Regulus Partners, the strategic consultancy focused on international gambling and related industries, takes a look at some key developments for the gambling industry in its ‘Winning Post’ column.
Italy: gambling duties – felice anno nuovo?
The Italian government ended 2018 with further material tax rises for its commercial betting and gaming sectors. In the machine sector, AWP and VLT duties will rise twice (January and May), accelerating the Dignity Decree (and continuing a medium-term pattern of regular increases). Additionally, betting duties have risen by 2ppts, or 9% for online to 24%, 11% for landbased to 20%, and virtual by 10% to 22%. Online gaming duties have risen by 5ppts or fully 25% to 25%. Notwithstanding the very last minute and immediate nature of the tax changes (although not retrospective), the budget amendments have been waved through by the European Commission – meaning the tax increases already apply, just days after becoming law and coinciding with the enforcement of Italy’s total gambling advertising ban.
From an overall market perspective, the tax rises are intended to represent an additional c. €770m LfL gross cost increase to the commercial sector (major caveats to this figure below), with the vast majority coming from gaming machines in absolute terms (c. 80%), but specifically VLTs alongside online gaming bearing the highest relative increases. The gross post-tax revenue impact for the overall commercial market (ie, excluding Lotto) pre- mitigation and behavioural change, would be c. 11% – and a double digit proportion of sector EBITDA. Indeed, this bleak prognosis is backed up through public company data. Gamenet has already warned of a c. €15-20m impact (c. 18% EBITDA) and Playtech c. €20-25m (also c. 18% Italian EBITDA) – over and above pre-announced machine tax hikes in the Dignity Decree. We estimate IGT’s gross potential impact to be c. €130m or c. 20% Italian EBITDA (pf, including DD increases), with lottery unaffected but a much higher machines mix within the commercial element. The leading online operators are likely to see a c. 20-30% impact on LfL EBITDA, in our view, with the losses of the (substantial) local long-tail widening further.
However, there are a couple of reasons why this ‘gross view’ is unlikely to play out in reality (despite appearing and anticipated in this way in the newly revised Italian state budget for 2019). First, gaming machine revenue is typically inversely proportional to gross margins, so a combination of mandated poorer customer value and additional operator action is likely to accelerate AWP top-line decline and stall stuttering VLT growth, in our view. However, data from Agimeg suggests that while AWPs are running on their minimum payout limit (70%, going to 68%), VLTs are on the whole more generous than the law demands (85%, going to 84%; but achieving c. 88%) – giving operators a lot more mitigation room. Given the high payout, recycling-driven nature of VLTs, combined with the fact that the duty falls on turnover, there is a strong possibility, in our view, that the VLT element of the tax can be more than mitigated by dropping the payout materially (caveat: customers may start to become less interested), while the AWP element is likely to result in a slightly higher tax yield for a small(ish) net revenue hit.
Consequently, by over-engineering turnover taxes and payouts, while focussing on what we believe to be the wrong metric of underlying consumer activity (turnover rather than revenue), the Italian government may have initiated major theoretical tax increases that will have the opposite effect in an aggressively managed reality (not just lower than expected tax yields, but lower yields on an absolute basis). Further, Italian operators have an increasing commercial logic to manage this aggressively, given that machine taxes are now materially over 50% of GGR (for the first time in the case of VLTs) and machine supply is now being actively reduced by legislation (local and nationwide). If this analysis is correct, then the operational impact will be far less severe than originally feared. However, while this might be good news financially and commercially, the Italian government is unlikely to leave the sector alone, in our view (and may well get punitive). From a strategic perspective therefore, maximising mitigation might therefore be very different to optimising it…
The second area where the net impact is likely to look very different to the gross (and another counter-intuitive positive) is in the online channel profitability impact of the combined changes. The advertising ban has accidentally made room for a material tax increase (we do not believe the Italian government has been so economically Machiavellian as to do this deliberately – especially given the fiscal flaws outlined above) by slashing largely unproductive costs from the long tail (rarely has advertising worked in Italy, with product and customer engagement / retail payments being far more important). It is probable that no advertising will impact some ‘over-trading’ driven growth, but since there was little evidence that demand was being successfully stimulated by advertising in Italy (unlike in more mature digital markets), there is little reason to expect a material reduction in revenue due to the ban. Instead, further organic consolidation is likely (ie, the strong getting stronger), albeit with some danger of black market leakage (though regulated consumer choice in Italy is high – covering over 100 licensed entities). In more general terms, it is worth considering that online represents only 13% of Italian commercial gambling revenue (vs. 50% in the UK and 60% in Denmark) – growth may be stymied and/or volatile, but there is still a very strong long-term secular underpin, in our view
In other words, we would anticipate that all things being equal, the Italian government will hang on to only c. 20% of its budgeted gross tax increases, with substantially all the slippage coming from gaming machines due to the direct payout impact of the duties. However, it would be dangerous to assume that all things will remain equal in Italy. On the current government trajectory, 2018 may be seen as closing over a decade of benign regulatory change for commercial gambling, with the pendulum of fiscal-regulatory pain still potentially having a fair way to swing (especially if lower than expected tax receipts are met with more tax increases – likely increasingly economically self-defeating from these levels, but when did that stop governments). In this context, material exposure to the more moribund and controversial elements of the Italian gambling sector (retail in general, gaming machines in particular) could shift from a dull cash cow to a painful strategic millstone.
