The stakes are high

The autumn period following PartyGaming’s float earlier this year was always going to prove challenging for those online gaming companies subsequently wanting to list. A number of recent articles have focused on the ‘transient’ nature of the online gambling boom and its dubious legality in the US. PartyGaming’s interim forecasts obviously did not assist in creating a favourable market view.

Unlike the dotcom boom, gaming companies are real and sophisticated businesses rather than off-the-wall ‘ideas’ intended to exploit the internet. They are businesses that have largely sought self-regulation and their increased corporatisation through listings and deals supported by banks and equity houses is a reflection of their desire not only to prove the legitimacy of their businesses, but their value as well.

However, there continues to be a concern about the position in the US. More than 40 per cent of all online gambling originates from US players, who also make up more than 75 per cent of the online poker market. The US Justice Department has made a number of public pronouncements about what it considers to be the illegality of online gambling and there were a number of alleged threats reported in the press to arrest PartyGaming’s owners should they travel to the US. However, this rhetoric is difficult to reconcile with the facts.

First, there have been a number of court decisions which make it clear that existing federal legislation (in particular the Wire Act) does not preclude online gaming, such as casino and poker games, as distinct from sports betting.

Second, there have been a number of efforts made by various senators in the last 10 years to pass legislation to ban all forms of online gambling or the funding of online games, which of course begs the obvious question: if existing legislation makes it illegal, why is new legislation needed?
Third, the existing federal legislation does not make it illegal for the customer to participate, so short of creating prohibition, the US would not be able to create legislation which has an extra territorial effect without the cooperation of the countries in which the operator is located. Not only that, any attempt to create a ban on a popular activity is politically suicidal.

The US view is also in sharp contrast to the attitude taken by the UK, as reflected in its passing of the Gambling Act 2005. The UK is proposing to license online gambling. Its view is that the transaction in terms of the wager takes place where the operator is located, and not the jurisdiction from where the customer communicates with the operator – thus it does not intend to preclude its licensed operators from taking bets from any specific jurisdiction, including that of the US. The UK’s lead in this regard has led to two of the main online licensing gambling entities revisiting their policies relating to licensees taking US bets in recent months (the Isle of Man and Alderney).

Despite this, the US approach remains an important aspect in the valuation and the ‘investability’ of the industry. On 15 September, US senator Jon Kyl made another attempt in the senate to stop online gambling, albeit through the indirect means of banning the payment processing which supports online gambling. His attempts to tag it onto another bill failed, but the fact that he has been attempting to pass similar bills for a decade displays the passion with which many US politicians condemn online gambling.

At the core of all of this, one needs to ask whether online gaming is an activity from which the greater public ought be saved. Are these really ‘sin stocks’? We are aware that the majority of the big industry operators make efforts to ensure play by minors is blocked and that adults have access to problem gambling counselling when needed. The difficulty that jurisdictions such as the US have is that, where domestic gambling is permitted, their views smack of financial rather than moral protectionism.

This was highlighted in the case brought by Antigua and Barbuda against the US, on the basis that the US was breaching its World Trade Organisation (WTO) obligations. The case (on appeal) found against the US and held that the discriminatory nature of some US laws could not be reconciled with the US’s WTO obligations under the General Agreement on Trade in Services, which broadly permits WTO members the freedom to trade with one another. The same issues have arisen in Europe, where countries such as Germany, Italy and the Netherlands have all made attempts to block gambling supplies from other EU states to citizens in each of those jurisdictions. Where each of those countries permit the supply of domestic gambling, objecting to the free movement of goods and services (and hence online gaming supplies) from another jurisdiction becomes difficult.

‘Offshore’ does not equate with ‘lawless’, and once countries such as the UK are granting online gambling licences perhaps a more informed view will prevail. Those companies which 10 years ago thought that online gambling only required a server and indifferent content have long since disappeared. In other words, we have already seen a weeding out of those that cannot survive in stiff, competitive waters, irrespective of external market views.

In short, from what we have seen, the claim of hype is misplaced; those that are dismissive of the gaming stocks have not taken the time to understand the sophistication of the offering. They generate the cash they currently do because of customer experience and satisfaction irrespective of media or analyst sound bites. If the market loses interest the industry may consolidate further, but it will not disappear.

Hilary Stewart-Jones is a partner ar Berwin Leighton Paisner

with many politicians zealously opposed. But does it matter? Hilary Stewart-Jones reports on an industry in the balance