Most gaming chief executives will remember the events of October 2006 with a shudder. The passage of acting through congress to improve security at America's docks suddenly turned into an assault on online gaming firms, with the result that the likes of 888 (888) had to end their presence in the market, or face the threat of crippling criminal prosecutions. The end result was an exile from the US market for UK gaming companies that has lasted the best part of a decade. That is until the state of New Jersey recently allowed online casino games to feature as part of its new regulatory regime. Investors have since rushed to buy up shares in companies with deals, or joint ventures with US-based gambling operators. While the possibility of big returns from online gaming-starved US gamblers is based on previous experience, there is a lack of clarity about what is exactly on offer in gaming's new (old) frontier.
Though chiefly famous for being next to New York City, and as the setting for HBO's feted TV series "The Sopranos", New Jersey has taken on the mantle as the great white hope for UK gaming companies who are trying to re-establish a presence in the world's most valuable gambling market. The state is now weighing up the merits of 37 separate applications to provide online casino games that are tied to a physical casino in Atlantic City, the region's gambling hub, with UK-based companies like Bwin.Party Digital Entertainment (BPTY) in the running. However, companies seem wary of taking too much risk on opening a US-based subsidiary, suggesting that memories of what happened during their last sojourn on the other side of the Atlantic are still strong.
Hedging bets…
The kind of deals that companies have agreed with US operators reflects two basic realities. Firstly, European companies are streets ahead when it comes to online gaming technology as the US government's action in banning online gaming hindered the natural development of the industry. This isn't just about games, but the payment processing, accounting systems and software development that makes up the nuts and bolts of the industry. Consequently, US casino operators like MGM Grand have to sign partnership deals in order to compete. Secondly, the cost and expense of setting up a subsidiary means that gaming firms are reluctant to risk significant amounts of equity, which is why fee-based deals and joint-venture partnerships that pay out a percentage of the rake (gross gaming profits) are the norm.
New Jersey is blazing a trail when it comes to online gaming, but this comes with several important caveats. To begin with, the changes to legislation in New Jersey are notable chiefly for what is restricted, rather than what is allowed. For instance, the 'Garden State' requires operators to link up with existing casinos in order to be able to supply casino games online. This leaves the potentially lucrative sports betting arena out in the cold, while the physical casino requirement feels like an artificial subsidy for an industry where revenues have matured and are actually in slow decline. The rule also means some potential operators are considering buying up existing casinos in order to be able to operate legally. For example, gaming investment group 2UP has a reported war chest of $330m (£193m) from Asian investors to buy a vacant or struggling casino in order to obtain a New Jersey licence. Prominent UK gaming groups who have applied for New Jersey licences include Bwin.Party, Betfair (BET) and 888.
Double or quits…
Whether the investment is worth it is currently anyone's guess. New Jersey reckons it can realise a tax take of $180m by 2017, which at an average tax rate of 15 per cent would imply an annual turnover approaching $1.2bn, according to gaming consultants GBGC. Clearly, that's a huge over-estimate given the relatively underdeveloped scale of the market as it currently stands. However, the estimates of first year of sales in New Jersey are in a range between $250m and $600m, and this probably captures an accurate portrait of America’s total market size if states agreed to online gaming on an individual basis. However, to put that into context, the UK online gambling market was worth £2bn ($3.1bn) in 2012, so it is still very early days.
Whether sales will meet forecasts is dependent on how well organised companies are when launched, particularly as there could be capacity constraints when it comes to getting punters through the online portholes. It is true that New Jersey had a larger than average participation in online poker before a US crackdown in 2011 dubbed "Black Friday", but worldwide gaming growth has been driven by smart mobile phones, and it isn't clear whether this will translate immediately into the US telecoms market as, generally speaking, Asians and Europeans have been quicker to incorporate apps and smart phones into everyday use.
Gaining a presence in new markets costs money, which is probably why UK companies seem content in the deals that have been signed so far, to let their US partners deal with the hassle of attracting punters and take a fee for their services instead. This could leave the way clear for firms that can supply the affiliates that ultimately influence the number of punters who use gaming services; affiliates direct users to specific sites in return for a fee and a percentage of future revenue the punter generates. Surprisingly, that might not include Playtech (PTEC) which seemed to give up on an entry into the US market in the short-term after cashing out its near 10 per cent stake in Sportech (SPO), which has a very large US presence in several gaming markets.
IC VIEW:
It is possible to be incredibly wary about claims made for the American gaming market. It is undeniably the richest and most underdeveloped in the world as things stand, but investors should not automatically assume that all will be for the best. Profits, at least in the initial stages, may be hard to come by and the partnership structure the industry has embraced is often not the best way to build a new business - witness the regular fallings out between William Hill and Playtech. For that reason we are inclined to wait and see before backing the online gamers to reach new share price heights.
