Sunday, Nov. 20, 2005
How the U.S. Is Getting Beat in Online Gambling
Wildly popular, yet still illegal in the U.S., Internet gaming has earned vast sums for its creators. Meanwhile, a wave of IPOs in Britain has left American banks out of the action
Gambling lore is filled with tales of the lucky¬ novice who walks into a casino and breaks the bank. This year it really happened. The fortunate neophyte is Vikrant Bhargava, who is from Rajasthan, India, and admits that he had never set foot in a casino until recently and still isn't all that fond of gambling. But in a single day in June, he and two colleagues walked away with the poker purse of all time: more than $1 billion in cash.
What distinguishes reality from myth is that Bhargava, 32, wasn't playing poker. He is the marketing director of PartyGaming, a company based in Gibraltar that operates the world's largest online poker site, PartyPoker.com Bhargava joined the firm in 2000 when it was an Internet start-up based in the Dominican Republic that was trying to establish a niche in the then novel world of online gaming. Today PartyPoker boasts that more than a million people have played for money on its site this year, the vast majority of them Americans, who are technically circumventing the law, according to the Department of Justice (DOJ).
Flush with success--and with profit margins of 60%--the firm went public on the London Stock Exchange this summer. The June 27 IPO, which valued PartyPoker at $10 billion, was Britain's biggest this year. Bhargava shared the pot with two other reclusive co-owners: a Net pornographer named Ruth Parasol, who switched from carnality to cards in the late 1990s, and Anurag Dikshit, an Indian software whiz whom Bhargava met when both were students at the Indian Institute of Technology in Delhi. They are not three of a kind, but they did cash out about one-fifth of the company. "Poker became a monster," says Bhargava, who sold stock worth $210 million and still retains almost 9% of the firm's equity.
Gaming is going global, and to stock markets, with a force that's making fortunes for a cluster of little-known industry outsiders and giving monstrous headaches to regulators, legislators and traditional casino companies. Poker is growing most rapidly; this year an estimated $2.7 billion will be spent on Internet poker games, almost double last year's take and 10 times that of 2002. That breakneck growth can't continue--one reason PartyGaming's stock drifted below its IPO price--but other casino games like blackjack, as well as lotteries and sports betting, are finding new homes online. According to Warwick Bartlett, who runs the British firm Global Betting & Gaming Consultants, almost $12 billion will be wagered over the Internet this year, or close to 5% of the world's total gross gambling yield. Over the next five years, the consultancy estimates, the total take will soar to about $22 billion, or about 7.5% of the industry total. "You've got at least 10 years of strong growth in the sector," Bartlett predicts.
What makes the numbers more extraordinary is that online gaming is either banned or legally questionable in several of the countries where it's thriving. In the U.S., where it is hard to avoid televised poker tournaments, the DOJ is unequivocal: it deems Internet gambling illegal, period. And nearly unstoppable. The DOJ admits that it faces hurdles in bringing to heel companies not based in the U.S. But it has pressured credit-card companies to reject gaming-related transactions and "urged" Internet providers and radio stations not to air online-gambling ads. Yahoo! and Viacom's Infinity Broadcasting are just some of those that are complying rather than cross the feds.
The U.S. legal situation is "absurd," says Mark Davies, international marketing director for the firm Betfair, based in Britain. "Poker is a game played by many tens of millions of Americans. It is played by Presidents and judges. It's strange to say it's illegal just because it is online." In other places, from Hong Kong to Sweden, online wagering similarly runs up against a thicket of restrictions. In Britain, where punters regularly wager in betting shops, online gaming is now legal, which is why companies such as PartyGaming have gone public on the London Stock Exchange.
But in much of Continental Europe, online gambling is bringing unwanted competition to state-owned monopolies, which provide a hefty chunk of tax revenue to national treasuries every year. In Sweden, as much as half the nation's fixed-odds betting has moved from the state monopoly to an online firm based in Malta. The U.S. is losing about $7 billion a year by prohibiting Internet-gambling companies, says Las Vegas attorney Anthony Cabot. Says Eugene Christiansen, chief executive of Christiansen Capital Advisors, based in New Gloucester, Maine: "They have to stand by and watch British and other countries' companies eat their lunch."
That juicy meal is being shared by PartyGaming and a fast-growing number of competitors. They have names such as 888.com Betandwin.com and Empire Online, and are mainly based in exotic, low-tax jurisdictions such as Gibraltar, Malta or Canada's Kahnawakee Mohawk Indian reservation. Says Richard Segal, an experienced British casino executive who joined PartyGaming as CEO last year and sold more than $15 million worth of stock in the June IPO: "It's like bees around the honeypot."
