Are All Bets Off?

INVESTORS BETTING ON small-cap gaming stocks are running into the gamblers' quandary of knowing when to hold 'em and when to fold 'em.

Take PokerTek (PTEK), the Charlotte, N.C., maker of electronic poker tables. Since reporting on May 11 that its first-quarter loss more than doubled, PokerTek shares have tumbled 20% to $9.56 (through Thursday). The stock is down 37% from its April 18 peak of $15.16, and sits below the October initial public offering price of $11.

PokerTek's fortunes are tied to its main product, PokerPro, an electronic poker table that's a hybrid between online gambling and live poker. With PokerPro there's no dealer, no cards and no chips. The table can accommodate up to 10 players who sit in front of personal video screens. A computer deals the cards electronically on the screens, and players touch the screens to place bets.

"I think players' attitudes toward it will parallel their attitudes toward online poker," say John Caldwell, editor-in-chief of PokerNews, a poker information web site. "You get the benefit of seeing your opponents live, but with the speed of playing online."

PokerTek's prospects were looking up on April 18, the day the company received regulatory approval to distribute PokerPro tables in the United Kingdom and California. Previously, the table was only allowed in tribal Florida and tribal Oklahoma. California holds the largest concentration of poker tables in the world, about 1,300.

But the disappointing first-quarter financial results erased much of the goodwill garnered by the regulatory approval. PokerTek reported a loss of $1.6 million, or 17 cents a share, vs. a year-earlier loss of $725,000, or 11 cents. Clint Morrison of Minneapolis investment bank Feltl & Co., the lone analyst covering the stock, had expected a narrower per-share loss of 14 cents. (Feltl underwrote the IPO.)

Revenues totaled $473,000, up from no revenues 12 months ago. Licensing fees were $360,000, with the remainder from equipment sales to Aristocrat, its international distributor. The company attributed the wider loss to boosting staff to 47, fees related to being public and noncash option expenses. As of March 31, the company had no debt and $18.3 million in cash. The company burns between $600,000 and $800,000 of its cash a month. In February, Aristocrat acquired approximately 10% of the company's shares from insiders, who still own 53% of PokerTek.

Going All In
Worries about whether the poker craze that has swept the U.S. in recent years still has legs may be contributing to the selloff. According to the American Gaming Association's 2006 survey, 18% of all U.S. adults played poker last year, a 50% increase from 2003. However, 2005 figures were flat with 2004. Consumer spending in Nevada poker rooms surged 30% year-over-year to $140 million in 2005, says the American Gaming Association, a casino industry trade group. The amount spent in New Jersey poker rooms leapt 27% to $67 million. (Figures exclude Native American-run casinos.)

PokerTek is counting on PokerPro tables to lift those numbers. In poker, players play against each other, not the house. The casino makes money by taking a flat percentage, called a rake, out of every pot. PokerTek says PokerPro deals 50% faster than human dealers. With more hands, casinos collect more rakes. Casinos also save money by not paying dealers.

"Online players are used to a faster paced game, and they find the speed of humans too frustrating," says Lou White, PokerTek's chief executive. "If you were to interview 100 poker players and ask them 'would you like to play more or fewer hands per hour?' I'd say 95% would want to play more."

So far, PokerTek is having a hard time convincing many that its electronic tables are more than a novelty. The tables aren't purchased but rather leased for $70,000 a year. According to Casino City Press, a publisher of gaming directories, there are about 5,100 poker tables in the U.S. That's a potential market of $357 million. The company began the year leasing 20 tables, but by the time the first quarter ended it had lost 12 contracts and installed six new tables, including four on cruise ships, for a total of 14 leases. PokerTek expects to end 2006 with 75 to 100 leases, down from prior guidance of 100 to 125.

"While we are intrigued by this product and the potentially large market opportunity, [the] most significant aspect of this quarterly report was the low installed table count, which is down over the past five months," says Feltl's Morrison, who reiterated his Hold rating. "The learning curve and adoption cycle of this product is clearly longer than originally expected. Until we have increased comfort that the installs are ramping and we see existing customers reorder additional machines, we are not comfortable recommending the stock. But as price comes down, I'm warming up to it."

In the end it really comes down to players and pit bosses warming to the electronic tables.

"This might have a place in towns where there are no casinos; in that market it could make a fortune," says Mark Speert, a professional poker player based in Las Vegas. "But for the 21-year-olds who have made millions playing on the Internet, they don't need the speed, they've made their money. They come to the casino for the experience, the interaction, the adrenalin rush and the feeling of playing the big players. And you can be sure the top players won't be playing this table."

Chips Are Down
One company with a vested interest in the PokerPro table's success is WPT Enterprises (WPTE). The producer of the "World Poker Tour" TV series has anted up for about a 5% stake in PokerTek. When we looked at the West Hollywood, Calif., company last year its stock had just soared 49% to $26.50. Doyle Brunson, one of the world's best-known professional players, had offered to buy WPT for $35 a share. In the 10 months since the stock has plummeted 80% to $5.45 (as of Thursday's close), below its 2004 IPO price of $8 a share. The unsolicited offer fizzled, and now the Securities and Exchange Commission is investigating. WPT says it's cooperating and not a subject of the probe.

More serious is the complete implosion of its online gaming business. Because online gambling isn't legal in the U.S., WPT has relied on a company with overseas operations to develop the business.

"We've had challenges with our technology partner, Wager Works," says Todd Steele, WPT's chief financial officer. The online gambling platform breaks down under heavy traffic. Wager Works is based in San Francisco.

"Certainly it's safe to say the online gaming portion of the business is likely to be the company's most significant growth driver," says Steele. Meanwhile, "World Poker Tour" is currently showing its fourth season on the Travel Channel and beginning production on the fifth. A new show called the "Professional Poker Tour" will start to air on the Travel Channel in July.

For its first quarter ended April 2, WPT swung to a profit of $3.6 million, or 17 cents a share, reversing a loss of $1.6 million, or eight cents, in the previous year's quarter. Revenues leapt 57% to $6.5 million. As of April 2, the company had no debt, cash totaling $3.7 million and short-term investments of approximately $35.9 million. Second-quarter sales are expected to be in the range of $10.5 million to $11.0 million.