In the longer-term, Italy’s fiscal engineering of its commercial gambling sector offers another significant policy headache likely to adversely impact commercial operators (with the underlying drivers not just applying to Italy): if channel shift switches supply taxed at c. 55% GGR equivalent (Italy landbased blended rate) to c. 25%, while regulatory frameworks at the same time seek to discourage an explosion in overall gambling activity, then a significant and structurally growing fiscal hole will inevitably appear…
Sweden: online regulation – up and running, save for the excluded
Sweden is officially open for business following the implementation of new gambling legislation on New Year’s Day. While around 60 companies appear to have received licences (with a glut arriving just before Christmas), others faced shut-out as the Government refused to entertain the prospect of temporary licences (which would have allowed companies to maintain trading pending validation of application for a full licence).
The Swedish government has introduced relatively straight-forward social responsibility rules for the newly liberalised market, covering harmful gambling, gambling by minors and criminal or fraudulent activity. The regulations are perhaps most notable for the introduction of a comprehensive self-exclusion system (Spelhaus) which will allow gamblers to exclude from all licensed operators. Not so long ago, such schemes were dismissed by many in the global industry as being overly paternalistic and unworkable in practice; but this is changing.
Sweden’s regulation is also likely to have a significant if nuanced impact on marketing. As well as an over-arching requirement to be ‘moderate’ (already being tested in the courts), bonuses are now sign-on only (hence some operators applying for multiple licences). This is likely to create a glut of over-trading as new licensees attempt to press this home, followed by increasing difficulties for undifferentiated offers to attract and maintain customers. Whether or not severe bonus restrictions will impact social responsibility directly (and how this will be measured) remains unclear, but the rules are likely to further drive organic consolidation to stronger product and UX-driven offers, while making life harder still for the ‘long-tail’, in our view.
More broadly as the exotic becomes the orthodox, so the bar on social responsibility is likely to be set higher. Ever tighter and more joined-up social responsibility systems seem likely to be a part of the industry’s future. Operators should welcome and embrace Sweden’s measured and nuanced approaches, in our view, potentially using the market as a testing ground for good practice to avoid stricter domestic controls later and provide a model for (working) liberal practices elsewhere. However, the required levels of restraint and strategic investment may not come all that easily to some quasi-domestic operators brought up on much more cavalier .com practices.
Netherlands: online regulation – KSA shot the Sheriff, and may not be done yet…
The jailing of executives at the Dutch online gambling company, Sheriff Gaming for money laundering offences ensured that a difficult year for Europe’s remote operators ended on a dismal note. The company’s chief executive, Stijn Flapper was handed a two-year custodial sentence by the Dutch Public Prosecutor (with two other executives receiving shorter terms) for allegedly washing between €30m and €50m of criminal proceeds. Western Europe has grown accustomed to increasingly significant fines for regulatory breaches (both Great Britain and Denmark posted record years in 2018 – as well as the Netherlands) but incarcerations are still mercifully rare.
The episode prompts a number of questions. Was this an isolated case of criminality or have other parts of the gambling supply chain been similarly engaged? What due diligence did Sheriff’s clients (including some of the largest remote operators in Europe) undertake on the company and what were their responsibilities? We must hope that the prosecution draws a line under this episode – but in an increasingly connected and global industry – risk to licensing requirements and to reputation can be both complex and obscure.
The prosecution and sentencing also highlights how tough the Netherlands is wont to be on gambling infringements. This is likely to be put to a very significant test should POC online regulations ever regain momentum (possible in Q1, but so far always disappointing hopes for progress) – especially in terms of what constitutes ‘bad actor’ behaviour and how strictly (and for how long) this will be applied. Given the number operators which have taken and arguably directly ‘enticed’ Dutch players, this list could be long and high profile (with Betsson, Bet-at-home, Mr Green and William Hill all recently fined, for example). There is something of a POC “Catch 22” here: stricter licensing is more likely to allow political momentum to be regained, but potentially in ways material elements of the online sector would not welcome.
Romania: gambling duties – local victory
Romania passed its ‘greed taxes’ after Christmas, but softened the blow to gambling operators both in terms of the rate (2% online vs. 5%; flat fee retail vs. 3%) and starting point (from this year rather than retrospectively). This represents a significant last minute lobbying victory, though the result still suggests a real terms tax increase of well over 50% for multiples-led businesses (albeit to still manageable levels) and a punitive c. 125-250% (and far more structurally challenging) increase for more singles and in-play driven offers. Perhaps most significantly, by removing the retroactive element the tax is now unlikely to be subjected to legal challenge – making it another unwelcome last minute reality for operators.
