Davy V. Bui

CryptoLogic's Future Too Uncertain

Thanks for your comments. Analyzing a prospect from all sides is great for making investment decisions. As such, you've given the bull case and a clarification of my bear case follows. I'm paranoid by nature and always try to focus on what may go wrong.

I did list Holland Casino as one of their licensees. Keep in mind that management mentioned that the Holland Casino does compete with some of their other clients.

As for your analysis, it looks good if you're willing to grant assumptions that you've made (20% revenue growth, 20+% margins, etc.). My main point is I'm not convinced CRYP will return back to previous levels of profitability, which makes your income projections moot.

I base this possibility on a) the loss of the US market is a structural industry change, b) more companies now fighting for smaller pie and CRYP is not the strongest of these competitors, c) comparing their 1st quarter operating results to the industry leader, Playtech and d) they have a new CEO.

Reviewing Playtech's results from 1Q 2007, it's clear to me that Playtech's competitive position is getting stronger. Just based on numbers taken out of CRYP's investor presentation, Playtech is the better company, generating more net income on half ot CRYP's revenues. And now everyone's squeezed into the same market (mainly Europe), fighting for a smaller pie. CRYP has fixed costs around $18M so they need to hit a certain threshold or else find new markets. China is not going to be an easy market to crack open. Playtech has already beaten Cryptologic there, and are running Mahjong and other games with limited success. As any heavy downloader will tell you, Chinese internet connections are painfullly slow so that could hinder any online gaming growth there.

As for numbers, CRYP had $19.5M in revenue in Q1 2007. They've said that Q1 & Q4 are their strongest quarters, since the better weather draws players away from their computers. So you can't assume $80M in revenue by multiplying Q1 by 4. I would also say that you can't assume they won't lose market share. As a side note, interest income was substantial and accounted for 100+% of Q1 net income and without it, they would have posted a loss.

So if I'm looking at the bear case, what is CRYP worth if things go wrong? Taking total assets and dividing by shares outstanding ($188M / 14 M shares) = $13 /share. If we break it down, here's my liquidation value for the company, listing the recovery factor for each asset:

cash 100% $77,312
security 0 $-
short-term inv 90% $22,500
Acct receiv. 90% $13,644
Prepaid Ex 25% $2,654
user dep 0 -
PPE (applying year-end 2006 ratios to $20.3M)
computer 35% $2,221
furniture 50% $783
software 25% $970
R&D 40% $2,062
leasehold 30% $1,000
intang asset 85% $9,858
goodwill 0% $-

Total ass $133,004
per share: $9.50

If you wanted to value it as a going concern, I don't know if the numbers would jump up all that much. The only barriers to entry are hiring the right people (payroll) and developing customer relationships, so you could probably capitalize some arbitrary percentage of operating costs for marketing but it wouldn't make a huge difference and might just get you back to total assets / shares outstanding.

Finally, I don't necessarily assume that a company won't waste its cash. So if we got to the worst case scenario, would all that cash still be there? That's why management is such a strong factor in my investment decisions and CRYP's management is a big unknown to me.

Please note I'm not saying people should short the stock. It's very possible that they will perform as you expect. I'm trying to assess the probability of CRYP returning to previous levels of profitability and looking at the downside if they miss.

All that said, based on what I know now, I'd look at it again in the $18-$20 range, when the floor is closer.

- Davy Bui