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Last Woman Standing<DATEANDTIMESTAMPWITHBR />
By JONATHAN R. LAING<DATEANDTIMESTAMPWITHBR />

LAST MONDAY WAS BLACK MONDAY for the internet-gambling industry on the London Stock Exchange. Industry giant PartyGaming lost about $5 billion in market value as its stock plummeted 58% to 45 from 107 pence. Falling more than 60% were the listings of Sportingbet and online-gaming cash- transfer services Neteller and FireOne Group.

The cause of the debacle was the passage on Sept. 30, during the waning hours of the U.S. congressional session, of a law to make it illegal for banks or credit-card companies to process payments to online gambling outfits. The measure, sponsored by Republican Rep. James Leach of Iowa and Republican Sen. John Kyl of Arizona, had been knocking around for months, stymied by various internal congressional squabbles and special interests such as the horse-betting industry's request for special exemptions. Finally, however, the ban made it, heaving across the finish line as a rider to the port-security bill. President Bush is expected to sign that into law in early November.

The immensity of the disaster to the online-gambling industry is readily apparent: the majority of its business comes from U.S. gamblers even though the companies are all domiciled in offshore tax havens like Gibraltar, Antigua and Costa Rica. Some 80% of PartyGaming's revenue, for example, originates in the U.S., mostly from poker players attracted to the site's 24/7 card playing. Now, most of the online companies have announced plans to pull out of the American market voluntarily.

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Some investors, of course, will try to find bargains amid the wreckage, perhaps thinking the companies could excel as vehicles for foreign betting. Fat chance. In fact, the outlook for this sector may well get worse in the months ahead, as the implications of the U.S. ban play through financial statements. One of the few investors likely to get out alive is PartyGaming's founder, a one-time backer of the porn industry named Ruth Parasol. She and her husband had the good sense to start cashing out more than a year ago. More about them later.
IF NOTHING ELSE, the collapse in the gaming shares bespeaks an obtuseness on the part of investors in the stocks. First of all, it's no secret that the Justice Department has long considered companies offering online gaming to U.S. residents to be violating existing federal laws, such as the Wire Act and the Illegal Gambling Business Act.

Moreover, some eight states have specific bans on online gambling and most other states prohibit all forms of unlicensed gaming (needless to say, none of the Internet-gambling companies has such a license).

Perhaps PartyGaming (ticker: PRTY.London) posed the issue most starkly -- and brazenly -- in its prospectus for its initial public offering of stock in 2005: "Offshore gaming companies rely on the apparent unwillingness or inability of regulators generally to bring actions against businesses with no physical presence in the relevant country."

Likewise, there have been plenty of warning signs of a coming U.S. crackdown. In July, BetOnSports chief executive David Carruthers, a British citizen, was arrested by federal agents in a Dallas-Fort Worth Airport lounge during a short layover en route from London to the company's headquarters in Costa Rica.

The company fired him immediately for his blunder. And Carruthers was held on a previously-sealed indictment charging him, the company and 10 other of its operatives with mail and wire fraud, money-laundering, tax evasion and taking in more than $3.3 billion in illegal wagers from the U.S. over the life of the company. Carruthers is now living in a hotel outside St. Louis, sans passport and sporting an ankle bracelet, grimly awaiting his next hearing date in federal court in that city.

Last month, Peter Dicks, non-executive chairman of Sportingbet, was likewise arrested at JFK Airport when he nonchalantly showed up in the Big Apple to attend a directors meeting of a tech company. His arrest was a result of a sealed warrant issued by Louisiana state authorities, charging him with "gambling by computer" offenses. Louisiana is rumored to have dozens of other sealed warrants covering virtually the entire executive rosters of the online-gambling industry.

In any event, Dicks was able to beat the Louisiana warrant in late September when New York Gov. George Pataki refused to order his extradition. Perhaps this was because Dicks had already resigned his position. He's now safely back in Great Britain.

