:: The Park Paradigm ::

Markets for the Digital Generation

Regular readers will be familiar with my take on the question of gambling vs trading (from ‘The Making of AmazonBay’):

In my eyes the difference between investing and gambling, betting and trading lies not in the underlying but in the approach of the person dealing in whatever instrument. Investing or trading involves a careful and analytical approach to decision making and risk taking. Betting or gambling involves a purely impulsive or emotional speculation. The irony is that many ordinary people are much more informed about sports or politics or the weather than macro-economic trends or the financial prospects of this or that company, and yet are encouraged by the prevailing culture and legislation to risk their savings investing in the latter through bonds or stocks while being chastised and in many cases legally prohibited from seeking to profit from their detailed knowledge of particular sporting or political outcomes.

So how do you trade (as opposed to punt) on American Idol? By creating and using sophiticated tools and algorithmns like this site called DialIdol created by Jim Hellriegel. The LA Times reports:

Hellriegel’s site provides two indispensable services for the 21st Century Idol fan. First and foremost, it provides users with a downloadable speed-dialing program they can use to maximize the number of votes they cast for their favorite contestant, allowing people to cast dozens or hundreds of votes in the brief window when the polls are open.

At the same time the statistics on those votes, as well as how many times a vote doesn’t get through because of a busy signal are sent back to the mother site. DialIdol then calculates the percentage of busy signals on each idol’s line. The site’s prediction is based on the assumption that the idols with more busy signals are getting more votes. The predictions are actually a tally of which idol has the highest percentage of busy signals.

Of course, DialIdol’s predictions are not foolproof. “It was never designed to get the results slot for slot right,” says Hellriegel. For starters, DialIdol only measures the voting patterns of people using its speed-dialing application, and it has no way of measuring the millions of votes cast by text message. Every time a call is answered by an operator saying “All circuits are busy” the site counts it as a vote. But, as Hellriegel says, “with a large calling base these factors should become moot points.”

Hellriegel adds that he would not recommend betting on DialIdol’s predictions. “That’s absolutely not the purpose of this,” he said. “I just had an idea in my laundry room one day and I thought, ‘Let’s see if this will work.’”

While this week his site correctly predicted the ranking of the idols with the three lowest scores, it has been less accurate in the past. Last week they picked Katharine McPhee to be out and placed Lisa Tucker in 5th place. Whoops.

Ok, so he has a big disclaimer on the site saying this is not scientific, etc. Still, I think it is a neat example of how demand (to know who will get booted off) and innovation marry to create something new.

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At Risk Magazine’s* annual shindig in Monte Carlo, day one ends with the following presentation:

Special guest speaker: Betting on the future: Online gambling goes mainstream financial
• You call it a derivative, they call it insurance, I call it a bet
• How financial institutions could make more use of betting markets
• Can you really make money betting on sports?

Sam Dibb, Director, CERTAIN RISK MANAGEMENT
…which advises companies on strategies to hedge sports-event related risks, develop innovative marketing campaigns and negotiate effective sponsorship arrangements by making use of liquid and keenly priced betting markets. Sam also provides advice to a number of betting organisations and writes on gambling and financial markets-related subjects for various publications. Previously, Sam spent over 10 years with PwC as an accountant and consultant to capital markets firms and is a reasonably good amateur gambler.

CRM advises corporate clients on placing risk among established bookmakers (e.g. Ladbrokes, William Hill, Coral, Paddy Power and Stan James) with whom CRM has a deep and up to date understanding of their product offerings and risk appetite. Whilst emulating some aspects of traditional insurance, CRM’s proposition bypasses traditional insurance brokers and underwriters, going directly to risk transfer with bookmakers. (more information)

Hello.

Was Sam inspired by AmazonBay? Is he a Park Paradigm reader?

Given that his website does not mention Betfair or Betdaq or any of the other sports exchanges (which is a bit strange imo given the business he’s in), probably not. Either way it is great to see others seemingly sharing similar views. He’ll have a great audience and I hope he manages to plant a seed. I doubt I’ll be there so I hope he posts his presentation on the net. I’ll keep my eye out.

*Risk magazine’s annual flagship congress is firmly established as the premier European event for risk management and derivatives trading professionals. Each year the most senior representatives from the leading financial institutions gather to share strategies and best practice approaches to meet the demands that rapid market innovations and increasing regulations are presenting.

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I am constantly amazed at how the US continues to attract and develop entrepreneurs and risk takers given the corrosive effect of litigation and the parlous state of its patent regime. We now even have a term to describe the opportunists that seek to mine this economic fault line - patent trolls.

eBay is currently labouring under a lawsuit regarding it’s ‘Buy it now’ service. Without going into the details of the case - the lawyers tell us it is complicated (surprise!) - what kind of system allows something like ‘Buy it now’ to be patented in the first place??? And now that Betfair has a successful business and a substantial valuation, surprise surprise up pops some guy asking for a cut. Skype is being accused of racketeering (!) and is being sued for $4.1 billion (not sure, but that number sounds suspiciously like the maximum pay-out for Skype shareholders in their deal with eBay…) It all reminds of a great line by King Julian from Madagascar :

“I thought of that, me. Write that down.”

