Opening bell: Setting up shop in Pennsylvania

There were many who thought US online gambling was doomed to begin and end in New Jersey. Jeff Ifrah, the head of egaming trade association iDEA, told EGR NA earlier this year that many members were considering abandoning the US altogether after years of futile lobbying efforts in Pennsylvania, New York and California to name a few.

“After almost four years of watching New Jersey grow, but watching the legislative push in other states stagnate, I became concerned about the future of the industry,” Ifrah said. “I worried we would be stuck in this rut, and my concern was that one state wouldn’t be sufficient for the companies. Some of my clients were talking about leaving the US market all together.”

888 was symptomatic of the mood among operators, refusing to spend any money on lobbying in the US until it saw at least some legislative progress.

For Ifrah and iDEA then, the push towards regulation in Pennsylvania in 2017 was seen in a lot of ways as a crossroads. Indeed, failure here could have been terminal. It is in this context that the passage of Pennsylvania’s bill to regulate egaming must be viewed as a massive victory and crucial for the future of the industry. After all Pennsylvanian casinos generate more revenue than any other state except Nevada, according to the American Gaming Association, and last year the state had the top casino tax revenue in the country at $1.4bn.

However, it wasn’t all good news. Ifrah admits the contents of the bill leave a lot to be desired, with the 54% tax on slots the elephant in the room. It is that aspect which is most worthy of discussion with table games and poker taxed at a reasonable 16%, representing a known quantity for experienced operators.

The problem

Slots revenues make up around 70% of total revenues in New Jersey, far outweighing table games at around 20% of revenue and poker at 10%. Assuming similar weightings for Pennsylvania, even with the lower tax rates of 16% for table games and poker, the blended tax rate comes out at around 43%.

“This rate will dramatically reduce the ability of casinos to spend big on marketing, which will ultimately reduce the size of the market,” says David Jennings, an egaming analyst at Davy.

“Therefore, while in theory the Pennsylvania market would have been expected to be bigger than New Jersey (given the relative size of adult populations), instead it is likely to be smaller. It is unlikely, for example, that the state will experience the blanket marketing that took place when the New Jersey market opened up in 2013.”

Credit: Play Pennsylvania

Local operators are even more pessimistic. Ifrah reports that iDEA members say there is “no way anyone could participate in the market at that rate.”

Chris Sheffield, the SVP of interactive at Penn National Gaming, says the tax rate simply “doesn’t work.”

“I’ve run the models and it’s very difficult to see how anyone can make a profit with that level of tax,” he adds.

The impact

So what does it mean for market participation, and will the state be able to shift all 36 licenses – three allocated to each land-based casino, one for slots, one for table games and one for poker?

“Nobody knows,” admits Dermot Smurfit, CEO of GAN, who will provide the real-money platform to Parx Casino when the market goes live. “Casinos like Sands Bethlehem are unknowns given their previous opposition to egaming, while several smaller casinos might not have the scale to make that $10m upfront investment worthwhile.”

Even Penn, one of the largest operators in the state, which has also been steadily building a database through its social casino product, says it has not yet made a decision about entering the market.

“We’re still working our way through the legislation line by line,” says Sheffield. “If you do take up the license, you go into it thinking long term, hoping the tax will change because I don’t see how you can make a profit. There’s too many people taking a piece of the pie online, with platform providers, marketing spend and so on.”

And any change to the tax rate will have to be done on a legislative level, which is of course no easy task. Ifrah says the best chance for change could come in the next year or so, if participation in the market is significantly worse than the state and the Pennsylvania Gaming Control Board (PGCB) is hoping for.

“If no-one is taking up the slot license [which costs $4m] after six to eight months, that would warrant a conversation about improving participation and that’s when we would come in and talk about a 20-22% rate,” Ifrah says.

“The hope would be the opposition is less vocal at that point, and a change would draw less attention and less lobbying opposition. I do have some hope here because this rate doesn’t work for anyone. The casinos are against it. Even poker operators, for instance, recognize this is crazy. Eventually cooler heads will prevail but it will take some time.”

First movers

But what impact does the rate have on the market in the meantime, for those participants – and there will definitely be some – who are willing to take the plunge immediately. Smurfit, for instance says Parx is aiming to be first to market in the hope of scooping up the high-rollers who are “queuing up” for regulated online gaming.

“It’s about land grab and getting those VIP players that exist out there,” he says.” We saw it in New Jersey, the earliest players were some of the best quality players and we can reasonably expect the same in Pennsylvania.”

Parx is projecting a launch in Q2 or Q3 2018 with uncertainty persisting over whether there will be a “switch on” day as in New Jersey, or whether casinos will be able to go live once they are ready and licensed. But how will Parx and other front-runners deal with the oppressive taxes?

Credit: Play Pennsylvania

The biggest changes to the standard business model will have to be in marketing and bonusing. Starting with marketing, as gambling analyst Paul Leyland explains: “The standard remote model demands circa 20-40% of revenue is pumped into marketing, meaning that after content and payment costs, slots will be barely contributing, if at all.”