THE ARRESTS FOLLOWED a heady growth spurt for the industry (see "Full House: Suddenly, the Whole World is Playing Online Poker," the Barron's cover story of Feb. 21, 2005). And they quickly changed the behavior of executives. A number of industry figures, including PartyGaming chairman and English "suit" Michael Jackson, disclosed that they no longer planned to travel to the United States. World Gaming Chairman James Grossman and Director Clare Roberts both resigned their positions with the London-listed and Antigua-based concern. Both had business interests in the U.S. that required continued access to America.
<TABLE class=imgrgtbdy cellSpacing=0 cellPadding=0 width=346 align=right border=0><TBODY><TR><TD>
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</TD></TR><TR><TD class=medcptnocrd>Party's Over: Shares of once-promising online gambling concerns have been under increasing pressure this year as legal and regulatory woes have mounted. Congress' move -- banning the transfer of U.S. funds for betting -- was the capper.</TD></TR></TBODY></TABLE>Likewise, CryptoLogic, a provider of online-gambling software, saw fit to announce plans to move its headquarters in January from Canada to Ireland. At the same time, its Canadian CEO announced he was stepping down "for family reasons." The company said that the change of domiciles was dictated by the need to be nearer to its customers. No mention was made of the U.S. regulatory mortar fire that seemed to be landing steadily closer to the company's quarters.
Offshore Internet-gaming companies and their major operatives had long lived in a world of denial, assuming that their operations were beyond the long reach of U.S. regulators. For one thing, such industry figures as PartyGaming's Parasol and BetOnSports founder Gary Kaplan, an ex-New York bookmaker, were assumed to be extradition-proof. After all, they were living in domiciles -- Gibraltar in the case of Parasol and Costa Rica for Kaplan -- where online gaming is legal. Moreover, all their company computer servers, cash balances and other assets are also in offshore locations that the government would likewise find all but impossible to access.

But the Leach-Kyl measure hits the Internet gaming industry where it hurts the most. It effectively cuts the companies off from all U.S.

wagering, the very lifeblood of the business. The bill makes any transfer of U.S. funds for the purpose of wagering or settling accounts illegal. Among other things, financial institutions will receive ongoing assistance from the Treasury, the Fed and the Department of Justice to identify new domain names and other conduits used by online-gaming companies to circumvent the rules for U.S. funds. A fairly ironclad "coding and blocking" system will be capable of identifying and thwarting Internet-gambling transactions.

For example, PartyGaming of late has directed U.S. gamblers to send money to a phone-card company front called PccPay.com, apparently to disguise the real purpose of the transfer requests from U.S. financial institutions. Other companies that probably will be targeted are such offshore "electronic wallet" concerns as Neteller and FirePay, which have become popular payment conduits for the offshore gaming industry since eBay's PayPal service, under regulatory pressure, stopped facilitating such transfers.
The legislation also will impose severe civil and criminal penalties on online-gambling companies and officials accepting illegal U.S. wagers. Seizing executives or gaming-company assets in their offshore redoubts will, as always, be difficult. But any major U.S. legal action against industry players, particularly those publicly held, would severely damage the companies' reputations and force them to incur heavy legal expenses.

At a minimum, U.S. authorities under the new ban would be able to easily win injunctions and default judgments in U.S. courts against offending gaming companies that fail to close down their U.S. operations, virtually eliminating the companies' abilities to advertise or maintain a U.S. Web presence. U.S. officials are also exploring whether international tax treaties might allow regulators to go after companies and executives on their home turfs for U.S. tax evasion.

Under the Internal Revenue Code, there's a 2% excise tax imposed on all wagers not authorized by state law. Such an imposition on PartyGaming last year on the U.S. portion of its $48 billion in wagering would come to about $800 million before penalties and interest. That alone would've nearly wiped out its net revenues of $977.7 million for the year.

Representative Leach, for one, thinks that the industry's prospects have been blighted by his legislation. "This may well be the death knell of offshore Internet gambling," he tells Barron's. "Only time will tell, however."

THE DOMINANT FIGURE in the online-gaming business remains the 39-year-old Ruth Parasol. In this month's Forbes 400 Richest Americans list, she and her husband, J. Russell DeLeon, are shown to have a combined net worth of $3.6 billion, which exceeds that of even longtime Las Vegas gambling mogul Steve Wynn, who weighs in at $2.6 billion. The magazine hit the newsstands just the week before the collapse in the stock, which lopped an estimated $1.5 billion off the couple's net worth.

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Parasol has long shunned the spotlight and today lives a quiet life with her husband and two kids on Gibraltar. A PartyGaming spokeswoman told us curtly that Parasol doesn't grant interviews.
Too bad. For hers is one fascinating life story. An excellent profile from the Los Angeles Times last year describes her unconventional upbringing in San Francisco's Marin County as the daughter of a holocaust survivor, Richard Parasol, and his Swedish wife.

