Saturday, February 25, 2017

How the 2YO Sales Fit Into Today's Racing Economy

Last week I pulled together a statistical overview of the two-year-old thoroughbred sales market. With the first breeze show of 2017 scheduled for Monday at Gulfstream, and the first 2YO sale set for Wednesday, here’s some context for those statistics and four thoughts about the future of the juvenile sales in light of overall trends in racing.

First, the 2YO sales scene has not shrunk at the same pace as the foal crop since the 2008 financial crisis. In 2005 – foals that could be offered at the 2007 2YO sales – the North American foal crop was just over 35,000. In 2014 – foals that could have been offered at the 2016 2YO sales – the foal crop was 20,450. That’s a decline of 42% in a decade. In contrast, the major 2YO auction houses (then including Keeneland) offered a total of just over 4,000 horses in 2016, compared to 4,800 in 2007, a decline of only about 17%.

That means the 2YO sales are presenting a bigger fraction of the total thoroughbred foal crop than before the financial meltdown. A decade ago, roughly one of every seven horses was catalogued in a 2YO sale; today, it’s more like one in five. That could mean that more end-users (i.e., owners who actually want to race horses) are using the juvenile auctions, but it also means that the sales catalogs contain more horses with lesser potential. If you are taking more of less, than the quality of what you are taking must have gone down. If 2YO sales had moved in proportion to changes in the foal crop over the past decade, we would now be seeing only about 2,800 in the catalogs, and not the 4,000 we can expect by the time all this year’s sales are done. Not surprising, then, that the number of horses sold as a percentage of catalog size has fallen off. It is time for the auction houses to start exercising a little quality control and shrink the catalogs.

Second, the 2YO market has been vastly simplified. A decade ago, OBS ran five sales, Fasig-Tipton five, Barrett’s two and Keeneland one. That’s now been consolidated into the two F-T sales and the three big OBS offerings, plus two at Barrett’s in California. That makes life simpler for consignors and buyers and probably cuts transaction costs, which are ultimately passed on to racehorse owners. (Though we still need better policing to make sure that so-called “bloodstock agents” don’t cheat owners and consignors by insisting on kickbacks from the latter while passing on an inflated price to the former. You guys know who you are.)

Third, we are still in thrall to the stopwatch. Yes, it’s true, as my friend Jeff Seder of EQB, Inc., and others have proven, that horses that breeze faster have, in the aggregate, more success on the racetrack than breeze show slowpokes. But is there really that much difference between a horse that breezes a furlong in 9.3 seconds compared to one breezing in 9.4? And how many of those horses listed in the catalogs but then scratched before the sale were victims of the aggressive training needed to get them ready for the sales ring? Anecdotal, to be sure, but my Castle Village Farm partnership owns a nice Broken Vow two-year-old of 2016 who might have fetched $75,000 at Timonium last year had he not bucked shins. We bought him privately for $25,000 and he’ll debut as a three-year-old next month; looks like he could be a useful horse, and he would have been better off not being rushed.

Finally, one must think about the place of these sales in the overall economy of racing. The basic economics are simple: someone breeds a horse and either races it or sells it. The person who races the horse pays the bills and gets the purse, and, sometimes, a return from breeding. Basically, that’s all the money there is, and as we all know, it’s not enough. Most horses don’t earn enough to pay for their training, let alone their purchase or breeding cost. Most owners lose money, which is pretty much the way it’s always been; being in the winners circle makes up for the cost of a lot of hay. For some rich folks, escorting a horse into a Grade 1 winners circle is more of a thrill than escorting an East European model into a charity ball.

But where does the money to pay for all the sales apparatus come from? The auction houses, the bloodstock agents and the sales vets all are getting paid, and ultimately that cost is coming from breeders and owners. In fact, that’s why the Florida breeders set up OBS in the first place, to capture some of that transaction cost for themselves. Today, with handle and purses flat in current dollars and in long-term decline when inflation-adjusted, there’s just less money to go around. Scaling back the 2YO sales would be a modest step in the direction of recognizing that reality.

