500.com Winning Share In China's Sports Lottery Arena

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China's lottery fans still mostly play the old-fashioned way -- through agents at brick-and-mortar locations. Only 6% of the country's $42 billion-plus lottery market is conducted online.

But the online lottery market has been catching on.

And500.com ( WBAI ) is leading the charge on the sports lottery side, which makes up about 50% of the overall online lottery market.

It's the No. 1 online sports lottery provider, using its Web and mobile platforms to aggregate and process lottery purchase orders from registered users.

Most of its revenue comes from service fees paid by provincial sports lottery administration centers. 500.com is the only commercially active online sports lottery operator authorized to provide online lottery sales service on behalf of the government. The others operate in the gray.

Playing by the rules has been good for its reputation and business. But it had a downside.

Licensing Saga

In 2012, 500.com voluntarily shut down operations for several months after the Ministry of Finance sent out an "Urgent Notice" to online lottery operators, requiring that they meet state standards.

During suspension of operations, 500.com lost active users and sales as it worked to gain approval. Revenue that year fell 25%.

The company was one of only two online sports lottery operators that made the effort to get approval. The other one, Sportier.cn, focuses on helping the government calculate odds and payouts and isn't commercially active.

Once approval was granted, 500.com spent heavily to market its status as a trusted name in the lottery market. It has since regained lost share to chief rival Taobao.com, and then some.

As of June 30, 500.com's market share was 29% to Taobao.com's 27%, according to iResearch.

Analysts say the government's stamp of approval gives 500.com a competitive edge over unlicensed rivals. As Piper Jaffray analyst Michael Olson noted, users have a "sense of trust" that their accounts and funds will be properly managed and payouts "reliable and safe."

"This is an important factor for new users during the nascent stage of the online lottery market," he said in a research report.

In a company filing, management said the "user activity level has been recovering steadily" since it resumed online lottery sales in November 2012.

In the three months ended Sept. 30, 2013, the number of 500.com registered users totaled 18.4 million, up from 16.6 million at the end of 2012. Also in those months, active accounts totaled 374,000 vs. 282,000 in the three months ended Dec. 31, 2012.

Shenzhen-based 500.com will report its December-ending quarter before the U.S. market opens on Friday, its first quarterly report as a publicly traded company in the U.S. It went public in November, raising $75 million. It priced at $13, the high end of its upwardly revised proposed range, and shares opened at $20 the first day of trading. Though volatile, 500.com stock is up more than 250% from the IPO price.

Analysts expect fourth-quarter earnings of 12 cents per American depositary receipt, or ADR, and 28 cents for the full year, up from 6 cents in 2012 on a pro forma basis.

Earnings are seen rising 230% this year vs. last year to 92 cents, according to a Thomson Reuters poll, while 2014 revenue is seen increasing nearly 100% to $81 million.

500.com is the ninth largest company by market cap in IBD's Leisure-Gaming/Equipment industry group that's dominated byLas Vegas Sands ( LVS ),Melco Crown Entertainment ( MPEL ) andWynn Resorts ( WYNN ). The group is currently ranked No. 12 of 197 that IBD tracks.

Winning History

One of the first outfits to start up online lottery service in China, 500.com began operations in 2001.

The company spent heavily over the years to build its brand, known as 500wan, which means "5 million" in Chinese -- the typical top amount of a lottery prize in China.

"Our users' record of winnings is one of the factors contributing to our ability to attract new users and retain existing users," the company said in a filing.

Lottery pool purchases and automatic tag-along sales are two of its most popular services.

Sports lottery products depend heavily on live broadcasts of major sporting events, especially soccer. Sales will likely get a bump from the World Cup in Brazil this June.

Piper Jaffray's Olson noted that 500.com's active user base during the 2010 World Cup grew 50% in the second quarter when it was held vs. the first quarter.

"In addition to the impact around the World Cup, there could be a positive residual benefit as new users become familiar with the service," he noted.

Summer Of Soccer

Concurring, Deutsche Bank analyst Alan Hellawell wrote in a report that the World Cup, held every four years, will likely drive lottery spend per account.

For an online sports lottery pure play, as Hellawell calls 500.com, the upcoming World Cup will likely be a sales catalyst.

World Cup or not, China's online sports lottery market is a beneficiary of China's fast-growing Internet population. Sales in the online sports lottery market is expected to double from 2013 to 2015, from $1.5 billion to more than $3 billion, according to Piper Jaffray.

While unapproved online lottery concerns continue to operate, analysts say they'll likely be fined and penalized, perhaps prompting them to jump through the hoops necessary to get government approval.

Hellawell expects the government to issue several other licenses to online sports lottery operations this year and next.

While competition grows, 500.com has been acquiring new users for its mobile platform. Partnerships with telco operators is key. At the end of January, it forged a strategic agreement with China Mobile E-commerce, a subsidiary ofChina Mobile ( CHL ). The former provides payment service across China Mobile's massive network.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: WBAI , LVS , MPEL , WYNN , CHL

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