Description

If you liked Neteller (NLR, posted by skca74 on 7/13), and you’re looking for an undiscovered way to play the online poker phenomenon, you should be looking at Empire Online.

EOL has revenue growth of 100% and a forward multiple of about 7x. Compare that to a Party Gaming forward multiple of about 17x and a Neteller forward multiple of 10-12x (from skca74’s writeup). EOL IPO’d on June 15th and trades on the AIM market in London. It is incorporated in the BVI with operations in Cyprus.

All numbers here are in dollars (including market cap above). 191p (EOL's Friday's close in London) is a stock price of $3.34.

Historical Numbers

FY02 FY03 FY04 Q105 Q205
Revenue 21.4 25.7 65.2 24.4 25.3
COGS -8.4 -10.7 -26.2 -11.9
GM 13.0 15.0 39.0 12.5
GM% 61% 58% 60% 51%

Other 0.2 0.0 – –
SGA -1.5 -1.3 -1.8 -0.6

OpInc 11.7 13.8 37.2 11.9
Op% 54% 54% 57% 49%
Int Inc 0.1 0.0 0.5 0.5

EBT 11.7 13.8 37.7 12.4
Tax 0.0 0.0 0.0 0.0

Net Prf 11.7 13.8 37.7 12.4 13.0
Divid 19.7 5.0

Rev
Poker 0.0 4.9 43.4 18.8 20.3
Casino 21.4 20.7 21.8 5.7 5.0

Mkt Cap: $980M
EV: $930M
Shares: 292.8M

Business

2/3’s of EOL’s business is from online poker, chiefly as a marketing company, driving traffic to empirepoker.com and other websites through online and offline advertising and player recruitment techniques. EOL acts basically as a shell for Party Gaming’s partypoker.com, driving traffic to the empirepoker.com website, allowing visitors to download Party’s operating software and then connect to their gaming servers. Although the software is Party’s, the EOL visitors have an Empire Poker branded interface and experience, even though they may be in a pool with users who are seeing the Party Poker interface. The rest of EOL’s business is from a similar marketing business for online casinos, mainly driving traffic to the servers of Cassava Enterpises, the operator of 888.com through sites such as www.entercasino.com.

EOL does not own or operate any online casinos. For the poker business, they get a percentage of the “rake” for each hand that Party Poker gets from EOL’s traffic. This is usually 3% of the pot, capped at $3. These are very competitive rates with compared to bricks and mortar casinos. On the casino side, EOL gets a percentage of the operator’s profits from EOL’s traffic.

Growth

70% of EOL players are in the U.S. vs closer to 80% for Party Gaming and the rest of the industry. EOL is aggressively winning European growth through innovative marketing including poker event and local bricks and mortar advertising in Europe, Google search engine results targeting, and referral bonuses. The bulk of EOL’s growth is still in the U.S., through targeted online advertising and informational/practice poker sites (at empirepoker.com and other sites) that direct traffic to EOL’s partners.

New Empire poker players per month has been growing at slower rates above the 13k level through the spring. This is triple the new addition rates from a year ago and the primary driver for earnings.

Q2 is a seasonally slow period for online poker growth rates—slowing in growth rates and margins are experienced at Party Poker and other sites as users spend less time indoors.

EOL’s margins and growth rates were affected by Q2 seasonality, but also by management’s decision to rush EOL to a public offering—EOL is under 100 employees and since the offering has occurred, they can get back to focusing on growth.

Even though Q2 growth was slower, EOL still grew active players 4% sequentially from Q1 to 126.5k players. This is up from 50k players a year ago. EOL should be able to get back to 20% sequential growth in Q3 and Q4.

Target Model

EOL has been almost tripling its customers annually. It should be able to double its revenue from here to the $50M level a year from now given the high growth rates in the industry, EOL’s smaller base and growing “rake” from existing players. This would give a run rate of approximately $200M in revenue and $100M in net income from Q2 of next year and imply well over $100M in net income for 2006. This is assuming current depressed margins of 50% and aggressive customer acquisition spending. A reasonable net income estimate of $130M gets you to a 7x forward P/E.

Cash flow has closely followed net income, and management has already indicated that it targets $30M in dividends to be paid in 2005 and that it will continue to return excess cash flow.

Possible Acquisition

The main reason for the IPO was to get a public multiple for the company and increase visibility. EOL would be a good fit for Party Gaming and would allow them to further consolidate the market. Party Gaming is generating plenty of cash and has an appreciating currency after its recent IPO.


Party Gaming / Cassava Risk

EOL’s current revenue is from Party Gaming (WPC Productions) for poker and Cassava for the casino business. The contracts with each company could be terminated on short notice. However, there are approximately 200 online poker operators and several casino operators EOL could choose for future business. You can see some of these sites listed at pokerpulse.com. Party Poker does have half of the market, but EOL’s number of recently active players (126.5k) is significant in comparison to Party’s recently active players (about 400k). EOL’s average real money players per day (17.5k in Q2 vs 16.6k in Q1) is large enough to offer enough liquidity as a stand-alone pool and larger than the average bricks and mortar casino. The software and servers can be purchased—the real value of this business is in the customer traffic. Customer acquisition costs are currently around $220 and are headed higher. Lately, EOL’s “rake” in $ terms has been growing faster than its number of new players—this probably indicates longer playing times, but also shows that there is no margin pressure from Party Gaming.

Legal Risk

In the U.S., gambling is technically illegal under federal law. This is where 75% of the online players come from. Congress has considered cracking down on payment methods for online gambling for years, but it has yet to pass any legislation. It is starting to be generally accepted that laws against online gambling would be unenforceable, but the U.S. position remains a risk and one of the reasons that these stocks are at low multiples relative to their growth. EOL is in Cyprus, and the U.S. government has not yet successfully prosecuted any foreign company that enables online gambling.

Catalyst

Analysts picking up coverage, World Poker Tour exposure, possible acquisition offer from Party Gaming