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Black Friday shut down the U.S. operations of PokerStars and Full Tilt. Traffic for the largest online poker company has fallen 30% since April 15, according to PokerScout, while the loss of Full Tilt’s operating licenses has shut down the network. The Department of Justice’s strike has also damaged their operations and reputations internationally, where the two giants previously held nearly 60% of the global market. Licences in countries like Italy and France are at risk as criminal indictments and billion dollar fines loom large. As a result, greater market share and profits may await European operators like bwin.party.

Market Share

Full Tilt had its licence suspended in France on July 4, fives days after the Alderney Gambling Control Commission revoked its operating licences, shutting down the company and freezing out players. Indictments and further licence losses will hinder future attempts to win regulatory approval in other jurisdictions. Market share is up for grabs. If PokerStars—the leading operator in both the French and Italian markets—is convicted and ousted from either, the move will free up almost a quarter of the market and remove the fastest growing operator, according to Ed Birkin at British investment firm Barclays.

How likely are further license losses? According to H2 Gambling Capital’s poker expert Joel Keeble: “It is difficult to say if PokerStars and Full Tilt will loose their licenses in Italy and France—Full Tilt excluded—but we do expect there to be further reviews. The loss of Full Tilt’s Alderney and French licenses appears to be due to the company’s inability to pay back deposits. PokerStars is not suffering from this and therefore has a stronger position. It is clear that Full Tilt will find it very difficult to recover from its license suspension.”

Euro-only networks, however, have yet to see significant gains from the Department of Justice’s crackdown. Shares of Gibraltar-based bwin.party soared 30% on the first trading day after Black Friday (April 18), as investors bid up prices expecting a major shift in liquidity. Shares, however, have slipped 18% since April 18 and are down 32% in 2011. Rival 888 Holdings’ stock has shed 38% this year, while shares of Ladbrokes and William Hill have faired better, up 17% and 26%, respectively.

Traffic numbers showed little-to-no improvement in the weeks following Black Friday, despite increased promotions. More recently numbers have spiked, especially after the AGGC decision froze Full Tilt players out of their accounts. Party Poker, now the world’s second largest site for the first time since 2007, is up 35% since June 29. iPoker and 888 have seen traffic rise 24% and 20%, respectively, while Microgaming is up a more modest 7%. Since the AGCC revoked Full Tilt’s operating licences, nearly 60% of the traffic lost by Full Tilt has already been absorbed by other poker sites, according to PokerScout, unlike Black Friday, where the bulk of U.S. traffic disappeared from the market completely.

However, it is not Party or iPoker picking up most of the traffic. On July 1, eGaming Review published data from industry research firm H2 Gambling Capital showing that PokerStars had claimed two-thirds of Full Tilt’s migrating traffic. In the first 36 hours following the shutdown, the average number of PokerStars players online increased by 2,607, more than five times the jump in traffic recorded by Party.

Any significant and permanent shift in traffic to Euro networks will take time, and may depend on further licence losses and DOJ convictions for PokerStars and Full Tilt. That’s the conclusion of Ed Birkin and his research team at Barclays, who see outsized returns for bwin.party and peers on the back of a collapse at PokerStars and Full Tilt. “The closure of the .fr and .it sites would have a very significant effect on other operators in those markets,” says Birkin. Currently both companies, particularly PokerStars, still have a “formidable presence in Europe,” according to bwin.party Co-Chief Executive Jim Ryan.

It is still too early to know if the indictments will lead to a systemic shift in industry rank like the UIGEA did five years ago when PokerStars and Full Tilt filled the void left by Party Poker, who made a $105 million non-persecution settlement with the Department of Justice and bowed out of the American market. What is known, however, is that by shutting down the U.S. operations of PokerStars and Full Tilt, the indictments have removed the companies’ ability to use U.S. profits to buy market share in Europe, analysts say.

Amongst European networks, bwin.party may be best positioned to capture liquidity and market share from PokerStars and Full Tilt due to its size and scale. Bwin and Party merged on March 2011 to form the largest publicly listed online gaming concern, with a market capitalisation of €1.3 billion as of yesterday’s close. The company reported pro-rata revenues of €357 million and earnings of €46 million for the 2010 fiscal year. Management says the deal will save €55 million by 2013 by streamlining platforms and removing duplication.

