Horse Racing Would Be Foolish to Decline A Yearly Payment For California Online Poker Concession

Recent reports coming out of California indicate online poker legalization may have a better chance of becoming a reality in 2016 than many people expected, thanks to a newly proposed $60 million annual payment for the state’s horse racing industry with the stipulation that the tracks forfeit their ability to operate online poker sites.

The state’s horse racing industry, backed by unions, has been unwavering on this key issue, saying nothing short of a bill where tracks would have the opportunity to receive full licensure would gain their support. However, the offer of $60 million annually is likely beyond their wildest expectations, and considering the potential size of the California market, and where racing would likely fall within the hierarchy, the horse racing industry would be very wise to accept this offer, or even a far less substantial offer*.

*$60 million is unlikely to be the final number, as tribal leaders have already expressed concerns over the size of the subsidy based on market potential.

Reason #1: Startup costs

There is a misconception that setting up an online poker site is relatively easy, and once you have it set up you can essentially print money. Reliable, user-friendly software doesn’t spring into being overnight, and the companies that have spent years and millions of dollars creating online poker software aren’t going to give it away for free.

By accepting the yearly payment, the horse racing industry will likely be the only group with a vested interest in online poker to turn a profit in the first year. By not launching an online poker site, tracks avoid the following costs:

• A proposed $15 million licensing fee
• The vetting and regulatory costs the state will bill them for
• A proposed 15 percent tax on gross gaming revenue
• Paying a hefty percentage of gross gaming revenue to an online gaming partner (likely in the 8-15 percent range for a turnkey product)
• Early marketing costs that will likely run well into the seven figures on a monthly basis

Reason #2: Market size

Based on analysis by Eilers & Krejcik Gaming, Acedimicon and PokerScout.com, Gambling Compliance, OnlinePokerReport.com, and historical data based on New Jersey and Nevada, California’s online poker industry will generate about $215 million in gross gaming revenue in its first year.

According to these same analysts, the market’s peak at full maturity is projected to be between $260 million and $360 million.

The $60 million annual payment to the racing industry amounts to 28 percent of the total online poker gross gaming revenue in Year 1, and 17 percent – 23 percent of the total gross gaming revenue at full market maturity.

Quite frankly, the racing industry will never have this type of market share.

Using an unachievable top-end number, PokerStars‘ profit margin of 40 percent (based on the numbers reported during the company’s acquisition by Amaya Gaming), racing would still need a  market share of 42 percent ($150 million of the state’s total GGR of $360 million) in a fully mature California online poker market to see profits hit $60 million.

And that’s best case scenario all around. In a highly regulated and licensed online poker market, with multiple competitors, profit margins are unlikely to be anywhere near 40 percent, and I suspect most operators would be ecstatic with 10 percent profit margins.

As Chris Sheffield of Penn National told a Pennsylvania Committee, “a 4 percent tax rate in Gibraltar left us with a 15 percent margin.” Sheffield went on to say that the margin would be lower in the U.S., and that was in regards to full online gambling, not the far costlier online poker.

Reason #3: Difficult to compete

I don’t know what racing thinks they’re going to make, but assuming online poker licenses were made available to California’s seven racetracks, the chance they could generate $60 million in revenue on a yearly basis is at best not-trivial, and the chance they could generate $60 million in profit (which is what the $60 million yearly payment would amount to) is a number approaching zero.

Just for a quick comparison, New Jersey’s entire online poker industry generated $24 million in revenue in 2015, and it’s unlikely that any of the state’s online poker operators — 888, PartyPoker, Borgata, and Caesars’ WSOP.com — made a profit.

California will certainly be a much larger market, by a factor of 10 according to most analysts, but with that larger market comes increased competition, and racing’s ability to compete is questionable at best.

The Pechanga tribe will be a major force in the market, likely partnered with several other tribes to create an online poker network.

Rincon and Caesars will likely launch a WSOP.com site.

And then there is the PokerStars network, that includes the Morongo and San Manuel tribes, as well as the Bicycle, Commerce and Hawaiian Gardens casinos.

The racing industry will have a hard time competing with these other entities, most of whom will possess marketing budgets that dwarf that of the racetracks.

What should tracks accept?

As I noted in the opening, I suspect the final offer to racing will be well below $60 million annually. That said, racing should still jump at just about any reasonable offer.

If it’s not already abundantly clear why, let me make explain why: If they’re offered $25 million annually, coupled with the ability to partner with operators as a service provider (affiliate or perhaps skin), this is still a very good deal, and far more money than they could ever reasonably expect to make as an operator.  

Assuming once again that the market is worth $360 million at full maturity, if they could somehow squeak out a 15 percent profit margin (unlikely), racetracks would need to have 46 percent market share ($165 million of the total $360 million GGR) to pull in $25 million annually.

I can’t understand why they wouldn’t accept any reasonable amount of money as a subsidy.