Article on US investors reaping the rewards of Internet gaming.

The New York Times
December 25, 2005
Wall St. Bets on Gambling on the Web
By Matt Richtel

Internet casinos are outlaw operations in the eyes of the federal government, but they look like solid investments to many of Wall Street's largest firms.

Blue-chip investment houses like Goldman Sachs, Merrill Lynch and Fidelity now hold hundreds of millions of dollars in shares of online casinos and betting parlors, which are publicly traded on the London Stock Exchange and headquartered in places like Costa Rica or Gibraltar.

The growing participation by American investors underscores a striking gap between the federal law-enforcement position on online gambling and the realities behind what has emerged as a booming business.

It also highlights the difficulty of policing cross-border activity in the Internet age at the same time that electronic commerce and a global economy are creating fast economic partners across national boundaries.

Legal experts are divided over whether American investors and the investment houses that operate mutual funds could themselves be seen as criminally liable for their actions by providing financial backing for offshore casinos. To be sure, it is not uncommon for Americans to invest in overseas companies whose operations may be considered illegal or unacceptable here, from sweatshop manufacturers to European energy producers that do business in Iran.

The difference with Internet gambling is that the activity takes place on domestic shores - with Americans placing bets online using their home computers - and the Justice Department has stated clearly that the operators are violating American law.

Jaclyn Lesch, a spokeswoman for the Justice Department, said that the agency considered online gambling illegal but declined to "comment on the liability or hypothetical liability of a company or an individual."

But Internet gambling analysts and company executives said that the investments highlight how widely the federal policy is, in essence, being ignored.

Millions of Americans use the Internet to play games like poker, blackjack and roulette, or to place wagers on sporting events. Online casinos advertise in magazines and on cable television while filling big billboards in Times Square and other places where crowds congregate. Celebrities like Jesse Ventura, the former governor of Minnesota, hawk their wares.

Representative Bob Goodlatte, Republican of Virginia, an opponent of gambling, said that the federal government had essentially given up enforcing laws against offshore casinos. He noted, for example, that casino operators now travel freely within the United States, gathering at trade conventions even though, he said, prosecutors would be within their rights to arrest and bring charges against them.

He said that the involvement of investment firms could be part of a pattern of laws being flouted.

"It's very bad, and the Congress ought to investigate it," Mr. Goodlatte said, adding that it may turn out that the investment houses are knowingly supporting and promoting illegal enterprises.

For their part, the investment houses have taken the position that they indeed know there are legal risks involved in investing in offshore casinos, but that the risks are outweighed by the benefits of owning shares in growing, highly profitable businesses. Those shares can give a lift to mutual funds and other types of investments sold by the investment houses, meaning bigger returns for clients.

"Our analysis shows the gain from these stocks outweighs the very small risk" of owning them, said a spokesman for one major investment house. The spokesman would not agree to be identified by name or to have his firm identified, citing regulatory policy that could restrict the company's ability to buy and sell individual securities if he commented upon them.

The ownership rolls of offshore casinos read like a Who's Who of America's top investment firms. For example, public filings show that tens of millions of shares of SportingBet, a company listed on the London Stock Exchange that allows people to place bets on sporting events, are owned by Fidelity, Merrill Lynch and Goldman Sachs.

Fidelity Management holds shares worth about $363 million, or 14.1 percent of the outstanding shares. Those shares are largely held in mutual funds. Merrill Lynch Asset Management has $164 million in holdings, and Goldman Sachs Group Inc. has $137 million.

Similarly, Goldman Sachs and Morgan Stanley Securities hold big positions in BetOnSports, another publicly traded firm in London that facilitates sports betting, according to public filings. Morgan Stanley has one of the biggest stakes - worth around $25.6 million - but the company said that the position is held on behalf of one large investor, whose identity it withheld.

It is hard to discern how many of the shares are owned by mutual funds available to American investors. Many of the funds, including some that exclude American investors, are operated out of London.

For instance, Goldman Sachs's International Growth Opportunities Fund, which is open to American investors, owns around 175,000 shares of SportingBet, worth around $960,000, according to a recent public filing by the company.

