PwC examines new entrants and market convergence in the growing online casino gaming space
We expect a continued strong level of deal activity in the industry driven by these disruptions from new players and from existing competitors positioning themselves to capture market share. It will be critical for deal makers to follow a disciplined approach to their deals to capture the value of these opportunities.
So what is the casino gaming industry? The sector has long been dominated by brick-and-mortar casinos which provide an all-encompassing entertainment experience looking to maximize customer value. However, capital requirements are high—ranging from millions to billions of dollars for each facility. Over the past two decades it has evolved into the online space, fueled by emerging technology and impacted by changing regulation.
EVOLUTION OF A SECTOR
As the dot-com era emerged in the late 1990s, innovation in technology and an essentially undefined regulatory landscape in the online space allowed the casino industry to expand into online gaming. This led to the clear establishment of two key segments in online gaming: real money and social gaming.
Real money gaming: Real money gaming is played on virtual casinos that offer traditional style casino games through websites, social networks, and mobile applications. Regulation varies by jurisdiction. Similar to the traditional casino model, users can wager real currency on games directly against an online operator.
Social gaming: Social gaming, the newest market segment, allows users to play traditional casino games for free through capped virtual currency provided at sign up or on a recurring basis. No regulation exists, allowing companies to reach users in real money restricted areas. Revenue is earned when customers choose to pay for additional virtual currency or other bonuses and locked upgrades. According to Morgan Stanley, the average conversion rate of customers (percent of players who spend money) is around two percent.
Historically, growth and investor entry into traditional casino gaming has been a challenging proposition, given the high fixed costs and barriers of entry associated with the traditional brick-and-mortar casino. The online casino space has been a game changer, allowing for market entry via lower capital requirements with the enticement of higher growth rates, compared to land-based casinos.
The result: New and existing competitors entering this space. As seen in the graph on page 43, social online gaming growth has declined, but is still projected to outpace land-based growth through 2017 and real money online gambling growth through 2016.
DRIVERS OF CHANGE
What are the real drivers fueling this sector transition?
The answer is technology evolution and regulatory change. To start, higher growth rates in online gaming have primarily been due to the innovation in technology driven social media platforms, mobile technology and smartphone use. As these drivers continue to evolve, the industry is expected to react accordingly.
Social media: Online casino game operators have developed casino platforms on high traffic social networks such as Facebook to ride the momentum of social network user adoption and gain access to more users. According to Globalwebindex, 80 percent of internet users use Facebook and on average spend two hours on social networks per day. Time spent may be diversified with increased options in social gaming via these popular platforms.
A smartphone world: According to Ericsson, smartphone subscriptions in 2010 were 0.5 billion and are estimated to increase 12x to 6 billion by 2016. Similar to the social network distribution channel, game operators have developed casino platforms on mobile applications that enable streamlined user gaming.
Ease of access to mobile devices increases the potential market of consumers for online gaming.
Online gaming is heavily influenced by external regulation and controls. Monitoring, predicting, and understanding legislation and the impact of regulation changes can be a key to success and has been a significant driver of change in this market.
Regulation of real money gaming varies by jurisdiction around the world. Countries are becoming more aware of real money gaming and have established regulation to capture tax revenue. Approximately 60 countries license online casino gambling in some form, while 17 percent of countries have bans in place, and a further 41 percent are unregulated. Asia and the U.S. remain two of the larger untapped real money gaming markets due to unfavorable regulation while Europe has a more mature online game market, according to a report from keycasino.com.
Regulations can be beneficial in providing certainty and structure to risk adverse competitors, but increases operating costs to maintain appropriate compliance controls. Companies that take advantage of the unregulated social market, to establish high market share in restricted real money gaming markets such as Asia, may be best positioned to upsell and win real money game opportunities when and if more favorable legislation passes.
A look at the U.S. landscape: Starting in 2013, online casino gaming in the United States became legal in New Jersey, Delaware, and Nevada after a high profile Department of Justice crack down of poker sites in 2011. While favorable domestic legislation shifts have garnered the attention of major international casino gaming operators, they continue to be hesitant in committing too much capital given the perceived risks.