Ruth Parasol went to an exclusive private school in the area where in her senior year she posed in a fur coat, with the caption underneath proclaiming that "Diamonds Are a Girl's Best Friend." Then it was on to the Jesuit-run University of San Francisco, followed by law school at Western State University in Fullerton.

Her father, according to The New York Times, had a long career in the porn industry, starting out with a chain of successful San Francisco massage parlors. The apple didn't fall from the tree: Shortly after her graduation from law school, Ruth joined her father as a legal adviser to his phone-sex billing operation. And soon she branched out into her own business, investing in, among other things, a porn Internet site that made a killing in 1996 by distributing a sex video featuring actress Pamela Anderson and her then-husband, rocker Tommy Lee, in flagrante delicto.
As regulators turned the heat up on the sex industry, Parasol diversified into online gambling in 1997. Her venture, Starluck Casino (now PartyGaming), was strictly small potatoes until she teamed up with a bright young Indian computer programmer, Anurag Dikshit, who devised the software for online poker players to join remotely in games involving literally thousands of other players. Internet poker exploded in popularity, creating a tidal wave of demand that the company has ridden ever since.
But if Parasol has learned nothing else operating in the demimonde of the business world, no good thing goes on forever. One must always have an exit strategy to get out of Dodge before the regulators arrive. Thus, she and her husband have been monetizing their ownership in PartyGaming as fast as possible in recent years, even with the company's booming business and succulent operating margins of about 60%.

The year before the company's IPO, PartyGaming bought an entity called ElectraWorks for $826 million. While ownership of ElectraWorks wasn't revealed at the time, Parasol and her husband were clearly major holders of the unit. The transaction was similar to the way private-equity firms often pay themselves huge special dividends before taking their controlled company public.

Then, in the IPO last year, which raised £1 billion, Parasol and her hubby sold 40% of the shares in the offering, reaping 436 million British pounds, or $815 million dollars at current exchange rates. The IPO was followed in June of this year with another insider sale of 200 million shares of PartyGaming stock for £232 million. In that sale, Parasol and DeLeon dumped exactly 66,666,666 shares for €77.3 million, or $145 million. The share total implies a certain puckish, if not devilish, intent. The insider secondary issue would have been far larger if market conditions had permitted.

So all in all, it appears that there will be no tag days for Parasol and her husband, even as PartyGaming shareholders are suffering huge losses. The pair has already cashed out an estimated $1.5 billion from the company. That certainly reduces much of the pain of the $1.5 billion loss they've taken on their remaining 30% stake.

The Bottom Line
Bargain hunters should firmly resist the online-gambling stocks, despite recent declines of about 60%. One could lose an arm trying to catch these falling knives.

MORE TROUBLE COULD LIE ahead for PartyGaming. Gamblers anxious to clear out their accounts could cause a run on the bank. For according to the company's June 30, 2006, balance sheet, PartyGaming owes its clients $192.6 million in liabilities and prize pools, while having only $132.9 million in cash and cash equivalents to meet that obligation. And those cash holdings are likely to have fallen sharply, because of $130.5 million of cash spent on an acquisition in August. Meanwhile, The Financial Times reported the cancellation of a $500 million bank credit line that the company had made some use of. PartyGaming recently cancelled a $115 million special dividend to shore up its cash.

The problem all this poses for gamblers is that, unlike the brokerage industry, customer accounts aren't segregated and insured. Your money and the house's money tend to be one.

Several phone inquiries by Barron's to PartyGaming on its current cash situation went unanswered.

Of course, the company could make good on its obligation with its retained earnings and shareholders equity, if there were any. But unfortunately the company has a negative tangible net worth of minus $53 million. And after what happened in Washington, one can bet that its servers and other physical assets are no longer worth the $58.3 million shown on the balance sheet. Nor are its goodwill and other intangible assets likely worth anywhere near their $144.4 million balance-sheet value. Not when the business has just gone up in smoke.

PartyGaming offers a sad tableau. Investors have already lost a ton. Its players may have their money frozen, or never get all of it back. There are no winners in this sordid tale, except Parasol and the other insiders. You don't beat the house.

http://online.barrons.com/public/article/SB116018480631785723-E7nqJqKei44PIzfxJ_qCG7gnerk_20061106.html?mod=mktw
 

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