Goldman Sachs also wrote in a report on Nov. 30 that over the next three months it "expects to receive or intends to seek compensation" for investment banking services provided to SportingBet and PartyGaming, two companies that operate gambling sites.

Goldman Sachs, Merrill Lynch and Fidelity all declined to comment.

George Hudson, a spokesman for SportingBet, said that there had been growing interest from the investment houses, and not just their European arms.

"It's not just London, it's New York," Mr. Hudson said, noting that the interest represents a change from two years ago when "the big banks wouldn't touch the industry with a barge pole."

According to Mr. Hudson and several other industry executives and analysts, a watershed event took place on June 30 when PartyGaming began trading on the London Stock Exchange. It was not the first Internet casino to go public in Britain, but it drew a great deal of attention because of the popularity of the company's sites. The ensuing demand for its shares put it among the exchange's top 100 companies in its market capitalization, currently around $9.6 billion.

At the time, I. Nelson Rose, a professor at Whittier Law School in Costa Mesa, Calif., who has written extensively on gambling law, was flown to London to advise a number of large investment houses - both American and European - on the risks involved in owning shares. Mr. Rose declined to specify the companies for which he consulted, but said that he had told them there was at least some risk of owning shares in the casinos.

Today, Mr. Rose said he believed there was only a 10 percent chance that the federal government would take action against the investment houses under the Wire Act, which covers online gambling, or federal statutes that permit the government to charge the partners of illegal operations with aiding and abetting their activities. But he said that if prosecutors did so, they could make a decent case.

The companies are shareowners "in an illegal enterprise," Mr. Rose said. "Therefore they are liable." Potential penalties could range from small fines to prison terms.

But Lawrence G. Walters, a Florida lawyer who specializes in investment law and who has consulted for some prospective American investors, said that the government would have difficulty finding a theory of liability given that the investors do not control the offshore casinos or direct their activities. They are "passive investors," Mr. Walters said.

"Nobody takes them seriously when they say this is a serious crime," he said of the government and anti-gambling laws. "But there is stuff still on the books, and somebody could go down heavily if government decides to turn its attention to them."

The bottom line, according to casino industry executives and some financial analysts, is that the opportunity for profit may be too good for the investment houses to pass up. Over all, Internet gambling is projected to reach almost $12 billion in business this year, up from $8.3 billion in 2004, according to Sebastian Sinclair, a gambling industry analyst with Christiansen Capital Advisors.

Individual companies are enjoying strong growth and big profit margins. Morgan Stanley on Dec. 1 published an analysis of SportingBet that noted that the company had acquired 700,000 new customers in a recent quarter, almost equal to the number of people it signed up all of last year. The Morgan Stanley report said that the company was taking in $530,000 a day just from its poker business.

"There is no other leisure business in the world with the same potential for growth and shareholder returns as online gaming," said David Carruthers, the chief executive of BetOnSports, noting that the major casinos each project 20 percent annual sales growth. "We're in our embryonic stages."

Mr. Carruthers said that the investments from American financial institutions have provided the stability and legitimacy needed to helped the casinos grow. "It says we're running a business legitimately and responsibly," he said, "and we're seen as a worldwide leisure product - similar to KFC, Ford, Coca-Cola, I.B.M. or any other global brand."
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NYTimes.com Link: Wall St. Bets on Gambling on the Web.

P2P Games releases the design for their advertisement in the upcoming iGaming Business Magazine (January 2006), which will be distributed to over 8,000 iGaming industry recipients all over the world:

For P2P Games licensing information, please email P2P Games.---
To get your free iGaming Business subscription, go to: www.iGamingBusiness.com/freemagazines.php

P2P Games President, Jesse Lindsley, delivers a mini-case study to be published in the January 2006 edition of iGaming Business Magazine as part of a highly publicized Skill Gaming Supplement for the gaming and gambling industry. Over 8,000 copies will be printed and distributed to a subscription base of over 6,000 and approximately 2,000 more to attendees of two very large gaming industry events.

iGaming Business :: Skill Gaming MINICASE :: January ‘06
How do you build a pioneering skill gaming platform from the ground up?

