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Shares of online payment processing company Optimal Group (OPMR) have been crushed on news that the Senate passed the Unlawful Internet Gambling Enforcement Act of 2006. The legislation, which directs the Federal Reserve and Treasury Department to enact regulations to cause financial institutions to identify and block certain transactions involving internet gambling, will certainly have an adverse effect on Optimal Group. The company owns 76% of FireOne, an Ireland-based provider of payment processing services for the online gaming industry.

I agree with those who say that FireOne is impaired as a result of today's legislation. According to the latest 10-Q, the gaming assets transferred to the FireOne division accounted for a little under half of the company's revenue. Since most of the gaming revenues are derived from U.S. customers, its fair to assume that over the next year revenues from this division drop as much as 80% and profits drop accordingly. Potential upside could come if: (1) there is a delay in the regulations; (2) the company develops a way around regulatory hurdles; (3) FireOne expands its non-U.S. customer base; (4) U.S. legitimizes regulated internet gambling and FireOne emerges as a payment processor; or (5) the FireOne unit, which is traded on London's AIM exchange, is spun-off or sold. Note that the company announced on August 7, 2006 that it had retained Genuity Capital to "explore strategic alternatives."

Even if the outlook for FireOne does not improve, I still think Optimal Robotics is a bargain. The company's non-gaming unit, Optimal Payments, accounts for more than half of the revenue. While it has lower margins than the gaming unit, Optimal Payments is still profitable on a GAAP basis and generates considerable cash flow (look at the Segmented Information table in the 10-Q then back out amortization).

The balance sheet is solid. The company has cash and investments net of bank debt and customer obligations of $118.9 million ($4.61 per share, fully diluted), working capital excluding reserves of $77.7 million, and shareholder equity of $212.0 million (all as of June 30, 2006).

Because Monday's huge gap down caused implied volatility to skyrocket, I took a bullish position by selling options. I wrote November $7.50 puts for $.45. If they are exercised, I will have a cost basis of $7.05, plus commissions. The stock traded at around $8.20 when the puts were sold, and now trades at $8.35, comfortably out of the money.

UPDATE: OPMR closed Monday at $8.80. I expect the volatility to drop quite a bit today and cause the price of the November $7.50 puts to drop as well.

DISCLOSURE: I am short November $7.5 OPMR puts. Not a recommendation to buy or sell any security. For informational and educational purposes only.

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Source: Optimal Group Crush Creates Buying Opportunity