Jim Chanos of New York’s Kynikos Associates was bearish on internet gambling sights long before Senate majority leader Bill Frist “ambushed” the industry with a bill making most internet gambling illegal. Contrary to claims detailed on a website yesterday, it didn’t take an elaborate scheme of inside information about the Senate’s legislative schedule to tip Chanos off on the dangers to internet gambling. For Chanos, the writing was on the wall, in the online gaming companies’ prospectuses and already built into various state laws.
“We were floored when the Senate bill came up and passed in the middle of the night,” Chanos told DealBreaker in an interview this morning.
On September 30, 2006, the US Senate passed the port security improvement act of 2006 by unanimous consent. The bill included an amendment preventing financial entities from processing credit cards, checks and similar transactions in connection with Internet gambling. Despite the fact that similar measures had passed in the House, many were caught off-guard by the inclusion of the anti-online gambling provisions in the Senate Bill. Indeed, some commentators had speculated that the Senate lacked time on the legislative schedule to pass the bill.
But not Chanos. According to the Financial Times:
“Kynikos Associates, had put a large slice of its $3bn in assets on a bold punt that shares in the internet gambling sector were about to go into free-fall.
And on October 2, shares in the companies did precisely that as about $5bn was wiped off their value in just a few hours of trading in response to a US Senate decision to introduce tough new laws cracking down on gambling on the web.”
Chanos had been bearish on the internet gambling stocks for several months.
In an interview today, Chanos described to DealBreaker three reasons, in addition to possible legal risks, that underlay his view of online gambling companies. “First off, we all believed that it was a cut-throat industry with no barriers to entry. Second, there was the faddish nature of poker. Television ratings were already down. Third, there was the silliness of the whole concept of Americans sending their money to off-shore companies with very little assurance about the way these operations were run,” Chanos said.
An internal Kynikos email dated September 9th, a colleague of Chanos describes the legal risks faced by the online gaming industry detailed in an article that appeared in the Guardian:
“The first paragraph is worth noting as it mentions that there are seven states that have internet gambling laws and that could be as a big a threat as the federal wire Act. The bottom part of the article is also worth noting because it shows this stuff is and should not be a surprise with respect to PRTY to anyone or at least as long as they read the prospectus and the section about violating state laws.”
Chanos is also quoted in the September 29th issue of Value Investor Insight newsletter from an interview he gave earlier.
Chanos also expects the plaintiff’s bar, representing gambling addicted clients, to be a threat. “When you run an illegal enterprise out in the open,” he says, “you’re exposed to all sorts of problems.”
The risks don’t appear to have been lost on PartyGaming top management.
The company has gone through two CEOs since going public in June of last year and three other top executives have left over the same period. “The early guys cashing in tells me they think the best is past,” Chanos says.
Indeed, Chanos was warning about online gambling as early as February 2006, when he addressed Kynikos Associates “Bears In Hibernation” conference on the subject. Later that year, in May of 2006, he addressed a conference at Goldman Sachs and reiterated his warnings about the risks faced by the industry. In June Chanos was interviewed on Bloomberg television, where he told Bloomberg's Deirdre Bolton that “a shakeout is actually eminent” in online gambling.
(The story on the website also made a big deal out of Chanos’ connection to former Nevada Attorney General George Chanos, Jim’s cousin. “I have never discussed internet stocks with my cousin,” George Chanos told DealBreaker. “And I never discussed the legislation with Senator Ensign.”)
This seems more than decisive to us. Chanos didn’t need a conspiracy to tell him that online gambling was in trouble. He just needed to keep his eyes and ears open. So there you have the answer we asked in yesterday's headline, "James Chanos: Genius Shortseller or Politically Well-Connected?"