All right, let's get directly down to brass tacks. Today, Motley Fool Hidden Gems selection CryptoLogic (NASDAQ:CRYP) announced that a customer, Betfair, is thinking about ending its outsourcing and taking its online poker offering in-house.
As a CryptoLogic shareholder, I do not view this as your run-of-the-mill trivial press release. Should Betfair make this move, it will be a setback for CryptoLogic. But let's take a closer look. Poker makes up approximately 25% of CryptoLogic's business, and Betfair is one of at least seven large poker licensees for CryptoLogic. So we can make a rough estimate that Betfair's poker operations make up somewhere between 3% and 9% of CryptoLogic's total -- not just poker -- revenue.
Assuming that Betfair makes up 9% of the company's revenue, losing that revenue would be dire. But it's small compared with the 22% blow to the abdomen that CryptoLogic's shares are taking today.
This is a phenomenon that the Fool, and specifically Hidden Gems analyst Bill Mann, has witnessed before. Before making CryptoLogic a Hidden Gems recommendation this year, Bill had recommended Coinstar (NASDAQ:CSTR) to Hidden Gems subscribers in 2003 after the company announced that it was losing Safeway (NYSE:SWY) as a customer of its coin-sorting machines. At the time, Safeway made up 10% of Coinstar's revenues, yet the market reacted just as swiftly and violently to Coinstar's announcement a couple of years ago as it has to CryptoLogic's announcement today -- Coinstar shares back then plummeted by almost 40%.
The business of counting and sorting coins is decidedly a lower-growth and less exciting one than online poker. But online poker isn't just about sexy, fast-growing revenues, either. There are regulatory concerns that vary by country, and it's necessary to have a critical mass of customers online at different stakes at all times to make the service viable. Finally, there's the issue of transaction clearing, which is absolutely unsexy but still an essential part of making online poker work.
With today's news, a decline in the share price was not only inevitable but also, to a certain extent, warranted. However, given all the information available today, and in the absence of any other customer announcements, it's hard to see the market's 22% reaction to what is by my estimates a 9% or smaller portion of the business as anything other than overblown.
For shareholders, it's painful to endure this setback. And for prospective investors, this can make it even more difficult to step up to the plate and buy. But events like this often create the small windows of opportunity for investors to get businesses with attractive levels of free cash flow at a large discount.
Nathan Parmelee owns shares in CryptoLogic but has no financial interest in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.