Friday, February 17, 2017

Two-Year-Old Sale Season Ahead

It's almost time for the annual two-year-old sale season. Fast-Tipton's Florida sale at Gulfstream on March 1st kicks off the season and almost always -- at least since the demise of Keeneland's boutique spring sale after 2014 -- promises the biggest prices and most spectacular bidding wars. Some of us still remember that sale (then held at Calder) in 2006, when Demi O'Byrne of Coolmore and John Ferguson of Godolphin compared penises -- oops, bankrolls -- and Ferguson won by cleverly letting Demi make the last bid, for $16 million. For those who may have forgotten this legendary horse, The Green Monkey started three times for Coolmore, never won a race and was ignominiously retired to stud in Florida for a princely fee of $5,000.

That fiasco aside, two-year-old sales have achieved an ongoing place in the racing business. While the most elegantly bred horses offered for sale tend to go to "end users" at the yearling sales, those who are looking for a decent racehorse and can't afford the cream of the crop will often turn up for the two-year-olds. At these sales, we can see the horses run, get better odds that they'll actually make it to the races, and not need to depend so much on Wayne Lukas's famed ability to "see the cat" or, in other words, to look at a yearling and imagine the racehorse that it would develop into.We're willing to pay a bit of a premium for having someone else, typically a pinhooker, bring the horse along through its K-6 education, in exchange for the additional information we can get.

Last year, roughly 2,000 two-year-olds were sold through the three big sales companies in the market: Fasig-Tipton, Barrett's and Ocala Breeders sales. The catalogs for those sales -- three at OBS, two each for Barrett's and Fasig-Tipton, included more than 4,000 hip numbers, so just over 50% of the horses listed failed to sell, whether as a result of scratches or because they failed to meet their reserve (RNAs). Those are much smaller numbers than the annual yearling sales, where more than a quarter of the previous year's foal crop is offered, but still significant. So let's take a look at recent sales and see where the market might be headed this year.

Of the three sales companies in the two-year-old market, OBS dominates the numbers, with over 3,000 of the 4,000 horses catalogued the last couple of years and over 1,500 of the 2,000 horses sold. OBS runs three sales, an upper-end sale in March and big follow-up sales in April and June. Over the past three years, those sales have been pretty stable. The median price at the March sale has wandered just north of $100,000, while the April sale median has been in a narrow band around $45,000. The June sale, however, has been in a bit of a decline, with the median dropping from $20,000 in 2014 to just $13,000 last year, and for the first time last year, fewer than half the horses in the catalog were sold. The bottom of the market, whether that's the market for mares, yearlings or two-year-olds, is weak, and in the case of two-year-olds, that bottom is almost entirely the OBS June sale. I wouldn't be surprised to see it cut back in size soon, from its current level of around 1,200 horses catalogued each year.

Out in California, Barrett's maintains its small, if regionally significant, market, though with more Asian buyers heading east and California racing in a death spiral, there are signs that the sale may not be viable in the long run. In 2014, Barrett's catalogued 281 horses across its two sales, in March and May, and sold 130 of them, with medians of $112,500 in March and $30,000 in May. By last year, the catalog was down a bit, to 268, but sales were down even more, to 106, and the two sales' median prices had dropped to $27,000 for May and $100,000 for March. With significantly less than 10% of the national two-year-old market, equal to less than 1% of the foal crop, Barrett's may be an idea whose time has passed.

In contrast to the wholesale approach of OBS, Fasig-Tipton fills two specific niches in the overall two-year. Its Florida sale in March is the unquestioned top of the market, and its May sale at the Timonium fairgrounds north of Baltimore is a must-go destination for blue-collar Mid-Atlantic and New York horsemen seeking to fill out this barns for the summer and beyond.

There's been no consistent trend in the Florida sale the last few years. The catalog listed 157 horses in 2014, ballooned to 175 in 2015, then dropped back to 154 last year. The number sold was a very weak 47 in 2014, nearly doubled to 89 in 20156, and dropped back to 66 last year. And the median price, at $180,000 in 2014, dropped to $130,000 on the larger catalog in 2015, then rebounded to $250,000 last year. The top of the market, at any rate, doesn't seem to be experiencing the continuing decline evident at the bottom.

The much larger F-T Midlantic sale at Timonium has also been erratic, but not at all in synch with the high-end Florida sale. Catalog size was 580 in 2014, 490 in 2015, and back up to 597 last year, with the number sold holding above 50% of the catalog in all three years. The median price was $31,000 in 2014, jumped to $45,000 on the smaller catalog in 2015, then fell back to $32,000 last year.  Considering the amount of money that's gone into horses by May, including stud fees and training costs to get to the sales, no one's getting rich on that $32,000.