In early 2004, there was no place online to play the games we played with friends and family - like backgammon, dominoes, cribbage, hearts, etc. - for money. Sure there were huge game portals where thousands of players could play, but the entertainment choices were one-dimensional: you could compete only for prestige. To us, it is more entertaining to play for money, whether that was for a quarter or a dollar a game. Online poker rooms had taken poker to a whole new level and were showing the way for people to play in head-to-head and tournament competitions for money. This approach was driving the entertainment experience - and thus the popularity - of the game.

So our vision was clear: to create a unique and entertaining player experience on the web by building a truly innovative online gaming platform for player-to-player skill games.

Now having a cool and original idea (and an experienced management team that is willing to work for sweat equity) is one thing, but execution means making good decisions and having a lot of things go your way.

Here is an overview of some of the key decisions we confronted in our early stages.

Build vs. Buy Software: Building it would take longer, but what we truly wanted didn’t exist. Fortunately, we had the technical and business acumen to build it at a fraction of the cost to buy.

Download vs. No Download Technology: Although downloadable clients are the industry standard, we felt the future of Internet gaming would be a no-download, browser-based experience. [We would end up building a platform that supported both solutions.]

In-House vs. Outsource Development: Overseas development would be cheaper, but we decided to mentor and grow our own talent. This would provide the nimbleness we would need to support our product suite. [We would end up with a small team, two deep in every skill set. As we expanded, we would utilize outsourced international labor.]

White-Label vs. Controlled Branding: Our long-term goal was to white-label our platform to strong, established brands to increase the overall player liquidity in our network. However, as a start-up, we needed a destination where we could have creative control and where the player community could help drive our requirements. [We would find a strategic partner that shared our vision and would become our first fully branded operator.]

License vs. Royalty Revenue Model: As a start-up, we were okay with either model, as long as both parties treated the other like a partner and had parameters that made the arrangement a win-win proposition. [To this day we have seen more revenue sharing than just pure licensing deals.]

Private vs. Institutional Financing: Operational decisions had been made, we had put in our own money to build a prototype, and we had a detailed business plan, so now we needed to raise the capital required to build the platform. After testing the institutional waters and finding too many “gaming climate” challenges in the US, we decided to raise the money through private investors.

One year after having implemented these key decisions, and completed our seed round of financing, we had built the P2P Games player-to-player gaming platform (See Technical Product Overview) and released several classic skill games including backgammon, dominoes, cribbage and gin. We had launched our first branded operator, Club Games, and in July of 2005 Club Games Backgammon began generating revenues.

Today, P2P Games is actively working with online operators to provide a platform to power their own branded skill gaming releases. We plan to be supporting three large operators by the end of 2006. On the investment front, we continue to look for and are evaluating both private and trade investors who believe in our team, and what we have accomplished to date. It is our expectation that with these operators and investors as strategic partners, we will ultimately be able to achieve our vision.

P2P Games Technical Product Overview

P2P Games has constructed a world-class multi-threaded Game Engine capable of handling tens of thousands of concurrent players. The extremely scaleable solution can be deployed across multiple servers, while the player perceives a single community. As demand grows, hardware may be added without a software re-configuration or interruption of service.

This complex system also offers secure, synchronous communication between Macromedia Flash and a Java Application Server. Using Flash, rich client interfaces, and animations offer an experience beyond the normal web presentation. Games come alive with movement and sound, offering lightweight yet powerful code delivered to all major browsers. Any game player, whether they use a Windows, Apple, or LINUX based system, can play on the network without installing software.

About the Author:

Jesse Lindsley, the President & Co-Founder of P2P Games, is responsible for all company operations including strategy, marketing, finance, customer service and sales. He has an accomplished consulting and management career in information technology and has worked with several e-commerce start-ups. Click here to email Jesse.
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To get your free iGaming Business subscription, go to: www.iGamingBusiness.com/freemagazines.php