Leyland argues therefore the market is “unworkable” for marketing-led remote offers and titled heavily in favor of omni-channel operators. In other words, land-based casinos already spending on marketing can shift their campaigns towards their online offerings without too much pain, but offshore brands like Betfair, which has had such success in New Jersey, are liable to struggle. In particular, brands like Penn, which has built a large database of social casino customers, will also have a significant head start.

The second piece of the puzzle is bonusing. Smurfit admits bonusing will undoubtedly be lighter than in New Jersey, but argues that operators looking to expand from New Jersey into Pennsylvania have to view the opportunity as incremental rather than a standalone case. “If you have a team and operations in New Jersey, it’s a relatively slight incremental extra cost to launch in a neighboring state with a bigger population,” he argues.

The last thing to note here is that operators can also attempt to minimise their slots business and push table games that act more like slots. Betfair in Europe, for instance, hosts a ‘table game’ called cash-out roulette. Essentially, the game lets players create side bets over a set number of spins. A customer could bet on there to be 10 reds in the next 15 spins, for example. If five reds come up in the next five spins, he can cash out that bet for a profit. The margin on these side bets is configurable, and could be set to a slots-esque 92% or below.

Known unknowns

Of course, until the regulations are published by the PGCB, there is still a lot of uncertainty about the exact technical specifications of the legislation, with things like market open date still to be determined.

The biggest question for most interested onlookers though is the question of skins and whether they will be allowed as in New Jersey, where they have enabled sites like Betfair and Sugar House to flourish without a land-based presence. The verdict on skins in Pennsylvania is still unclear. Ifrah thinks the state is unlikely to allow them, while Sheffield says “the wording is vague, but we are assuming they are ok.” Given the example set by New Jersey and the extra taxes generated by each additional site, it is perhaps reasonable to expect Pennsylvania to mimic that model.

The Liberty Bell in Philadelphia, Pennsylvania (PA)

So given all the potential pitfalls and unknowns, what are the expectations for Pennsylvania? Participants like Penn are loath to guess, with Sheffield saying they will “leave that to the analysts.”

A white paper from Online Poker Report and affiliate brand Play Pennsylvania calls for revenues of $154m in a base case first year of operation, rising to $275m in year five. The paper adds: “These projections are broadly consistent with the performance of New Jersey’s legal online casino market, and critically, numerous pieces of evidence suggest that this revenue will largely be new revenue from new customers, and not simply a reshuffling of existing casino revenue.”

These are impressive figures, but the report also notes how much revenue the state is missing out on thanks to its dizzying slots tax. At a 20% tax rate across the board, the report predicts revenues would exceed $400m in year five.

Creep

But what does this mean for the future of the industry beyond just Pennsylvania? For Ifrah, it’s a huge step forward with the potential to trigger that much-feted domino effect.

“PA is a major state,” he says. “It’s the biggest state to come on-board so far and it will encourage New York to look at this more seriously. We also have Michigan and Illinois in the background working on bills here. Like you saw with progressive lotteries, which quickly went viral, I think the same could happen here. This is a huge achievement.”

The key here is New York, which neighbors both Pennsylvania and New Jersey and is home to a thriving brick-and-mortar casino industry. It has seen its Senate pass an online poker bill two years in a row.

Ifrah believes the casino operators in New York will now be pushing for egaming legislation, for fear of PA consumers staying at home and playing rather than crossing to play in New York.

“PA is a major state. It’s the biggest state to come on-board so far and it will encourage New York to look at this more seriously. This is a huge achievement” – Jeff Ifrah

And while there have been rumblings of a poker and casino bill emerging in 2018, Ifrah believes poker-only is the odds-on favorite given that online casino legalization would require the support of a voter referendum. But is the domino effect an overrated phenomenon? Gary Pretlow, the chairman of the New York Assembly Racing & Wagering Committee, told Gambling Compliance the Pennsylvania legislation would have zero effect on his own state’s actions.

But Chairman Pretlow’s recalcitrance is likely more an example of political positioning than actual reality, says egaming affiliate and analyst, Adam Small. “No doubt New York has its own issues to resolve, which are substantially different than Pennsylvania’s, but the outlook is certainly more attractive today than it was a month ago,” Small adds.

Building the pool

The recent agreement for New Jersey to share egaming liquidity with Nevada and Delaware will also set a precedent for a bigger market that will help convince regulators and operators that a New York poker market can be a success.

That compact, which Pennsylvania is expected to join, will also be impactful for smaller states, which see the roadblock of low liquidity removed. Small points to Massachusetts and Connecticut as potential dominos to fall, adding: “The most likely state, though, is Illinois, which is bogged down in a massive, multi-year political and budgetary mess that’s even worse than the one we’ve been witnessing in Pennsylvania. Online gambling, and gambling expansion in general, appears likely to be one of the ways they’ll try to dig their way out.”

October 2017 then could one day be looked back on as an inflection point in the history of egaming in the US. Following the landmark liquidity sharing agreement, one of the largest states in the union passed a truly wide-ranging gambling bill that offers opportunities for online casino, poker, DFS and sports betting. The regulation itself will need some fine-tuning, but its very existence could kick-start an egaming push across the North East.

Pennsylvania earned its Keystone nickname for its foundational role in holding together the states of the newly formed Union – will it prove to be the critical link for the expansion of online gaming in the US?