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Online Gambling Is Set to Explode; Who’s Holding a Hot Hand?

The potential sounds big, but the publicly traded waters are murky

   

If you’re a fan of online gambling games but are frustrated by the fact that it’s (mostly) only for pretend money, hang tight — that might be about to change in your locale soon. But it’s not just a brewing opportunity for skilled poker players — investors can play a hand in the brewing boom of digital betting too … through stocks.

As is always the case, however, some of these stocks are better bets than others.

Merge Ahead

Just for the sake of clarity, note that two markets are served by online game publishers.

The first one is gamers who enjoy spinning a virtual roulette wheel as a way to win hypothetical money — aka “social casino gaming.” The revenue model is mostly advertising-oriented. If you’ve played the online poker game from Zynga (ZNGA), you’ve fueled this market, though from Zynga’s standpoint you might as well have played Words With Friends or FarmVille.

The second market is real-money gamblers who win and lose actual dollars by betting online. The revenue model here is the traditional casino’s model — “the house” scrapes off a tiny percentage of every dollar laid on the table.

If you’re thinking online gambling (for real money) is illegal, you’re right … for the most part. In the U.S., web-based betting is only legal in Nevada, Delaware and, most recently, New Jersey. It’s also legal pretty much everywhere else in the world; blocking U.S. residents from playing online — even though illegal in most scenarios — has proven difficult.

The revenue at stake isn’t chump change, either. Globally, gambling is a $417 billion annual industry, and about $125 billion of that is generated inside the U.S. Online gambling contributes only about $35 billion of that global figure each year, or about 8% of the entire market. That’s still better than the online portion of the U.S. gambling market though, which only makes up 3% of the domestic betting industry.

Even then, it leaves social casino gaming’s revenue in the dust. The play-money version of the global gambling market is only worth $1.7 billion per year now, and according to Morgan Stanley, will do well to grow to $2.5 billion by 2015. That’s big growth, but still a minor market.

Given those numbers and the potential revenue at stake when social betters gain access to real-money gambling games, it’s no wonder why so many social casino game publishers are looking to enter the actual betting arena … if not as the house, then as the technological backbone for brick-and-mortar casinos. And with individual states starting to ease up on web-based betting now that tax revenue is on the table, it’s becoming increasingly possible for software designers to do just that.

The question is, who’s going to lead that charge, and how?

These Companies Have Winning Hands

There’s little doubt as to the first name investors think of as the best way to play the convergence of social casinos and real poker … Zynga shares soared from $2.56 to as high as $3.73 in a little over a month after New Jersey effectively legalized online gambling in early February. After all, Zynga is “the” name in online social gaming.

Problem: Zynga is losing its “the” status in the world of social casinos.

Ellers Research reported that in the second quarter of this year, Caesars Entertainment (CZR) subsidiary Caesars Interactive Entertainment overtook Zynga as the world’s largest social casino publisher. It’s a small margin: 18% of the market for Caesars versus 15% for Zynga. Zynga is losing ground in the race, though, and with International Gaming Technology (IGT) running a close third with 14% of the market, it becomes clear that the old-school, real-world gambling names have the edge in the world of online gaming — not the newer online-gaming publishers.

Zynga and its rivals in the online game industry must preemptively strike at the brick-and-mortar casinos on their home turf if they’re to have any chance at success in this new arena. The company filed a request for a Nevada gambling license in late 2012; the approval can take anywhere from a year to 18 months, and ultimately requires Zynga to have some sort of physical presence in Nevada (most likely through an established partner). Barring what’s been dubbed a “compact” with other states who will allow it, Zynga’s Nevada gaming license is only applicable in Nevada for people who are in Nevada. Thing is, if a player is physically near a real casino, how marketable is a Nevada-only online poker game going to be?

To be fair, it’s not like Caesars, International Gaming Technology or any other actual casino won’t hit similar headwinds in the virtual world. The partnership between MGM Resorts International (MGM), Boyd Gaming (BYD) and Bwin.Party is arguably the most successful co-venture of real and virtual casinos, and even it’s facing regulatory headwinds overseas now that its key market nations have blocked bettors from playing with anyone outside of that country — a stance similar to the state-based online gambling rules in the United States. But, like Caesars, at least those physical casinos are backed by real casino revenue, and have a much better name to leverage with real-money gamblers.

As if Zynga and other game publishers weren’t facing a big enough challenge already, chew on this: Privately owned PokerStars (with its recently acquired Full Tilt Poker in tow) controls about two-thirds of the global real-money poker market. If for no other reason than PokerStars is deeply entrenched and already generating an estimated top line of at least $1 billion per year, it’s going to be tough for newcomers to make a meaningful dent in the market.

Bottom Line

These waters will remain murky as long as the regulations are being hammered out and other states mull the legalization of online gaming. But as it stands right now, there’s no publicly traded pure play worth a shot.

The best-positioned web-based betting name is Caesars Entertainment, and even if the industry expands to the projected $2.5 billion by 2015, Caesars’ potential cut still will only be a drop in the bucket compared to the company’s $8.5 billion in annual revenue.

Zynga is surprisingly uninspiring, particularly now that a new CEO will have to get up to speed.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/07/online-gambling-is-set-to-explode-whos-holding-a-hot-hand/.

©2014 InvestorPlace Media, LLC

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