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Investing in Online Gambling

Online poker rooms exploded onto the scene around the same time that poker became the red-hot hobby of people around the world. And now that the profit potential of the Internet has been established, more real businesses are popping up in this arena. One such company trying to combine the popularity of both the Internet and gambling is Party Gaming, listed on the London exchange.

Online card rooms now routinely have thousands of players logged on 24 hours a day. Much of this has been due to the success of the Travel Channel's World Poker Tour, owned by both World Poker Tour Enterprises (Nasdaq: WPTE  ) and Lakes Entertainment (Nasdaq: LACOE  ) .

Party Gaming is extremely profitable. Profits in 2004 were $391 million on over $600 million in revenue. For the first quarter of 2005, profit was an astonishing $128 million on $222 million in revenue, for a net margin of 58%.

The company went public on June 27, at an initial price of 116 British pence, or $2.04, giving it a market cap of $8.5 billion. Today it sits at 149 British pence, or $2.62. Is the business worth that much? At the current run rate of $500 million in profit on $888 million in revenue, you're looking at a company with earnings growing at about 26% and revenue growth of 46%. Slap a 26 P/E on that half-billion in profits and that's a $10 billion market cap. I'd say you're looking at a fairly priced company -- in an industry that's showing tremendous growth and popularity. More online poker sites are lining up for their IPOs.

There are two possible downsides here. One is that poker will turn out to be a fad. I'm becoming less convinced of that. If it does, we'll see it when entries into the major tournaments flatten out or decline.

The other concern is that it's illegal for online casinos to take bets from U.S. customers. In theory, if the company's founders set foot on U.S. soil, they can be arrested, fined, and/or imprisoned. However, its prospectus notes, "PartyGaming and its directors rely on the apparent unwillingness or inability of regulators generally to bring actions against businesses with no physical presence in the country concerned." Given that the company's directors are now worth billions each and the company is based in Gibraltar, I don't expect them to be returning to the U.S. anytime soon.

Investors who are not dissuaded by these downsides and want to take advantage of Party Gaming will need to check with their brokers about buying stocks on the London exchanges.

For more poker stories, check out:

Fool contributor Lawrence Meyers does not own stock in any companies mentioned, but does play poker both online and live.

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