Some gambling-industry lawyers are building up a body of international case law to bring their clients onshore. In the U.S., for example, the 5th Circuit Court of Appeals ruled in 2002 that only sports gambling is covered by the Wire Act, a 1960s law aimed mainly at mobsters that prohibits anyone in the gaming business from transmitting bets by wire communication. And in March the World Trade Organization in Geneva upheld a complaint by Antigua that U.S. restrictions on cross-border Internet gaming amounted to a breach of free-trade rules. Says lawyer Mark Mendel, who represented Antigua: "They say all Internet gaming is illegal throughout the U.S., but that simply isn't true."
Lawyers for online firms, especially those seeking to reassure potential investors before an IPO, cite such cases as critical precedents. Not all are convinced: one of Wall Street's leading law firms, Skadden, Arps, Slate, Meagher & Flom, recently warned investment-banking clients to steer clear of online-gaming companies because of concerns about their legality in the U.S. Should the DOJ decide to crack down, the gaming firms, at least, have an exit. PartyGaming's prospectus takes pains to point out that the company has no tangible assets or physical presence in the U.S. Indeed, one reason co-founder Parasol plays no official role at the firm other than shareholder and keeps a very low public profile--she refuses all interview requests--is that as a U.S. citizen, she's potentially at risk and doesn't want to harm the company, according to lawyers who know her.
This odd legal standoff in the all-important U.S. market shows little sign of ending, as neither Republican efforts to stiffen the laws nor Democratic efforts to loosen them are getting anywhere in Congress. In the face of such inertia, gaming firms are getting brazen. One British outfit, Sportingbet, runs ads on ESPN for its Sportsbook.com site and recently put up a huge billboard in New York City's Times Square featuring a pretty model and the slogan EVERYBODY BETS. PartyGaming CEO Segal says big American media groups seem less reluctant to air gaming ads than they were. "The U.S. is a clear example of prohibition not working," says Peter Collins, an expert on gaming regulation at Britain's Salford University, who advised the British government on its new gaming legislation.
The headache for regulators may be just beginning: the next big thing in the industry is gambling on mobile phones. In the past few months, PartyGaming and several other companies, including land-based British bookmakers such as Ladbrokes, have launched pilot wireless-gambling projects; in PartyGaming's offering, mobile-phone users can download the software free by sending a text message and then play roulette or slot machines for fun or money.
For PartyGaming's Bhargava, the world could hardly look more different from six years ago, when he took a blind leap and joined the company. After his studies in Delhi in the early 1990s, and business school, he worked at Bank of America and British Gas before heading to Mexico for a change of scenery. On a whim, he e-mailed his former college friend Dikshit, who, it turned out, had just set up a software company and was trying to develop a gaming start-up for Parasol, a lawyer by training. Parasol's history has filled the pages of British tabloid newspapers this year largely because of her involvement in online pornography and her investment in a company that made adult videos--activities that, ironically, have fewer legal encumbrances than gambling. But by the time she joined up with Dikshit and Bhargava, she had severed those ties. "She's not a porn queen. She's an entrepreneur," Bhargava told TIME.
The trio's timing was propitious. Internet poker was already available in the late 1990s, but the technology was clunky and the game less popular than sports betting and lotteries. Dikshit created a version that enabled multiple players to participate, and PartyGaming quickly went after the market leader at the time, Paradise Poker. "We weren't ready for the launch when we did launch" in August 2000, Bhargava recalls, shuddering at the site's initial reliability problems. The breakthrough came a year later, when the company hired a well-known poker player, Mike Sexton. He came up with a gimmick that got gamblers' attention: a $1 million first-place prize for an all-comers tournament.
When poker took off in the U.S. after the Travel Channel began televising tournaments in 2003, PartyPoker was holding aces in the hole. The contests, with peephole cameras under the table capturing the action and graphics showing each player's odds of winning, proved a smash hit for the cable channel. PartyGaming paid a bargain $7,000 per 20-sec. spot to advertise on the show. "We saw our market share go up from 20% to 50% in a fairly short period," Bhargava says. PartyGaming spent a whopping $52 million in the first half of this year to entice paying customers to the site--more than triple the amount it spent a year ago and up from just $10.6 million for all of 2003.
That hefty increase in acquisition costs is a plus, though, because it amounts to a formidable obstacle for new competitors. PartyPoker can afford the ante. In the first nine months of this year, the average daily "rake"--its cut of the amount bet--rose a third, to more than $2 million. Despite a summer stock swoon, market players are still betting that online poker isn't a short-term fad. One thing hasn't changed: you won't find Bhargava in a casino, online or real, anytime soon. "I can see myself playing poker off-line, but I can't find low-limit games," complains the centimillionaire. "Online is very different: that's entertainment." Besides, he's already won that game.
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