Romania’s historical liberal online regime probably suited undifferentiated offshore operators best given its low taxes and light touch. By introducing a (relatively low) turnover tax as well as a GGR tax, localised mass market led offers are likely to relatively outperform offshore sportsbooks. Romania has therefore started 2019 favouring local organic consolidation and local specialism over .com businesses morphing into POC licensees (ie, driving operator fragmentation at the macro level) – adding to a growing roster and a growing trend of increasingly challenging POC markets.
Cyprus: IR casino – casino gaming takes flight ahead of IRC opening
The expansion of casino gaming in the Republic of Cyprus continues apace with the opening last month of a third casino at Larnaca Airport. From a standing start in 2018, the country now has three casinos (at Limasol, Nicosia and Larnaca) with another two set to open in 2019 (at Paphos and Ayia Napa). All of this is of course a mere prelude to the opening of Melco’s City of Dream’s Mediterranean in 2021 which will be Europe’s first integrated resort casino.
In the three decades since Steve Wynn opened the Mirage in Las Vegas, the integrated resort casino has enjoyed commercial success and relative political popularity in North America, Asia-Pacific and Africa. Despite numerous attempts (most notably in Spain but also in Hungary, Ireland and Great Britain), similar developments in Europe have remained elusive. It remains to be seen whether the ‘domino effect’ (where the opening of a resort casino in one jurisdiction triggers further developments in a region) that has been observed in the US and in Asia-Pacific follows the Melco opening in two years’ time.
In the meantime, the development of satellite casinos in Cyprus; the return of the table games to Paris last year (after a ban of nearly a century); moves to modernise and ultimately privatise Holland Casinos; and plans to launch a Hard Rock resort casino in Catalonia, all serve as a reminder that the expansion of remote gambling supplements rather than replaces consumer demand for land-based gambling (particularly where it is experiential rather than simply transactional).
US: online regulation – sagging in Michigan
Last minute hopes for online gaming legislation in Michigan were dashed by the veto of the (now departed) governor. While there is every possibility of progress this year in what could be a material state market, the reasons for the veto are telling: protecting lottery revenue (and by extension lottery-led state funding). Such concerns tend to be ridiculed in Europe, where lotteries have co-existed with commercial gambling for some time, with over 15 years of increasingly material online competition. However, the question is a more open one in the US given the lack of any commercial gambling competition to the high value scratchcards that have been the motor of US lottery growth (in most states) as well as the pervading lack of online lottery traction (though this is building in some states – including Michigan and Illinois). Given the similarities between slots (and parlay bets) and scratchcards, especially online and/or at the higher end of scratchcard stakes and payouts, this is an issue that is unlikely to go away and could be increasingly dangerous for commercial gambling lobbyists / evangelists to dismiss as a credible stakeholder concern, in our view.
Global: online regulation – YouTube loots children?
High profile YouTubers Bryan ‘Ricegum’ Le and Jake Paul have been criticised for promoting MysteryBrand.net to children. The site offers the chance to win prizes including sportswear, tech products and luxury cars to children by opening virtual boxes for a fee – its functionality being close to that of loot boxes within computer games, while the player ‘wins’ every time, the prize is randomly selected and can be of more or less value and could arguably be considered a game of chance within some gambling jurisdictions. Players have the opportunity to ‘sell back’ unwanted items, although the site takes a minimum 20% of the value of the item (similar to cashing out an unwanted bet).
MysteryBrand.net does not imply an age limit for sign up, with users also able to log in through games trading site Steam which has an age restriction for those under 13. This unfortunate association by Steam (which is operated by games developer, Valve), may cause further reputational damage to the company since the recent skins betting controversy in the US – particularly as the company has been highlighted as a potential contributor to underage betting using skins in the newly published Report on Illegal Gambling by the Danish Gambling Authority.
Although ‘skins betting’ and ‘gambling like’ chance elements within computer games have been around for a number of years, it is only recently that regulators have begun to take note of this potential loophole, however, it is clear that the risk of children coming into contact with potentially harmful and/or wrongly unregulated material goes far further than this – with these types of sites being promoted through social media channels by people who have effectively become children’s entertainers and role models. From a regulatory perspective, there is a danger that too much focus on principles-based decisions and/or an over-application of a rule book designed for real-money gambling will either overshoot or undershoot optimal outcomes. Equally, this is not an area that many regulators are likely to feel strongly equipped to deal with in terms of experience or resource. There is therefore a critical need for operators to handle with care or invite increasingly knee-jerk responses from the political and/or regulatory establishment, in our view.
Global: M&A – summary
The founder of Korean online video games producer Nexon is set to sell a US$9bn controlling stake in its holding group NXC Corp
Nektan is attempting to raise funds totalling £3.5m through the partial sale of Respin (a US subsidiary: 57.5% for £2m) and the proposed placing of new ordinary shares (£1.5m), as well as converting shareholder loans to equity.