Put yourself in the shoes of the average Western finance minister. National debt has soared. You’re scrabbling to close the budget deficit. Raising VAT and petrol duties helps up to a point, yet this also slows output and boosts inflation.
What do you do? One neat solution is to regulate and tax the online gambling industry. This gives state coffers a boost and lifts GDP, all without affecting the consumer price index (CPI). It’s been a win-win situation for Britain, so it’s little wonder that other countries are following suit. Australia legalised the sector a couple of years ago, while the likes of Spain, Turkey, Greece, Italy, France and Germany are not far behind. Indeed in March the European Union launched a study with the aim of harmonising laws across the entire E6bn market.
So what about America? After banning the activity in October 2006, that decision is now being questioned. California, Iowa and Florida are among states seeking to introduce online gambling. Last week Federal prosecutors closed down three off-shore poker sites that were deemed illegal. The upshot is that this clamp-down could be a game-changer for operators like Ladbrokes, Britain’s biggest bookie.
Why? Because firstly this swoop could be clearing the decks ahead of a future re-opening of this estimated $12bn market. Moreover it means that thousands of non-US punters who were previously using these three sites may switch to regulated providers. With such an internationally renowned brand, Ladbrokes will be at the front of the queue when it comes to picking up these displaced gamblers.
Ladbrokes is a solid recovery story too. 2010 operating profits, excluding high-rollers (wealthy individual gamblers), climbed 20% to £202m, with strong cash generation knocking net debt down by a similar amount. Costs have been cut too. Yet the real fruits from the turn-around plan are coming through in its revitalised online activities, where profits rose 36%.
To take advantage of the firm’s huge popularity, chief executive Richard Glynn plans to spend £50m on improving Ladbrokes’ internet technology. The focus is on organic growth, although Mr Glynn has just ended takeover negotiations with 888.com and was previously linked to exploratory talks with Playtech.
I believe the group should be able to achieve sustainable operating profits of £285m on turnover of £1.31bn by 2013. Using a ten-times multiple, discounting back at 12%, and adding in future positive cash flows, delivers an intrinsic worth of around 175p a share.
But what are the risks? If there’s a double dip, the group would be hit by rising unemployment and lower consumer spending. There is always a chance that taxes will become too onerous, but the sector has shown its resilience in providing cheap entertainment during periods of economic turmoil. And there’s the added boost of the 2012 Olympics and the European football championships. So with the stock on a p/e ratio of just 10.2, and paying a 5% dividend yield, Ladbrokes looks worth buying. Deutsche Bank has a target price of 165p.
Last week both Apple and microchip giant Intel smashed Wall Street earnings estimates, due to booming sales of data-hungry devices such as iPads and laptops. The popularity of these products will heap more strain on already over-loaded telecoms networks. Indeed, mobile data traffic is expected to grow 26-fold between 2010 and 2015, equivalent to an annual growth rate of 92%.
That should be good for networking titan Cisco. It sells more than half of all optical routers and 70% of switches globally. And despite the recession, turnover has risen by an average 8.8% a year since 2006, hitting $40bn for the year ending July 2010. Two-thirds is derived from business or government customers, with the rest from telephone operators (such as AT&T). One of Cisco’s core strengths is that it is a one-stop shop, allowing customers to pick from a smorgasbord of internet solutions and assemble them into one inter-connected platform.
So why have the shares tanked by 40% over the past year? The group has been a victim of its own ambitious goals. It diversified into several unrelated areas, such as consumer devices, which distracted management and led to a fall in profit margins. The good news is that CEO John Chambers is fixing this – its ailing Flip video-camera unit got the chop earlier this month. And elsewhere, prospects are much brighter.
For one Cisco’s huge installed base of customers provides a rich seam of recurring sales and cross-selling opportunities. It has focused on video-conferencing, where its Telepresence system uses 3D surround-sound and life-size images to recreate the feeling of meetings without any of the problems of jerky pictures and poor audio quality. This helps customers to slash their travel costs and their carbon footprints.
The balance sheet is rock-solid too – net cash of $25bn offers plenty of ammunition for strategic acquisitions and stock buybacks. Wall Street expects current-year turnover and underlying earnings per share (EPS) of $43.78bn and $1.59 respectively, rising to $48.5bn and $1.76 in 2011/2012. That puts the firm on p/e ratios of less than 11. I’d rate the stock on a multiple of ten times the 2011 operating profit. After adjusting for the cash mountain, that generates an intrinsic worth of $24 a share.
Cisco is exposed to the usual concerns of price deflation, tighter IT budgets, foreign currency shifts and component supply issues. But one risk is over-stated: the fear of being swamped by Chinese rival, Huawei. Sure, Huawei is a threat, but many Western nations continue to be concerned about buying kit from China after several high-profile cyber attacks. All told with internet traffic going through the roof, together with the emergence of 4G technologies, Cisco is a good play on the future growth in optical networking. The Juda Group has a price target of $26, and the next quarterly results are due out on 11th May.
Paul also writes share-tipping newsletter Precision Guided Investments. Call 020-7633 3634, or see moneyweek.com/PGI.