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If you want to bet on the Net, Canada's CryptoLogic Inc. (CRYP) could be your lucky stock. Quoted on the Toronto exchange, CryptoLogic, with $30 million in sales, began trading on the Nasdaq in March. The maker of gaming software is the clear leader in online gambling, a business that should be two-and-a-half times larger by the end of 2001, with $3 billion worth of bets posted online, according to a study of the industry by Bear, Stearns & Co. At its current price of $21 11/16, CryptoLogic is down (along with the rest of the Nasdaq) from its IPO price of $42. Nonetheless, the company's stock has more than 100% upside potential for the next 12 months, predicts even the most conservative industry analyst.
If a potentially hostile U.S. regulatory environment does not put a crimp in its game, CryptoLogic has all the elements it needs for more robust growth: strong technical prowess, with some of the industry's favorite software; a growing online client base through the largest virtual casino, Intercasino; and earthbound gaming clients who are starting to go online.
CryptoLogic's soon-to-be-released version 4 software is considered by industry analysts to be the best program devoted to gaming on the market. Like the earlier versions, it lets gamblers play most of the games offered in a casino, including blackjack and baccarat. Players can buy the software in English, Spanish, and Japanese. In addition to these features, available with version 3, version 4 adds tighter security. It also has images that make the play more realistic, such as croupiers' hands dealing cards.
"Graphics, interactivity, and security are the three most important technological areas for gaming software," says Brandon Osten, software and Internet analyst for Sprott Securities in Toronto. "With version 4, CryptoLogic will arguably be in a leadership position in all three."
BROADENING ITS REACH.
But CryptoLogic's real advantage over the industry's No. 2 -- Swedish gaming-software maker Boss -- is that it's the first to crack the land-based casino market. CryptoLogic has licensed its software to two reputable international-gaming companies for their Web sites. Analysts believe the entrance of physical casinos into the online market will be the key to the industry's success because their brands have such a large number of devotees, and gamblers will follow the brands they like to the Web.
CryptoLogic's recent deals with physical players also broaden its international reach. In February, the company signed a deal to provide software for the Web site of Australian casino group Jupiter. Last November, CryptoLogic inked a similar deal with William Hill, an Antigua-based gaming company well-known in Britain.
Jupiter is 20% owned by Park Place, the No. 2 gaming company in the U.S., so CryptoLogic has a foot in the door if Park Place's best-known brands -- Flamingo, Caesar's, and Bally -- go online. And that would mean lots of hard cash. According to the terms of the licensing agreement CryptoLogic has signed with its 17 online casino clients, it gets 30% to 40% of their takings, as well as an additional 10% in e-commerce fees.
BIGGEST CLOUD.
The company's main cost was the development of the gaming software that allows people to interact with a casino online the way they would if they were there in person. Once the programmers have designed this software, they continue to improve it, update it, and tailor it to specific licensees, but generally that requires considerably less time and effort than starting from scratch. Now that CryptoLogic's software only has to be maintained, its aftertax profit margin is around 60%.
CryptoLogic President and CEO Andrew Rivkin, who co-founded the company with his brother Mark five years ago, is confident: "We had 43% revenue growth in 1999," he says. "We think 30% to 40% growth [each year] is realistic the next few years. Our goal is to maintain our position as the dominant player in the marketplace and grow proportionately."
Rivkin's projections depend in part on whether Congress decides to crush online gambling or otherwise rein it in -- the biggest cloud on the horizon for CryptoLogic. In the U.S., which could offer a huge market for online casinos, antigambling sentiment runs high on the Religious Right. This point of view has made so much headway among lawmakers that last November, Senator Jon Kyl (R-Ariz.) persuaded the Senate to approve a bill prohibiting Internet gambling.
Defenders of online gambling argue that it sets limits on the damage people can do to their finances, unlike real-world gambling. "[Gambling Web sites] limit the money you can lose on a weekly basis," points out Peter Swan, security analyst at San Francisco-based Pacific Growth Securities. "The first week the limit might be $500, and after that it steps up to $2,500 per week, but you can lose that in Vegas in 10 seconds on one spin of the roulette wheel."
KNOTTY PROBLEM.
Analysts are fairly confident that the Kyl bill will never make it into law. But that doesn't mean there won't be plenty of regulation of Internet gambling -- whether it's to protect customers from threats to honest gaming posed by organized crime, to reduce fraud on the part of players, or to set age or spending limits. There is still an ongoing debate about whether that regulation should come under state or federal jurisdiction.
The federal-vs.-state debate likely has more to do with revenues than morality. "The government will probably come around to the position that it wants to heavily tax these activities as well as regulate them," says Sprott's Osten. Even if Congress and the White House can reach a decision about where the authority lies in the U.S., there's still the knotty problem of regulating Internet sites based overseas.
"It's going to be impossible to regulate because enforcement is virtually impossible," says Marc-Andre Chournard, technology analyst for CTI Capital in Montreal. For one thing, enforcement would involve regulating people's credit-card purchases, the standard mode of payment for online gamblers. But even if that were to come to pass, Chournard is certain Internet gamesters will find other ways to pay for their pastime.
"E-CASH IS THE ICING."
CryptoLogic offers one solution to the enforcement conundrum that the company believes might also have a market outside online gaming. Its e-cash software permits fast and secure financial transactions for clients of online casinos to cover their gambling debts. The system operates like an ATM, allowing users to make deposits to and transfers between bank accounts. The funds stay in CryptoLogic's system only for the time it takes to settle up. Then they are transferred to the bank account of the gambler or casino. The software supports payments and transfers in multiple currencies to service CryptoLogic's users in 240 countries.
It's the same sort of cash-management software used by banks and e-commerce retailers. But so far, it has a far lower fraud rate -- 0.7%, according to CEO Rivkin. Of course, financial-transaction software has a lot of competition on the Net, and analysts are not banking on it for CryptoLogic's growth. Still, as Pacific Growth's Swan points out, "with the gaming software, they've got the cake. E-cash is the icing on the cake."
Analysts anticipate revenues for 2000 of $39.7 million to $42 million, with earnings per share ranging from $1.43 to $1.78. In 2001, revenues should ramp up to around $58 million, with EPS of between $2.16 and $2.38. With such strong growth expected, the 12-month targets for the stock price range from $50 to $64.
This kind of price appreciation will simply be recognition of CryptoLogic's industry leadership, according to Osten, who backs the $64 target. "If I had to guess who would become the industry standard, I would say CryptoLogic has a leg up on the rest of the industry," he says. That's a hot tip for investors in a betting mood.
Popper covers the markets for BW Online EDITED BY BETH BELTON
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