With only two of the catalogs for the 2017 season even available yet, it's too early to make any firm predictions. But the auction houses, and, by inference, breeders and pinhookers, seem optimistic. Fasig-Tipton has catalogued 162 horses -- a few more than last year --for its marquee Florida sale in March,. And OBS has 677 in the catalog for its first sale in March, up about 10% from the level of the past two years. Assuming that Donald Trump hasn't brought about the end of the world by next month, we'll see if that optimism is justified.

Wednesday, December 21, 2016

NYRA's Finances

Watching a 90-minute replay of last week's New York Racing Association (NYRA) Board meetings ranks right up there with a self-inflicted root canal as something to put at the very bottom of one's to-do list. But, in the interest of catching up with the state of NYRA's finances, I did it anyway -- so you don't have to.

And it did have its moments. Perhaps the highlight was hearing someone (couldn't recognize the voice) say he'd been celebrating ever since Trump won the election. Nice to know that the m/billionaires on the NYRA Board feel an affinity with the billionaires in Trump's entourage. But the unbearable whiteness of the NYRA boardroom is a story for another day.

At the end of this year, Chris Kay and his team of guest experience enhancers will have been in charge of NYRA for three years. He's an easy figure to poke fun at, with his deep lack of knowledge of racing, his ignorance of any language other than entertainment-industry suit-speak, and his love for the big day at the expense of the year-round racing program. But, to be fair, NYRA really does seem to be in a better financial position than it was three years ago, even if it is not quite sound enough to survive without the slot-machine life-support that was part of the deal giving the state control of NYRA.

The financial report distributed at last week's NYRA Board meeting, available here on the NYRA website, is not exactly what you'd expect from a company that handles a couple of billion dollars a year. In fact, the report isn't the typical quarterly income statement and balance sheet that you'd expect -- and that NYRA until very recently did make public. Instead, it's mostly a 2017 budget document, with 2015 and 2016 figures included for comparison. The report doesn't purport to be constructed according to generally accepted accounting principles, and it perpetuates Kay's myth that somehow non-operating expenses -- pensions, retiree health care, income taxes, interest and depreciation -- don't have to be paid unless there are slot-machine revenues to offset them. Nonetheless, assuming that the actual numbers reported in the document are accurate (and I do trust NYRA's Dave O'Rourke and Jelena Alonso at least on that front), they reflect a maturing, if only marginally profitable "new NYRA" that could continue to operate a high-class racing program in New York for as long as the slot-machine tap remains open.

Let's start with what matters most -- handle. Despite the lack of a Triple Crown possibility at Belmont this year, total handle through the end of the year is estimated at almost exactly $2.5 billion. That's roughly a quarter of the total annual handle for ALL US racing even though NYRA runs only about 5% of all the races run in the country. From that handle, NYRA makes net revenue of $271 million, about 11%, even though its blended takeout rate is closer to 20%. The difference, of course, is that most of the handle comes by way of simulcasting, where the takeout isn't retained by NYRA but split between NYRA and the simulcast outlet, whether another race track or an ADW site like Twin Spires, Expressbet or TVG. As discussed in more detail below, NYRA is also benefiting from the mid-2016 launch of its own ADW, NYRABets, which is now available to residents of 28 states. All the takeout from NYRABets wagers stays with NYRA, unlike a big share of the takeout on bets placed through TVG or other ADW sites.

Even though only a small fraction of total handle is actually bet at NYRA tracks (less than 10% at the Aqueduct meet, for example), the net retained revenue from on-track and NYRA Bets wagering for 2016 is forecast (there are only four more racing days this year, so the forecast should be pretty accurate) at $133 million, or nearly half the total wagering income. Of the rest, $115 million comes from ADWs and other simulcast outlets, and $24 million from the ever-weaker New York OTB entities.

Out of that $271 million that NYRA gets from the takeout, $106 million goes to purses, $5 million to the NYRA Bets rebate program, $16.7 million to tracks that send their signals to NYRA, and $16.9 million to what NYRA unhelpfully lists as "other statutory payments," for a total of $144.9 million in payments directly tied to wagering, leaving $126.8 million in "net wagering revenue," in essence, NYRA's take-home from the bettors. Add to that $17.6 million in "on-track racing related revenue," (gift-shop sales, vendor payments, $8 beers, ticket sales and who knows what else from the monetized guest experience) and $18 million in unspecified "other revenue" (sponsorships?), and total net revenue from racing operations is $162.5 million, pretty much where it was in 2015.

