CryptoLogic Reshaping Poker Business

21 October 2008

While CryptoLogic Ltd.'s online poker network has lost further momentum with the departure of William Hill and, less significantly, World Poker Tour Enterprises Inc., the Dublin software developer, in response, plans to rally 'round its core casino products and anticipates a collaborative deal on poker that would significantly reduce costs.

Atop the online poker world as recently as 2005, CryptoLogic's poker network -- in line with the majority network operators that left the United States in October 2006 -- has struggled in what PartyGaming Chief Executive James A. Ryan recently termed a hypercompetitive European market. To paint a picture, between the third quarter of 2006, when poker revenue totaled $8.3 million, and the first quarter of 2008, when revenue totaled $4.2 million, CryptoLogic's poker business dropped a precipitous 49.4 percent.

Yesterday's deal between William Hill and Playtech Ltd. to form a complex, jointly owned entity called William Hill Online answered months' worth of speculation on whether Hills would indeed leave Crypto's network. The move, though, did not prove as disastrous as the market anticipated -- in fact, Crypto's shares closed up 11.63 percent in London today.

"Certainly we would've preferred to have kept William Hill as customer than not, but in terms of their contribution to our revenue and earnings, I think that they're assumed to be significantly more important to us than they truly are," Justin Thouin, CryptoLogic's vice president of product management and business development, told IGamingNews by telephone.

"I don't think that people recognize the significance that our other customers -- specifically, our Inter group of customers -- represent from a revenue standpoint for CryptoLogic," he continued. "They are far, far in excess of the contribution that William Hill makes to CryptoLogic."

Although Crypto has neither publicly disclosed revenue contribution from William Hill nor its Inter group of customers (which includes Intercasino and Interpoker), according to financial sources, Hills was thought to contribute between 20 percent and 30 percent, with the Inter group at approximately 50 percent. World Poker Tour Enterprises, which terminated its licensing agreement with CryptoLogic last Friday, was thought to contribute a less substantial 0.5 percent.

The CryptoLogic poker network is, arguably, at a serious crossroads with just nine licensees -- assuming the loss of William Hill and World Poker Tour Enterprises.

Rather than buy liquidity, Mr. Thouin said, Crypto is in talks with a company he did not identify to do a liquidity-sharing deal. Public discussion of liquidity-sharing deals has taken on more pronounced shades of urgency and frustration this fiscal year as many of the industry's leading names are reporting flat or marginal growth in poker, quarter over quarter. Most first-half analyst calls and executive interviews with IGN, moreover, featured concern -- thinly veiled -- on the disparity between the likes of PokerStars, which benefits from United States-Europe synergies, and the rest of the field, which don't.

Crypto's liquidity-sharing deal, should it be consummated, stands to knock between $12 million and $15 million in costs off of the company's P&L. And despite the possibility of a less hearty poker revenue stream, there is of course upside to the reduction in costs: the bottom line.

"From a bottom-line perspective, we're going to be much better off than we were," Mr. Thouin said. "It's important to understand that with the revenue that comes from William Hill, there're also costs -- there are costs to support them and there are also opportunity costs in terms of time that we spent on William Hill, from a poker perspective, that now can be spent on new casino customers or on giving current customers like Intercasino more product updates."

With regard to new customers, news on the company's growing casino client stable has been upbeat. Following recent deals with Kurastica, a curious spin-off of an undisclosed company with ties to gaming businesses across several former Soviet republics, as well as blue-chip companies like 888 Holdings, PartyGaming yesterday agreed to license six of Crypto's casino games with the possibility for more.

As the company's poker business stands to be reshaped, so too does its casino and gaming content distribution philosophy, Mr. Thouin said.

"In the past, what you've seen -- if you want to analogize it to a restaurant -- we used to offer a fixed-price menu," said Mr. Thouin, who prior to joining CryptoLogic was in consumer marketing with Maple Leaf Foods Inc., the Toronto food-processing giant. "So, you'd only be able to take our full casino, and if you didn't take our full casino, you couldn't have anything else. What we're doing now is looking to distribute our content to as many of the top operators in the world as possible, so it's almost an a la carte menu."

As Crypto turns toward its casino and games business, the issue of M&A looms. The company has zero debt, a depressed share price and cash of around $60 million, rendering it compelling from the standpoint of both predator and prey. Mr. Thouin declined to speculate on future deals but said an announcement on the liquidity-sharing deal is expected in "a month or so." Analysts have told IGN this week that 888 Holdings (Pacific Poker Network) and Boss Media A.B. (International Poker Network) are likely candidates.

What the Analysts Say

On CryptoLogic, to me, there would have been far more M&A already if there was no credit crisis or Justice Department settlements to worry about.

Simon J. Holliday | H2 Gambling Capital

Given the previous loss of Littlewoods (4% of rev) and the decline in the company's stock price we believe investors were largely betting that the company would eventually lose William Hill as well. We note that William Hill likely represented 15%-20% of total revenue or $10-$14 million. Based on the Littlewoods and WH losses we believe mgt's strategy is a step in the right direction. While the timing is uncertain, we believe the company can transition from casino and poker provider to a profitable casino operator/games provider.

Although we like the shift in strategy, there are still many unknowns at this point. First, it's unclear how quickly William Hill revenue will ramp down in CY09 as the company migrates over to Playtech. Secondly, the migration of poker clients to another network and the associated cost savings also depends on the company signing an official agreement. If CryptoLogic were to sign a deal prior to the end of the year, we believe a full migration could be completed by 2Q09.

Todd Eilers and Adam Krejcik | Roth Capital Partners

Chris Krafcik is the editor of IGamingNews. He lives in St. Louis, Mo.