U.S. sports wagering primer
Although the U.S. sports betting market is soon to be up and running in 10 states, it’s still very early in the game… states still have plenty of time to get it right, and they’ll need it
It has been said that sports betting is a low-hold business and that it’s easy to oversell its revenue potential. Both of those statements are true, but there’s also a strong argument that legal and regulated sports betting is the most dramatic development to hit the American gaming industry in decades.
Indeed, sports betting will test the very fabric of gaming regulations, the relationship between lawmakers and regulators, and open the door to expanded mobile and online betting. It has the potential to touch more potential customers and test the ability of jurisdictions to adapt to a changing technological landscape than any new form of gaming in years.
Sports betting will also force a reckoning with the massive illegal online gaming market in the U.S. The scale of its success or lack thereof will depend largely on regulated gaming’s ability to compete with an entrenched gray-to-black offshore market. This aspect of the sports betting saga will also inevitably result in profound—and many would say long overdue—changes to the American market.
Since the Supreme Court green-lighted states to create their own sets of laws and regulations for sports betting last May with the repeal of the Professional and Amateur Sports Protection Act of 1992 (PASPA), there have been innumerable discussions in the industry on how best to proceed. This article will summarize a few of those… namely sessions on sports betting at last fall’s G2E and a webinar hosted last month by the consulting firm of Eilers & Krejcik. Combined, these discussions will give readers a good flavor of many of the key issues facing all sports betting stakeholders in the legal U.S. market.
LEGACY ISSUES ABOUND
By the close of 2018, it was clear that all gaming states are not created equal when it comes to getting new sports betting markets off the ground. Commercial jurisdictions with relatively uncluttered casino markets got off to quick starts, while tribal markets, most facing far more complicated legal paths, are still in wait-and-see mode for the most part.
New Jersey, for instance, which by the end of November was approaching $1 billion total sports wagers for its new market, was very well-positioned for sports betting because in 2013 it rolled out online casinos, according to George Rover, managing partner Princeton Global Strategies, at the G2E session “Changing the Game: the Legal and Regulatory Impacts of a PASPA repeal.” “As a result, we got to know companies like William Hill and a lot of the European operators, so a lot of the tough spade work was done,” said Rover, who was head of New Jersey’s Division of Gaming Enforcement from 2011-16. “Meshing sports betting on top of the online product was relatively seamless for New Jersey regulators.”
Mississippi is another jurisdiction that got off to fast start. With sports betting potentially in the offing last year, the state cleared the way by repealing the portion of its gaming law that prohibited sports betting—so long as it was limited to casinos. That important step resulted in a tale of two sports betting markets in the neighboring states of Mississippi and Louisiana. With the Supreme Court repeal of PASPA, Mississippi needed just 10 weeks to roll out sports betting on August 1, just before the NFL preseason. “It has worked very smoothly,” said Jay McDaniel, deputy director, Mississippi Gaming Commission. “We have 28 commercial operators, 21 of which have a sports book. We are limited geographically; we don’t have Internet or remote wagering statewide but you can do it on-property. Operators were prepared as were regulators. In the first two months, I think results have exceeded expectations of our operators. Annual earnings are expected to be around $40 million, which is good for our state, which is a small population state.”
Mississippi’s results have been buoyed by the absence of sports betting in its Louisiana feeder markets. Senator Daniel Martiny introduced legislation to legalize sports betting last year at 16 casino locations, but the bill faced a couple of hurdles.
“This was not a fiscal session so there were no taxes associated with the bill,” explained Trudy M. Smith, confidential assistant, Louisiana Gaming Control Board. “The only financial piece that was addressed was $1 million on the cost side.”
Then along came racetracks and video poker, who wanted in on the market. “So it went from 16 casino locations to 964 bars, 537 restaurants, 13 racetracks and 202 truck stops… in other words, it went from regulating 16 locations to over 1,700 locations, which increased the cost figure to over $25 million with no taxes to offset it,” said Smith. “And then you had the overlay of anti-gambling and anti-expansion of gambling. But Senator Martiny is committed to bringing it back, and I think that the next session, which will be a fiscal session where we can add the taxes back in and work out a more feasible plan.”
The state of Mississippi jumped into sports betting and when they did, the Mississippi Band of Choctaw Indians was able to follow. “What’s important and different about that is there is no exclusivity provision in their compact,” said Stephen M. Hart, partner, Lewis Roca Rothgerber Christie, at a session called “Sports Betting: The Path Forward for Indian Country.”
Hart pointed to North Dakota as another tribal market that can move forward with sports betting; their compact says that “as long as PASPA doesn’t prohibit,” and, he noted, PASPA doesn’t prohibit anything anymore.