Barclays estimates that if 10% of PokerStars and Full Tilt’s non-us players migrate to the bwin.party platform, the shift would lead to a 52% spike in player numbers for the newly merged company. This would yield a 52% increase in poker revenues for fiscal year 2012, and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) could jump 25%, even factoring in the increased marketing and payment processing costs needed to attract and retain new players.

While the indictments of PokerStars and Full Tilt offer bwin.party the opportunity to capture market share in Europe, the regulation of the American market looks less promising. Proposed legislation thus far would only allow European operators into the market as business-to-business partners, with regulation rigged to benefit U.S. companies. In Sen. Rockefeller’s bill, expected to be unveiled this autumn, and Rep. Joe Barton’s bill, released June 24, foreign operators would only be allowed to enter the market after a period of exclusion. In other proposed legislation, they would be barred all together. As a result, potential earnings for European operators if the U.S. legalises online poker will be less than most hope.

The United States government is not interested in free and fair trade here. Speaking at the Gaming Executive Summit in Madrid on July 6, AGA Chief Executive Frank Fahrenkopf revealed that Sen. Harry Reid’s attempt to pass federal legislation last December failed because Las Vegas Sands’ Sheldon Adelson “was personally offended by the fact there would not be a ‘penalty box’ [for offshore operators] and called leaders in both houses, as did Steve Wynn”. The AGA represents the nation’s brick-and-mortar casinos, and it’s clear that federal legislation will only pass if it benefits U.S.-based businesses and punishes overseas operators.

Still if bwin.party is shut out as a business-to-customer operator but can profit as a business-to-business partner, this may suit the company. Co-Chief Executive Norbert Teufelberger told eGaming Review in August 2010 that withdrawing from the United States would be “the biggest mistake I ever made” if PokerStars and Full Tilt were not frozen out of a regulated market. Teufelberger was involved in writing down Ongame after buying it for €474m; Ryan helped negotiate Party Poker’s $105 million non-persecution settlement with the Department of Justice.

Legislation

Bwin shares continue to zig and zag amid regulatory uncertainty. The week following the announcement of Germany’s prohibitive sports betting proposals saw the price of bwin.party drop 16% in one day, and fall 34% below its March 31 float price of £1.94. On April 18, shares saw their biggest jump in two months, rising 30% after the AGCC suspended Full Tilt Poker’s operating licences. In attempts to placate investors and steady its share price, bwin.party announced on June 30 plans to buy back up to €75 million in stock and issue a dividend of €30 million.

Investors have reacted most violently to news from bwin.party’s key German market, which makes up 23% of revenues. This spring, 15 of the country’s 16 Länder approved the country’s State Gambling Treaty, with the State of Schleswig- Holstein the sole objector. Analysts say all eyes are on the European Court of Justice, who on July 18 will decide if proposals to restrict the online sports betting market to private operators are in compliance with EU law. In addition to a 17% turnover tax for sports betting, German lawmakers want to restrict online poker and casino licences to brick-and-mortar companies.

Bwin.party is not the only gambling company complaining. Betfair has also publicly objected. According to the Financial Times, the British bookmaker wants the European Commission to force German states to relax its “protectionist” betting reforms. A decision on the country’s State Gambling Treaty is expected later this year in October. Analysts say the market is likely to be regulated on a state-by-state basis after current legislation banning online gambling expires in 2012.

Bwin.party maintains that its presence in Germany since December 2007, just before the current State Gambling Treaty came into effect, is on solid legal grounds. Bwin.party won a landmark court battle in November 2010 when the Federal Supreme Court upheld a ruling preventing Westlotto (the monopoly operator of the State of North-Rhine Westphalia) from taking out injunctions against the company in Germany. Bwin is also involved in a number of other disputes before German civil and administrative courts. Fines levied from December 2007 to date against the company, its subsidiaries, and directors amount to €2 million.

Outside the German market, the biggest trend in European regulation has been the proliferation of the dot country websites. Italy created Europe’s first dot country site in 2006, and its success has led other EU member states to adopt the model. Italy added tournament poker to sports betting in 2008 and bingo the following year, while cash poker and casino games launched this year.

Italian tax revenues from online gambling rose from €145 million in 2009 to €195 million in 2010 as the market grew 30%, says Trust Partners, a consulting firm based in Roma, Italy. The launch of pit games and cash poker this summer could double turnover by the end of the year, according to eGaming Review.

