From Russia with Luck -- Compu-Dawn Gambles on Lottery License

Everyone knows lotteries are a gamble, but an investment in a lottery that doesn't yet exist represents a special roll of the dice.

Compu-Dawn (CODI) is willing to take that risk. The Cedarhurst, N.Y.-based company on Wednesday announced it was purchasing a 50% stake in Press-Loto, a Russian company that holds the right to establish the first national online lottery in that country.

Currently, Russia has no online lottery, which ostensibly would be run from computer terminals placed in retail outlets. The lottery operations are expected to start in Moscow and expand to Nizhny Novgorod, the country's third-largest city, sometime within the next two years, according to the company's press release. However, Compu-Dawn officials also predicted a lottery could be profitable in as soon as six months with a limited amount of computer terminals.

After a trading halt Wednesday on the Nasdaq SmallCap Market to announce the news, the stock spiked to a historic high of 15 1/8 before falling back. Compu-Dawn was trading at 10 5/8 at midday Friday.

In a conference call Thursday afternoon, Mark Honigsfeld, chairman and chief executive of Compu-Dawn, went into great detail about how the lottery would work, how much money other national lotteries generate, and the potential revenue on the horizon for the company.

He shied away from deal specifics, probably for good reason. The stock payment for the lottery stake will initially dilute Compu-Dawn's outstanding shares by 55% with the potential to increase that dilution to 80%. Such dilution to the stock at its current price could deflate the per-share price to around $2.30 for current shareholders. The deal also will change the management of the company, and obligate it to raise further capital to fund the start-up of the lottery.

"We admit we are giving away majority control of the company, but this deal could result in revenue of hundreds of millions, if not billions, of dollars," said Honigsfeld in an interview.

Of course, someone also could make "hundreds of millions, if not billions, of dollars" if they found a way to turn lead into gold, too. And running a profitable lottery in Russia is only slightly more likely than that age-old alchemist trick, according to some people familiar with such things.

"There is no national legislation supporting a Russian national lottery," said a spokesman for Gtech Holdings (GTK), which runs 70% of the world's lotteries. "Without government support, lotteries there are prone to all sorts of wild practices."

Alan Woinski, president of Casino Journal Publications Group, a trade press for the gaming industry, agreed. "If Gtech and the other big boys are not bothering to pursue a lottery in Russia, I find it hard to believe that there is such a good market for it."

In its press release and the conference call, Compu-Dawn compared itself to Gtech, a $1.4 billion market cap lottery company that is a main supplier to the U.K. online lottery. The U.K. lottery raised $7 billion in annual revenue in its first year of operation. Indeed, Honigsfeld implied Compu-Dawn actually beat out Gtech in securing a piece of the Russian pie.

The spokesman for Gtech said the company had never heard of Compu-Dawn, and Gtech would not pursue a deal in Russia without national legislation and government support. "A license without government support is not worth the paper it is printed on," he said, adding Compu-Dawn's announcement is the latest in at least a dozen recent announcements of Russian lottery license bonanzas.

Under terms of the deal, Compu-Dawn will issue 3.7 million new shares, worth roughly $43 million, and additional warrants, performance-related common shares and convertible preferred shares to Rugby National in exchange for Rugby's 50% stake in Press-Loto. Compu-Dawn said the total value of the deal could reach $117 million -- roughly 3.5 times its current market cap.

Rugby National is a U.S. private company with no operations; its sole possession is a half-ownership in the intellectual property rights to the Press-Loto license to hold an online lottery in Russia. The other half of Press-Loto is owned by the Union of Journalists of Russia and its charity, with a minority interest held by a private Russian group.

Right off the bat, the issuance of the new shares under the terms of the deal will more than double Compu-Dawn's outstanding float to around 6.5 million shares, and give Rugby National a 55% stake in the company. The warrants and convertibles, if all exercised, could balloon Compu-Dawn's outstanding shares to almost 14 million, giving Rugby National an 80% stake in Compu-Dawn. Rugby National founder Harvey Weinstein will become chairman and president of Compu-Dawn when the deal is closed. Honigsfeld will remain CEO.

Honigsfeld stressed that the deal carries guarantees for Compu-Dawn's shareholders. Most importantly, the company must see a stream of $36 million in solid earnings from the lottery business before Rugby National can convert any of the preferred shares, he said. Compu-Dawn would have to see earnings of $5.40 per share before the convertibles become exercisable, Honigsfeld said. Even on a fully diluted basis (such as, if the outstanding shares reach 14 million) investors could expect $2.57 in earnings per share, he said.

Those are lofty numbers coming from a company that dabbles in red ink as much as Compu-Dawn. The company is a $34 million market cap business whose sole operations, up until this week's announcement, consisted of making software for use in law enforcement communications. Even with annual revenue just over $500,000, the company reported a net loss of $4.4 million, or $1.95 per share, last year. That figure was a whopping five-fold increase from its reported net loss of $570,769, or 34 cents per share, in 1996. The company blamed a one-time amortization of previously deferred costs in its bridge loan financing for the increased losses. No analysts currently follow the company, which went public last June.

Honigsfeld describes the Russian opportunity as a double-win, since he believes Compu-Dawn will be able to sell its law enforcement software to the Russian police departments. Compu-Dawn already has contracts with police departments in New York's Westchester and Putnam counties, among others.

The company has just 2.83 million shares outstanding, with about 51% of them held by insiders, including a 30% stake by Honigsfeld.

With that tight grasp, Compu-Dawn should not have trouble getting this deal past shareholders. A vote, which needs to take place within 90 days of the deal announcement, has yet to be scheduled.

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