“New Mexico could also start offering sports betting today,” said Hart. “Their compact says they can do all Class III gaming, and certainly sports betting is Class III gaming. Off-reservation, online or mobile might be more complicated.” Shortly after these comments, the Bernalillo, N.M.-based Santa Ana Star Casino Hotel went live with sports betting.
The big complication for Indian tribes and sports betting right now is exclusivity, according to Hart. “It’s a very important concept but it’s very tough when it comes to sports betting,” he said. “All of the state people who negotiate compacts and do that kind of work got stars in their eyes and thought this would be worth billions and zillions of dollars. And then as discussions go forward and you try to correct that, it’s not easy. The revenue shares start looking smaller to governor’s offices and then other people come in to lobby, and when tribes come in and say, ‘hold on, we’ve got exclusivity here,’ a whole other discussion starts. So I think there’s a good future for Indian tribes and sports betting, but it’s going to have to begin with some very hard and earnest negotiations.”
Steve Bodmer, general counsel, Pechanga Band of Luiseño Indians, echoed those comments: “There’s an initiative in California that people surmise may have come from the cardrooms or Las Vegas gaming interests,” he said. “To me, that’s not important. The question we need to think about is where does tribal exclusivity reside with respect to sports betting?”
If you look at California, exclusivity applies to slot machines and that’s in the Constitution, explained Bodmer, so if you would like to offer sports betting as an amenity in California, you have to reopen the Constitution for one sole purpose: to add sports betting. “Is that for tribes only or do you allow competitors?” he asked.
Reopening the Constitution means other longstanding unresolved gaming issues involving more than just tribes could potentially be up for discussion, adding to the time it will take for sports betting to ultimately be available to consumers. For instance, Bodmer noted that there’s an initiative in California that “people surmise may have come from the cardrooms or Las Vegas gaming interests…the initiative would allow tribes to offer craps and roulette. It also prohibits the governor from negotiating compacts with tribes who are not federally recognized.”
THE VIEW FROM WILLIAM HILL
With operations in Nevada, New Jersey, Delaware, Iowa and West Virginia, no sports books operators in the U.S. has a more hands-on view of the market than William Hill. At G2E, CEO Joe Asher addressed a number of key points, such as the politics of sports betting in the U.S., taxation, relationships with sports leagues and betting and technology trends.
“The day the Supreme Court ruled, Mark Cuban, owner of the Dallas Mavericks, said the value of every professional sports franchise just doubled, so I’m not sympathetic to the notion that state legislators should take money from taxpayers and divert it to sports team owners,” said Asher. “They’re going to make plenty of money. We did a sponsorship deal with the Las Vegas Golden Knights. It’s a scenario where they’re delivering value to us and we’re paying for that value. That’s the measure of how folks should expect leagues to be compensated. MGM made its deal with the NBA which, according to reports, is a lucrative deal to the NBA and all power to them.”
Asher added that the idea that betting operators should get the result of all or some wagers using official league data is a monopoly. “If you have to get the results using their data they can charge you all they want,” he said. “So we don’t think that would be fair or commercially reasonable for a state legislature or Congress to mandate.”
The average hold for sports books is generally placed around 4.5 percent, so adding costs to what is already a tight profit equation is a competitive issue; low-end estimates of black market handle, per Eilers & Krejcik, are $60 billion in annual wagering. “There is this massive black market that exists for sports betting in the U.S.,” said Asher. “Anything that makes it more difficult for the legal and regulated market to compete with the black market is not in anyone’s interest; not the legal operators, the government, from a revenue perspective, or the leagues. We should be together on the issue of doing whatever we can to fight the black market, and taxes on the legal market that the black market is never going to pay is not helpful. The black market bookie is not buying official league data from the NBA, and he is not paying the .5 percent or 1 percent integrity tax.”
William Hill’s business experience in Nevada, where it has close to one-third of the market, is a case study for states looking to see what works from a product standpoint. For instance, in-play wagering, which is betting that occurs after a game has started, is clearly the fastest growing piece of the business, said Asher. “People are still betting on the outcome of the game, i.e. who’s going to win it, or the total score,” he said. “In-play is not so granular, as… ‘Will the next pitch be a ball or a strike?’ These are bets on a subset of the game. In baseball, a very popular bet is will there be a run scored in the next inning, yes or no? It distills a three-hour game and chops it down to a 20-minute game. There’s not that much time to get a bet down in game situations whereas in baseball you have a natural break between innings. As part of the Golden Knights deal, they’re now displaying the in-play option in T Mobile Arena between periods. Those are the types of things that will become more significant.”
TAXES & FEES
As states ponder the best way forward on sports betting legislation, there isn’t a lot to go on in the way of domestic experience… but there’s plenty to learn from overseas. In “What’s your sports betting potential?” a webinar presented by Eilers & Krejcik, Managing Director Chris Grove said that in a year or two, we’ll have a far better chance to assess the short-term effects of tax policy in the U.S., but we do have some salient observations from international markets.