France was next to adopt the dot country model, with lawmakers first issuing licences for fixed odds sports betting and pari-mutuel horse racing in June 2010. The French model has not been as successful as its Italian counterpart, however.  The market was set up to protect monopoly incumbents such as FDJ and PMU, and has received criticism due to its prohibitive tax rates, limited product range and cumbersome registration process.

Following Italy and France, other EU member states are eager to introduce dot country structures, requiring companies to be licensed, taxed and operated from within national borders. More than half of member states are in the dot country pipeline, and H2 Gambling Capital projects that the value of dot country activity will approach parity with traditional dot com operators across Europe by 2015, according to research published in eGaming Review. Traditional dot com operations currently account for 80% of activity in Europe, according to the Manchester-based data firm.

In October 2010, the Dutch government announced plans to license and regulate online poker, sports betting and casino games. In January 2011, Greek lawmakers introduced the first draft of the country’s online gambling legislation, proposing five-year licences and a 6% turnover tax. On July 8, however, the European Commission issued a detailed opinion against Greece’s legislation, citing concerns over its incompatibility with EU law. Bwin.party and Betfair, who last month filed a complaint with the European Commission over the proposed ban on betting exchanges, praised the decision.

Denmark is expected to issue online gambling licenses by the end of the year. “A proposed 20% gross profit tax, broad product range and the ability to tap into international poker liquidity is expected to attract many of Europe’s leading operators to apply for a licence,” according to a report published by eGaming Review. Belgium is also set to legalise and regulate online gambling. Like France, the market is being set up to favour incumbent companies. Legislation has granted 34 licences to land-based operators and new applicants must locate servers and infrastructure to Belgium, protecting operators from competition on their home turf.

What’s clear is that other countries are not following the lead of the United Kingdom, whose gambling Act of 2005 (effective September 2007) does not require operators to obtain licences and pay taxes in Britain. Most sites have chosen to operate and be headquartered offshore, taking away potential revenues. While companies can currently advertise and operate without being licensed by the UK Gambling Commission, this is soon to change. In July 2010, the European Court of Justice upheld plans for the UK Gambling Commission to directly licence operators. In January 2011, Britain’s Culture Secretary Jeremy Hunt announced plans to ban advertising by offshore operators.

The emergence of dot country markets has made investors uneasy. While most players look forward to regulation, investors are weary of the short-term uncertainty. For operators, legislation can increase market share when favourable, but often comes at cost. Take bwin.party, for example. The newly merged company had 50% more customers in the third quarter of fiscal 2010 following French regulation compared to the same period in 2009, with revenues increasing over 70% from €7 million to €12 million.

However, the cost of entering newly regulated markets, especially those established to favour incumbent companies such as France’s Winamax and Italy’s Microgame, caused profits to dip. Duties, taxes, commissions and fees (a licence in France or Italy costs €100,000s) tripled to €12 million, from €4 million last year. The marketing push needed to attract and retain players in newly regulated markets increased more than 30% to €31 million. This slashed Bwin’s margins in half, and resulted in a loss of €6 million compared to a profit of €8 million in the same quarter last year.

Consolidation

Executives from bwin.party think the company’s size and scale will allow it to be one of the few operators to be able to enter all newly regulated markets. Further consolidation is inevitable. The bwin.party merger has put pressure on the industry’s smaller players to wheel and deal in order to gain the size and scale needed to compete in all markets. Currently the list of companies positioned to operate in every country is limited to bwin.party and Playtech. PokerStars, too, remains a formidable player that will continue to flourish if it can avoid convictions, billion dollar fines and license losses.

Ladbrokes, 888, Sportingbet and Unibet are seeking scale through consolidation. Others may look to enter dot country markets where they have an established base and brand, while some will remain in existing territories. Companies need to act quickly, though. The European market, which is expected to generate poker revenues of €2.7 billion in 2011 according to H2 Gambling Capital, is splintering into a patchwork of dot country markets and grey territories that have yet to establish clearly defined legislation. The fragmentation is the most fundamental change to regulation in the industry’s history. PokerStars aside, bwin.party is best positioned to capitalise and investors may see market-beating returns in the future, especially if PokerStars and Full Tilt are convicted or ousted from key markets.

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