It’s the new new racket. Goodfellas without the gore (from TechNewsWorld):

However, there is a reason why most of the large tech companies have thrown their support behind eBay: Legal activity against tech firms has exploded over the last 18 months, with many of the lawsuits brought by companies that have obtained rights to various technologies and/or business processes. Many of these firms have done so explicitly with the hope of a payday down the road.

Representing defendants against such firms accounts for about half of his current case load, attorney Michael Sacksteder, a partner with Fenwick & West, told the E-Commerce Times. “We have seen a significant uptick over the last 18 months,” he noted.

“Some are what you might call shakedown artists — they propose a settlement that is crafted to be less than the cost of litigating their claims,” he said. Other firms go to court in the hope of hitting the jackpot — that is, successfully suing an eBay or RIM.

Under those circumstances, if the plaintiff is granted an injunction, it basically has the defendant by the throat as it negotiates for damages.

If eBay prevails, the situation may ease somewhat for these firms. The threat of injunction would remain, but it would not be as fearsome a possibility in such cases. Meanwhile, there is little chance the suits will ease over the coming years, Sacksteder said, no matter what is decided with this particular case.

“There are a lot of patents out there and more are issued every day,” he commented.

The Economist’s view is more balanced:

Some industries, such as pharmaceuticals, have much to fear from a looser approach to patents. Typically, drugs rely on one or two patented compounds. Most observers accept that injunctions are a vital part of the legal armoury that protects the industry’s leading firms. They need to be able to clamp down speedily on those who would piggyback on treatments that have taken years and vast sums of money to develop.

The tech industry is different. By and large, its big firms are less focused on exploiting patents than they are on getting innovative products quickly to market. The vast ocean of patents covering high-tech components, software and business processes means that each new product, generally comprising thousands of pieces of technology, usually infringes on several patents. Since most big tech firms both hold banks of their own patents and regularly infringe on those of their rivals, they tend not to take each other to court—patent give-and-take ensures a détente of sorts.

I am (obviously) not a patent lawyer, but - and I think that this is the point - as a lay person common sense tells me that ‘Buy it now’ or ‘ one-click shopping’ or ‘trade electronically’ are not things that should be patentable. These are things that are bloody obvious and success in business using these ideas is and should be down to execution. Furthermore, I don’t know how anyone can defend the idea of patenting what is in effect a business model. In my eyes the US patent system is broken. My emotional response is that business processes shouldn’t be patentable. I’d love for someone to try and convince me of the contrary but I can’t see it happening. Where does it stop? How much time/energy/money is wasted rushing to the patent office everytime you decide to change the way you offer your service? Who is to say that ‘Buy it now’ is any more novel than ‘Place item near check out counter’…who holds the patent on that idea? My point is that if you open the door to patenting business processes, the risk is that it just becomes a big “wacky race” to see who can get the highest number possible of ways to sell something or buy something or showcase something possible filed on the basis of collecting an arbitrary rent for having better patent lawyers than the guy across the street.

As long as the US remains the largest and most dynamic economy in the world, it may just be a little sand in the gears, but that place in the sun isn’t guaranteed to last forever. In the medium to long term it is not inconceivable that many new innovative companies will choose to avoid or ignore the US market altogether to avoid the legal tar pits dotting the US business environment. That may seem far-fetched, and I’m not suggesting it is a foregone conclusion, but the US share of global GDP is in secular decline in any event (for good healthy reasons having to do with the rest of the world catching up to the US, often by adopting the same policies that allowed America to flourish in the first place.) In any event, I think that would be a bad outcome for the world and I hope good sense ultimately prevails. We’ll see.

Who holds the patent on lemonade stands? Kids of America watch out!

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The weekend press (Sunday Times, Telegraph) reported on the acquisition of 23% of Betfair by the Japanese firm Softbank, a deal that was initially announced at the beginning of March. The Times article questions the valuation (67x 2005 earnings but 30x forecast 2006 earnings) :

At just over £300m, the investment values Betfair at about £1.5 billion — 30 times 2006’s projected earnings and 67 times last year’s operating profit. Multiples like that remind City analysts of the dotcom boom of 2000. But in Betfair’s case, its supporters argue, the rating is justified…

…The sceptics accept that the Betfair model has revolutionised gambling, but many doubt that its premium rating is justified. “Betfair’s growth has been phenomenal, but it no longer has the market to itself,” said one analyst. “Things could get a lot tougher.”

I think it is interesting to compare this with the valuation multiples observed in the world of financial exchanges. If you recall, I posted a great graph (by Morgan Stanley via the Economist) on this subject a couple weeks ago. Here it is again:

Without knowing the exact numbers, at 30x forecast 2007 earnings (if the Times report is correct), it would seem that Betfair would fall more or less in line with this universe. It will be interesting to calibrate as and when they disclose their growth figures.

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Reuters reported this morning that for the market on who would be Italy’s next Prime Minister, Betfair had Prodi 1-5 on and Berlusconi as a 4-1 underdog. As can be seen from the chart below, he subsequently traded as wide as 44-1 before coming back in to around 10-1 this evening (as of 7pm London) as the votes were being counted.

As reported in MaltaToday, Italy has recently enacted a law blocking 684 online gaming sites not licensed in Italy on the grounds it was protecting Italian gamers from “phishing” – the fraudulent acquisition of passwords and credit card details. Many think the real reason for the law was to “protect the Italian government’s monopoly which runs betting in Italy.”

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