The bounce back in legislation is positive news to the online gaming market. According to the National Conference of State Legislatures as highlighted above, seven other states have introduced online casino gaming bills this year to continue to expand the U.S. market. Entrance of just one new state can result in access to thousands of new customers.
The online casino gaming market growth prospects have resulted in an increased appetite for new and existing gaming companies to enter and increase market share using M&A as a vehicle. As seen on the chart on page 42, in select M&A online gaming related transactions, convergence across the sub-sectors has been a common trend over the past five years and will likely continue as these drivers become more prominent.
Buyers varied over a wide range of verticals including traditional casino, real money gaming operators, lotteries, horse racing, land-based suppliers, game developers, and private equity. The market is addressing the fragmentation of the sub-sectors, and acquiring full solutions to cross market segments and enable more efficient operations. The game developers are the most fragmented segment due to low capital requirements to form startups, opening the door for increased M&A opportunities.
Caesars acted as one of the few brands to move outside the traditional casino online segment (use of third-party hosted platforms) through its acquisitions (Playtika, Pacific) to enter social gaming.
Real money gaming operators (which host owned and third-party branded casino platforms for real money games on websites) merged through large deals (Party Gaming and bwin, 888 and bwin.party) to increase distribution capabilities, pool player networks, and lower operating costs through cost synergies, have found success through M&A.
Land-based suppliers (which traditionally manufacture games for brick-and-mortar casinos) may have become the most diverse of the sub-segments across the online providers, through acquisitions of application providers (MacroView Labs), B2B real money platform technology (Jadestone Group), and social gaming developers (DoubleDown, Product Madness). Layering suppliers’ proven land-based game content that can be converted to real money and social gaming on top of the acquisitions, makes this segment a serious threat. Lottery acquisitions of top suppliers (WMS, IGT) allowed for additional cost and revenue synergies through merging back office and field / customer service operations.
Social gaming developers (which develop social games to host on operator platforms) increased content and user base through tuck in acquisitions of smaller social gaming developers. Cross marketing of games and pushing acquired content through existing distribution channels can provide significant revenue synergy. Zynga, a top social gaming developer, made a push for real money gaming through its acquisition of Spooky Cool Labs.
Overall real money operators defended top market positions, while social became fragmented with multiple competitors across segments. Real money outsiders may have to acquire an established operator in order to become a market leader.
CHALLENGES TO ADDRESS
M&A opportunities may also bring challenges. These challenges can be better understood and mitigated through due diligence and integration planning. Awareness of common challenges within the casino gaming sector is key to successful diligence and planning efforts.
Back office scalability: Back office platforms are often dated and lack scalability. Back office diligence can be conducted to evaluate the target’s systems and scalability, to ensure that such capabilities will align with the acquirer’s growth plans.
Talent retention and cultural considerations: Acquisitions focused on casino game content and developer resources require culture assessments for cross border transactions, as well as talent retention strategies to ensure continuity post transaction.
Brand transition: Deals involving multiple brand purchases can cause confusion to the market if not positioned correctly. Market analysis and stakeholder buy-in is a critical first step to ensuring “NewCo” has the right brand strategy. Following brand decisions, careful planning and execution of customer, employee and vendor communications helps ensure the right positioning in the market.
The regulation factor: M&A in the real money gaming sub-sector will have regulatory implications, with complexity varying by jurisdictional scope. Regulatory compliance requires expertise (external or in-house) and may result in detrimental impacts on deal value if not planned for properly.
Contract assessment:Mergers of companies with the same service providers may result in conflicting commercial agreements in place that can result in high breach penalties. Proper due diligence on potential contract risk should be fully understood and factored into the purchase price.
Capital investment: Level of effort and the required capital investment to port casino game content to new and existing operator distribution channels must be quantified. Exhaustive inventories of games that a company acquires may require significant time and effort to transfer to existing distribution channels (mobile, social network, etc.), as well as large one-time investments in new capital infrastructure.
As the casino gaming sector continues to evolve with the changing technology and regulatory landscape, companies may increase the odds of successful future M&A transactions by employing the strategy of rapid, thorough due diligence, and by executing on detailed integration planning with strong executive sponsorship. Following these strategies should allow companies to enhance their social gaming positions and move fast to capture real money online market share, as the sector continues on this exciting path of evolution.