The Gambling Stock You Can't Afford to Ignore

Brad Briggs's picture

Wednesday, October 21, 2009 - 11:29am

by Brad Briggs

The gambling business is a license to print money. Everyone knows that.

But for investors who want the cash flow without casino's real-estate risk and their potentially crushing debt, there's an alternative: Online gambling.

The first Internet gambling site was launched in 1995, but it wasn't until Chris Moneymaker, an amateur online poker player, won the 2003 World Series of Poker that the business really took off. Today, more than 2,000 online gambling sites offer sports betting, virtual slot machines, poker and other casino games.

Several publicly traded online casinos dominate the market, including 888 Holdings (LON: 888), PartyGaming (LON: PRTY) and Playtech (LON: PTEC). These companies are listed on overseas exchanges, which presents an obstacle for U.S. investors unaccustomed or unable to place overseas trades.

The Unlawful Gambling Enforcement Act of 2006 made online gambling illegal in the United States. The law doesn't target individual gamblers, it punishes banks and credit card companies that allow transfers to online-betting accounts. This forced the online betting companies to move overseas.

Fortunately for investors, there is Cryptologic (Nasdaq: CRYP).

The company develops software for the online-gambling market and licenses its products to gambling operators. The company uses what it calls a "build once, license often" growth strategy that generates multiple revenue streams based on the wagers placed in the licensee's online casinos.

Because Cryptologic isn't involved in the transaction side of online gambling, its business is legal. And despite the unfavorable online gambling climate in the U.S., the company is developing plenty of business elsewhere.

Cryptologic sells its software to some of the best-known names in online gambling, including PartyGaming, 888.com, SportingBet.com and Betfair. Its products include traditional card games, video slots, table games, jackpot games and more. The company even offers branded slot machines based on Marvel Comics or "Call of Duty," the popular video game franchise.

All told, the company has 280 games on the market that it licenses to 24 companies. The company expects to return to profitability in the third quarter once the effects of the downturn are behind it. The company has a pristine balance sheet: $28.6 million in cash and zero debt.

Cryptologic is a small company positioned for enormous growth. Offshore gambling sites brought in about $6 billion from U.S. gamblers in 2008. The worldwide market is worth $21 billion and is expected to grow to $30 billion by 2012, according to H2 Gambling Capital, an industry research group.

Cryptologic wins a bigger piece of the pie each time it secures a new client or the industry grows. Online gambling accounts for about 6% of the gambling industry. This is forecasted to increase to almost 9% by 2012.

Cryptologic's shares are attractive on their own merits, but what's most promising is the prospect of more and more online gambling bans being overturned, including in the U.S.

House Financial Services Committee Chairman Barney Frank has submitted a bill to legalize and regulate online gambling in the United States. The measure is gaining support, and the Obama administration is expected to recognize the tax revenue potential of this growing market and support the measure. H2 Gaming Capital estimates the U.S. online gambling market could be worth $13.4 billion within five years.

The European online market is also considering loosening its restrictions on online gambling. The market is worth $9.4 billion right now and could nearly double by 2012. Lawmakers in France are considering whether to legalize online gambling: The bill there has passed the national assembly and awaits a vote in the Senate.

Liberalization of gabling restrictions are also possible in Portugal and Italy.

Cryptologic's shares sit at about $6 a share, but were changing hands for about $30 before online gambling was outlawed in the U.S. They could easily regain that level if restrictions are reversed in the U.S. and Europe and online gambling continues to grow.

Brad Briggs does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.