Arbuthnot Says PartyGaming Future Looks Grim

2007 May 22, Jonny Vincent

Arbuthnot Securites is an UK-based investment banking and brokerage firm. The company has just released an extensive report on the Italian gaming market and an assessment of the current share prices of listed online gambling firms.

The Arbuthnot report is titled Italian Gambling Sector – The Italian Job. Despite a lot of recent good news for the online gambling industry, Arbuthnot believes the outlook is not as positive as many believe. Arbuthnot believes the share prices for listed online gambling giants such as PartyGaming are heavily over-inflated.

PartyGaming (LSE: PRTY) closed at 39.75p overnight, down almost 30% from recent highs in the last month. Much of the March and April gains could be attributed to the market believing the US House Financial Services Committee chairman Rep. Barney Frank would introduce a UIGEA repeal bill in the House, but instead he introduced a watered down bill calling for licensing and regulation which should serve to benefit US entities (PartyGaming is licensed and based in Gibratar in Europe).

The Arbuthnot Securities report was released when PRTY was trading at 46p and the share price has since dropped to below the 40p mark. Arbuthnot believes the prospects for the beleaguered company are more negative than positive, and have set a target price of 15p.

Their arguments for this bearish view are four-fold: "First, company guidance 'issues' during Q1 has already led to a 30% consensus downgrade for 2007E and we believe the assumption that 2008E will not be affected is at best optimistic. Second, we see hopes for a US re-entry as negligible, given the limited prospects of any bill and the highly-regulated nature of any subsequent Act. Third, the lack of domestic licenses in key markets (even where available, such as Italy), significantly enhances regulatory risk. Finally, a 2007E P/E of 54.3x implies too much hope value."

P/E is the price to earnings ratio and a P/E of 54.3 means if you bought the company today, and earnings remained the same, it would take you 54.3 years to make your money back. Arbuthnot believes their 15p target price is "generous" and "conservative", considering that price would give the company a P/E of 17.

They go on to argue that "PartyGaming is at a competitive disadvantage to poker operators taking US bets, European marketing costs are structurally high and could increase; and European regulatory risk remains a threat to both operations and sentiment".

Despite recent optimism for the online gambling sector in Europe, with the recent European Court of Justice ruling in the Placanica case that European member states cannot monopolize state-sponsored gambling within their borders, Arbuthnot believes other EU states will follow the Italian model (license and regulate online gambling, but keep some operators like PartyGaming out). Arbuthnot believes countries like Canada, Germany, Sweden and Spain may soon follow the Italian example, and all these countries contribute a high percentage of PartyGaming's customer base.

Arbuthnot believes PartyGaming's own forecasts are unreasonably optimistic, saying "we are deeply skeptical of this guidance since it requires record customer growth, a marked improvement in European player yields and/or much better customer lives – none of which is likely, in our view, let alone guaranteed…our 15p target price…would put the stock on 17x 2007E earnings, which we believe to be generous given the stock's regulatory, operational and credibility issues.

Dresdner Kleinwort has consistently offered a bullish view on PartyGaming, but they are PartyGaming's house broker, and can hardly be considered objective. If Arbuthnot Securities is perhaps focusing somewhat on the negatives, Dresdner Kleinwort is focusing on nothing but positives.

It might be time to dump those PRTY shares.