“The sweet spot for tax rates is somewhere in the 15 to 20 percent range of gross gaming revenue,” Grove said. “Obviously, every jurisdiction has its unique considerations and some tax rates might work in one jurisdiction that aren’t necessarily appropriate for another. When we talk about a sweet spot, that’s a tax rate that provides the greatest benefits to the government in terms of revenue and sustainability of the market. The lesson that we’ve learned from international jurisdictions and the lesson that most states seem to adhere to, by and large and to date, is that between 15 to 20 percent delivers the greatest amount of value to state and district governments, consumers and creating a market that’s commercially viable for operators.”
Considerations for policy makers include: How does my tax rate intersect with the amount of revenue that I can capture from the existing illegal sports betting market? How much is left over for operators to reinvest in the product? How much marketing can be done? Grove pointed to a sharp drop-off in capture rate once the tax rate starts to move above 20 percent. “As you move above that threshold, what’s happening, and what researchers have seen happen, is the product becomes less competitive, pricing and promotions become less competitive, and the regulated market can’t withstand the competitive pressure of the existing illegal market,” he said.
Also, for most jurisdictions, the federal excise tax is going to come into play. That’s one-quarter of 1 percent of the total amount bet. Every quarter percent of handle represents about a 5 percent tax on revenue, according to Grove. So regulated sports betting in most states is starting with a 5 percent tax rate that has to be paid to the federal government before the state tax rate even comes into play.
As for license fees, in Grove’s view these are an effective extension of a tax rate, especially when those fees are substantial. “Everyone has taken note of the wide delta between states like West Virginia, with a relatively modest license fee for sports betting, and states like Pennsylvania, which assigned a license fee of $10 million to operators who want to bring regulated sports betting into the market,” he said. “When you see license fees escalate to those kinds of numbers, they effectively become an extension of the tax rate when you’re talking about topics such as illegal market capture and consumer appeal.”
Grove added that a given state’s stakeholder landscape should factor into its approach to license fees, namely who are the key license holders that they want to participate in sports betting and what sort of cost thresholds are appropriate if they want to win full participation. “A state like Pennsylvania may be dealing with a wildly different set of considerations on that front,” he said. “Also, license fees don’t just apply to primary operators. You also have license fees for suppliers and, with sports betting and online gaming in general, you have non-endemic brands who are interested in competing in these markets. I think that’s an issue for state regulators; is there a separate license fee structure for other brands that are interested in accessing the market and is there a license fee structure that balances what you are trying to do competitively with state government goals?”
LESSONS FROM NEW JERSEY
As mentioned above, New Jersey’s entry into online gaming in 2013 has facilitated its early success in sports betting. The state’s experience also offers some valuable lessons for the U.S. sports betting market as a whole since, whether states enter the online arena or not, they will compete with it as soon as they launch legal sports betting.
First, on the issue of taxes: New Jersey has a range of tax rates on sports betting, for brick-and-mortar casinos, online operations and racetracks. “One thing we need to keep in mind is the cost of customer acquisition and customer retention in an online environment is much more expensive than in a land-based environment, and I think New Jersey gets that,” said Jeff Ifrah, founder, Ifrah Law and executive director and general counsel, iDEA. “New Jersey understood that in order for the mobile side of gaming to succeed at the same pace as land-based gaming, they needed to understand all the expenses that go into making a successful mobile program. You can’t ignore the high cost of acquiring those customers and continuing to market to them in order to retain them. If a customer comes into a land-based casino and has a good experience they’re there, they’re captured. You can sell them food and entertainment. An online customer may only be there for a fraction of a second to place a bet in the sports betting context or to play a sit-n-go at a poker game.
“The point is you don’t have everything to sell that a land-based environment offers. It costs much more to keep them there and keep them engaged. New Jersey didn’t look at this issue as superficially as some other states are thinking about doing and it has allowed online gaming to grow there. Not initially—they didn’t turn a profit for four years—but keeping tax rates and license fees at appropriate levels has allowed that industry to succeed.”
Similarly, New Jersey serves as a model on how regulators can work with the industry to solve competitive issues within the online space. “If you’re going to take a huge license fee from operators, as in Pennsylvania, you’ve got to hope that regulators are going to turn around and help you out by keeping out this huge offshore competition; New Jersey did that without a huge license fee because they want the program to be a success,” said Ifrah.
It’s very difficult to convert offshore customers into players in a regulated environment, but Ifrah noted that there’s a general belief that consumers in the U.S. would rather play in a regulated system all things being equal. “What regulators in New Jersey did, working with the industry, was identify who was promoting those offshore books online and they basically wrote them all cease-and-desist letters, and they threatened legal and enforcement action,” he said. “They also reached out to a lot of operators and their advertisers in the New Jersey market and let them know when they identified one of their downstream partners or vendors promoting an offshore book and telling them it needed to stop. Dedicating resources within your enforcement division and using those resources to learn about the offshore market, the advertisers and the affiliates that participate in it, and threatening them with penalties and enforcement is literally how you stop the promotion.”
