May 30, 2007

CryptoLogic: Undervalued?

From the Fool:

Cryptologic is a provider of software and services for the online gaming (read: gambling) market. See the problem yet?

In its year-end filing, the company gives a three-year history that starts off by saying, "The global online gaming industry including the United States grew from $5.7 billion in 2003 to $10.7 billion in revenue in 2005." It then quickly continues on to the juicy part, where the U.S. government issues the Unlawful Internet Gambling Enforcement Act (UIGEA), which pretty much says that online gambling in the U.S. is illegal.

The UIGEA was approved in September 2006, and now, eight months later, Cryptologic is still very much alive and kicking -- though maybe not quite to investors' satisfaction. As of the most recent quarter, the company's revenue was down 27% year over year, and though it stayed profitable, it did so at a much lower margin. Possibly more concerning is the fact that the company, which historically has produced a lot of cash, burned through $11.1 million in operations for the quarter.

The issues facing the company make me think of something Berkshire Hathaway head honcho Warren Buffett said earlier this month at the Berkshire annual meeting. When asked for his take on whether gambling would continue to be a good business, Buffett replied that as long as it stays legal, it will continue to be a very good business. He also added that as it becomes easier for people to gamble, there will likely be even more gambling going on.

So the question might be: Is anybody making it easier for people to gamble than Internet gaming companies?

Not having full legal access to the gambling-hungry U.S. population is a huge concession, but Americans aren't by any stretch the only group that enjoys gaming. Even before the UIGEA legislation, the majority of Cryptologic's revenue came from non-U.S. sources. While CAPS players are not all fans of gambling, many of them do see opportunity to pick up undervalued shares of Cryptologic.

CAPS All-Star bmw201030 said, "Since recent US legislation, the stock has been a drag. Mr. Market is once again over reacting. Most of this company's revenues come from overseas not from the US. While the impact is small the stock price drop was too much."

Crazykling, another CAPS All-Star, adds: "I like the short term prospects for a more appropriate price, I like the long term growth potential for online gambling, I like the non-US dollar revenue to hedge inevitable decline of [the dollar], I like the fact it's Toronto/Irish based and has government contracts which builds trust worthiness." Crazykling also cites the stock's relatively low P/E ratio, its relationship with Playboy, and the fact that Mohnish Pabrai holds a 12%-plus slug of the stock as reasons to give this beat-up stock a second look.

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