Only the Strong Survive

Hum4n produced a brief analysis 3 months ago noting the strengthening position of the leading companies and the deterioration in performance of the followers who were experiencing faster churn and lower returns per active player day - in other words 'profits were eroding'. We are now beyond the World Cup which was cited as the cause of 'difficult operating conditions' and the summer seasonal low.

Figures used in this article are from published company data and PokerScout. French and Italian national site data is reported on separately. The analysis is limited to the top 20 companies/networks since these account for nearly all the volume. Market Share moves since our last report in June show the two leaders have gained nearly 7% of share up from 61 to 68%. Together they gained 7,200 players whilst the rest lost 2,555 - the best performer amongst the rest gained 160 players.

The Big Get Bigger

'So what?' you may be thinking. Extensive research shows that the market leader is significantly more profitable than the number two and from 3 down making a profit becomes increasingly a struggle. The lower the level of product differentiation the stronger this effect leading to the maxim 'get niche or get out!' The very significant moves in poker market share and volume are increasing the pressure on those with below 10% market share. Their profit per active player continues its inexorable slide in spite of large increases in marketing spend.

In the case of the third placed operator, PartyGaming, which arguably has the strongest brand (amongst the followers), bonuses are up from 20 to 25% of gross revenues, customer bad debts up from 6 to 10% reflecting a lower quality of customer may be being accepted, acquisition/retention costs as a percentage of revenue are up from 15 to 21% yet attrition rates reported are the highest ever.

It is these sorts of pressures that have led to the PartyGaming $1.76bn reverse takeover of bwin. Party's first half EBITDA from poker slid from €18.0m to €8.6m - a 52% slump compared to last year.

888 Numbers Fall

At 888 first half of 2010 poker TOI (total operating income) compared to the same period last year was down 25% with sales and marketing up from up from 30 to 36% of TOI. As is commented in their latest interim report "some companies will not make it" adding "that the world was moving quicker than expected". We think they are right on both counts. A lot of hope is being pinned on new regulated markets.

However, the lower levels of potential volume available in a hermetically sealed national market (allegedly in contravention of European law) liquidity becomes even more of a problem which will squeeze out smaller operators. We believe the market leaders are significantly more profitable and therefore have far more financial clout. If they choose to enter these markets then it will be hard to resist them. PokerStars already leads in Italy and France. There has been heavy advertising in France recently.

Whether it increases the size of the market or just affects how it is shared is yet to be seen. In any event we would predict an early reduction in the number of sites. Player feedback is already reporting empty rooms - 'Sit and NoGo' one might say.

Warning Signs

Meanwhile software platform providers have been largely insulated from these problems since their revenues are not directly affected by increases in their licensee's costs. They also continued to sell new licenses and additional services into the user base which continued to grow - 17 new poker sites within the top 20 since June, plus of course other games.

Playtech saw EBITDA for the first half rise to €52.2m (€45.3m) on revenues of €87.9m (€66.9m). They are, however, vulnerable in that about 40% of their revenues come from their top two licensees (67% from the top 5) - and they do not own the end customer, the eventual source of revenue.

Furthermore, few of their licensees have the financial resources of the top three. If trends in other industries are repeated then expect to see some of the software providers' large licensees, the large independent operators, being bought by the likes of Partybwin, William Hill and Ladbrokes. The other cloud on the horizon for the platform providers is the essential need for brand differentiation as the market matures and consolidates.

This will increasingly dictate that market leaders will want the exclusivity (meaning ownership) for their software platform. bwin Italy licensed DragonFish's Casino offering in March but was followed in August by Microgame S.p.A. Limited differentiation potential here. Strong branding requires a unique proprietary product.

Predictions

1. PokerStars will increasingly dominate the online poker market.

2. There will start to be reduction in the number of online poker sites.

3. The PartyGaming acquisition is the start of a round of vertical and horizontal consolidation over the next two years.

a. The PartyGaming acquisition of bwin will report improvements from cost cutting by reducing the number of platforms etc but will not be easy. Yield per active player will probably not improve.

b. Platform rationalization could lead to the acquisition of a leading platform provider and the progressive absorption of their clients.

c. PartyGaming will start acquiring the larger clients of the platform providers.

4. 888 will become increasingly vulnerable to acquisition lacking critical mass.

5. Current operators will increasingly focus on alternative games where more differentiation is possible. If they succeed they can expect to be acquired by a stronger brand.

6. More attention will be focused on other differentiators such as Customer Service and Content.