As a result of these efforts, New Jersey is the only state in the country that has been able to literally get offshore providers to block New Jersey residents from signing up. “That’s a pretty significant concession,” said Ifrah.
iDEA has studied the overall impact of online gaming in New Jersey. “The first thing the casino industry was interested in knowing: Does online gaming cannibalize revenue at existing gaming facilities?” said Ifrah. “The answer to that question is a resounding no, it does not. Our report concluded that the entire market ends up benefiting and growing when you bring gaming online.”
In addition to generating over $1 billion in revenue, online gaming in New Jersey also created over 3,300 jobs and $83.5 million in tax revenue for state and local governments.
So what would sports betting mean economically for a state like, say, Indiana? Eilers & Krejcik studied that issue for the state. It considered a tax that was 9.25 percent of gross gaming revenue (GGR), not counting the federal excise tax, so it approached Grove’s “sweet spot” range. “We looked at mobile and retail betting; in the case of retail-only, it’s only about half the impact,” Grove said. “For the first five years, which is a ramp-up period where we don’t anticipate results to be at full-impact stage in the first couple of years. In that period, the study anticipated $88 million in gaming-related taxes and $59 million in non-gaming taxes.”
Tax conversations tend to revolve around the GGR rate and GGR tax revenue, but it’s almost as important to look at secondary impacts of things like payroll taxes, income taxes and excise taxes on other forms of spending, according to Grove. “If we consider other cases, where we have a tax rate of 20-30 percent or even higher, we might not see the market reach near the same potential… in that case, we don’t see the same investment or the same employment nor do we see revenue from taxes that are associated with employment like income and payroll tax,” he said.
Looking at employment, it breaks down to roughly one job for every $350,000 in revenue, according to Grove. “That’s probably a number that works ok for other jurisdictions,” he said. “In this case we found two jobs for every one direct job. That’s going to differ state-by-state. A state that’s larger and can source more things internally will see higher impacts. Probably the one exception to this small state vs. large state would be Nevada where a lot of the suppliers already exist within the market.”
Other impacts local professional sports stakeholders need to take into account: increased betting leads to increased engagement in sports, which means increased visitation to the state, such as visitors spending an extra hotel night and eating a few extra meals. These impacts are meaningful and can be quite large but they aren’t necessarily captured by basic economic impact methodology.
“Policy makers are treating these studies with caution,” Grove acknowledged. “This is uncharted territory, particularly the related impacts. And even with regulated sports betting, outside of Nevada, we still in the really early days of understanding how it’s going to work. These numbers are encouraging for policy makers but they are waiting to see some direct experience and direct impacts before going all-in on the idea.”
BALANCING LAWS & RULES
Washington DC is discussing sports betting and one of the approaches lawmakers there are considering would be for most mobile betting to run through the DC Lottery. [NOTE: After this webinar, the District of Columbia Council approved a sports betting bill that gave a mobile gaming monopoly to lottery operator Intralot.] This led to a question on what should be explicitly defined in legislation and what should be left for the regulators to decide, among other things.
“Generally speaking, legislators should set out the big picture, set down the absolutes, and in sports betting there are several,” said Mark Lipparelli, founder, Gioco Ventures and former Nevada State Senator and ex-chair of the Nevada Gaming Commission. “Bankroll requirements, auditing, record keeping, mobile gaming, the ability to have redress in case of a dispute… those are all big picture issues that legislation might contain. The challenge with having legislators get down into the nitty gritty is it creates lock-in—once legislation is in place, it can be a bugger to change. To the extent that a state has a robust regulatory framework, it’s good to give the regulators and the commissions the tools to frame specific regulations that are flexible and can adapt to the marketplace.”
Regarding the DC mobile gaming discussion, Lipparelli said one other important consideration regarding lotteries being a part of the operating process how will the agencies adapt to the changes in technology that are likely to occur over a five year period.
“As everyone who participates in the gaming industry knows, when those changes come if you’re locked into a long-term lottery contract, the marketplace will demand quicker turn on new kinds of technologies,” Lipparelli said. “There will be people who come to the industry with ideas, whether it’s mobile devices; interactive TV and all those kinds of options; or connectivity to stadiums. I think you’re going to want to leave regulators with the requisite amount of flexibility. New Jersey has been a tough regulator, but at the same time realizing that the industry won’t be able to succeed and patrons won’t make their way to the market if the rules are too rigid and the regulator proves inflexible. You have to strike the right balance but doing that at the legislative level is not the right place to do it.”