Article / 16 October 2015 at 4:49 GMT

Lifting of lottery ban no sure bet for smaller players

China Watcher / Shanghai
China
  • The ban on China's provinces approving lottery sales and payouts has been lifted 
  • The biggest beneficiary of the change is online sports lottery 500.com
  • But the company has much larger rivals that offer their own lottery service 

By Neil Flynn

The Chinese government has announced that individual provinces can now approve lottery sales and payouts. The industry was previously banned by Beijing after concerns over the growth of lottery sales and their legitimacy in the eyes of the law. 

Since April, all lottery businesses have ceased operations, but the latest announcement should benefit a wide range of Chinese firms that had a lottery business, as they have all seen revenue notably affected. 

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 Numbers game ... despite the lifting of the ban, it's unclear if smaller lottery firms can
compete with their larger rivals. Photo: iStock

Online sports lottery firm 500.com is the biggest beneficiary of this because it represents 100% of its revenue. Upon the announcement of the government ban in April, the company issued a statement explaining that it expected to earn no revenue until the ban is lifted. This expectation was correct as net revenue for the second quarter was nil and will be for the third quarter, but the relaxation of the rules will make for an interesting 2016 for the firm. 

The initial problem that the firm has is that the government will change its rules and allow provinces to approve their own lottery sales. Anyone that is familiar with Chinese politics knows that there’s a substantial gap between central government announcements and actual implementation, particularly when local provinces are involved. This leads me to believe that fourth-quarter revenues will be minimal at best. 

I have had my doubts about 500.com since its strong performance during the 2014 football World Cup. Management claimed that it would build on the popularity of the World Cup and expected to enjoy the same amount of enthusiasm throughout the club football season. Of course, that expectation was never likely to transpire, and the company’s woes were compounded by the ban on lottery sales in April. 

Over the past six months, the company has traded like a penny stock, which is logical given that the firm has had no revenue, and any movements in the share price have been solely based on rumours surrounding the resumption of the lottery business. 

But while expectations of this resumption will now be a case of "when" rather than "if", the question remains as to whether 500.com can still be competitive. The problem that it has is that much larger rivals have their own lottery service. 

I have repeatedly discussed the mobile ecosystem business model that has been so successful for Baidu, Alibaba and Tencent, and it has become essential for other firms to be a part of. All three of these tech giants have their own lottery platforms, and given that they have huge user bases that can store their money inside the ecosystem’s proprietary payment platform, there is no particular reason for a user to gamble on 500.com instead. 

In addition, given the troubles that 500.com has had over the past 12 months, users would likely be concerned about gambling their money with a company that has been on the brink of bankruptcy for a while. 

500.com may be the biggest beneficiary of this announcement, but most tech firms have some form of lottery business. Qihoo also benefits, as its value-added revenue has suffered over the past few quarters. Qihoo is a firm that I have followed closely and become increasingly critical of over the past few months. 

It is likely that this will be discussed in the earnings press release from Qihoo, but whether there will be more to be discussed than the pre-prepared statement remains to be seen. Qihoo declined to host an earnings conference call for its second-quarter earnings release, which was frustrating for investors because it would have been the opportune moment to discuss the ongoing privatisation bid. 

However, I believe that the conference call wasn’t hosted specifically to avoid discussing this issue, and it may be the case again that Qihoo will decline to hold a conference call for the third-quarter results. 

Singles Day on November 11 will mask these issues for the next four weeks, as investors focus on the state on retail ecommerce in China as opposed to other aspects of consumer spending. However, with earnings season for US-listed Chinese firms beginning in November, the focus should quickly shift. 

– Edited by Gayle Bryant

Neil Flynn is a Shanghai-based China watcher and equities specialist. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.

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