John: Right. So is that what you attributed the drop to that day?
Paul: Management need two things to do a good job out of results and also a good job out of the company. They need management information that's accurate and easy to understand, and they need experience.
John: Right, ok. Let's talk about 888, and your reaction to their recent listing on the London Stock Exchange.
Paul: It's a full price. It's understanding, you see of all of the problems that the City has, that the long only funds, you know the typical old fund managers , for lots of very understandable reasons, are somewhat skeptical of this space. They became a hell of a lot more skeptical after PartyGaming. And so they say, prove yourselves and we'll maybe give you some money.
We're not going to make a whole load of random people we've never heard of rich, to buy into a random product we've never heard of either.
So you carry on. You end up with hedge funds in, and when you've got hedge funds in, you provide an enormously useful service to the market. You end up with a book that you can, to some extent; well you know that if you've got enough people with big short positions, one is gonna go down in the first few days. So, it's par for the course. Practically every gambling firm system's done that. The "long only's" feel pleased that they haven't bought in, while the hedge funds, some of them are shorting, some of them are waiting for the longer term. The management thinks 'Well this is normal, and anyhow we're locked in so it doesn't matter. All that matters is what the price is going to be in twelve months time.' And so everyone just gets on with it.
John: Ok, no big shock....
Paul: No, the real, the real key with 888 was not that it went down, was that it was four or five time over some subscribed. That's the important thing.
Join us next week as we discuss multi line gaming companies, and the five-letter word that Paul says is the next big thing in online gaming.