Operating expenses, not counting those pesky retiree payments, taxes and depreciation, add up to $157.9 million, of which the biggest elements are salaries and fringe benefits. That leaves $4.5 million in operating profit before accounting for slot-machine revenue on the one hand and those non-operating expenses on the other. Let's see, using total handle as a surrogate for turnover, that's an operating profit of 0.18%. Not even as good as those famously low supermarket margins. Easy to see why for-profit companies aren't exactly beating down Andrew Cuomo's door begging for a piece of the action, but a LOT better than NYRA in the bad old days that led to Bankruptcy Court.

Now let's add in the slots and the hidden expenses. This year, the 5,000 or so slot machines at Genting's Resorts World Casino at Aqueduct will have a net win (equivalent to takeout) of $845 million.  If we assume that slot-machine takeout is 10%, that means the machines are handling something like $9 billion a year. Remember, NYRA's overall handle is $2.5 billion, or less than a third of what's pushed through the slot machines.

Out of that net win, purses got $63 million (less $1 million that the legislature in its wisdom decided to give to NY-based jockeys, the highest paid in the country, to pay for their families' health insurance). In total, just under 40% of total purses come from slots, just over 60% from betting handle). In addition, NYRA gets $34 million earmarked for capital spending, and $25.5 million for operations.

Compared to the $25.5 million in "operations funding" from the slots, NYRA spends $24.4 million in retiree benefits and taxes (it's virtually debt-free, a huge accomplishment, so no interest) that are not included in its statements as operating costs, even though they are just that. And, compared to the $34 million from slots for capital spending, NYRA is actually spending $34.4 million this year and budgeting $35.2 million for next year in a variety of capital expenditures. So, in fact, slot-machine revenue very neatly fills the holes in NYRA's bookkeeping by paying almost precisely for the items left out of the income statement.

So yes, Chris Kay, your team has done a good job in getting NYRA to break-even status or even a little above that, taking ALL the costs and all the expenses into consideration. But, as Casey Stengel said of his World Championship with the Amazin' Mets in 1969, "couldna done it without the players." And one of the players here is most definitely that slot machine palace at Aqueduct. Let's hope that the notorious racing-hating Cuomo doesn't set his sights on that particular golden goose.

I'll be joining other New York refugees at Gulfstream for the two weeks after Christmas. Will resume regular blog postings in January.

Thursday, December 8, 2016

By the Numbers: the State of the Industry

Yesterday, my blogging colleague Bill Shanklin, on his HorseRacing Business site, pointed out that, as we all know, the number of races run each year and the number of foals born each year has significantly declined over the past two decades and made a couple of predictions for the future. Bill suggested that (1) the number of foals and races would continue to decline, although a full-time 24/7/365 betting menu would be available for us diehard degenerates via television and the internet, and (2) that urban development near Lexington KY and Ocala FL would lead to a spreading out of the breeding industry to more rural areas.

Following up, and looking at the actual numbers, I’ve gone into some additional detail, using numbers from the invaluable Jockey Club FactBook to illustrate some trends in the industry over the past 25 years and to make some extrapolations of my own.

First, to put some precision into the figures that Bill mentioned. In 1990, there were some 72,664 thoroughbred races run in the US. That number has steadily declined over the intervening years, reaching 38,941 in 2015, a drop of 46.5%, or nearly 2% per year, averaged over the whole period. And, as Bill mentioned, the foal crop has also declined, albeit in a much less straightforward manner. In 1990, there were 40,337 thoroughbred foals born, and in 2015, The Jockey Club estimates that there were 20,600.  That’s an overall decline of 49%, close to the drop in the number of races. But three-quarters of the decline is just in the past 10 years, as breeders quickly responded to the effects of the financial crash of 2008. From a foal crop of 35,050 in 2005, to the 20,600, last year, the drop has been more than 41% just in the past decade.

So, no argument about the  numbers; the foal crop is smaller and there are fewer races today than a quarter-century ago. But what of the future? Will the inexorable decline continue, as Bill suggests?

To get some handle (sic) on that question, examining a few more sets of figures may be helpful. Let’s start with an easy one: has there been a precipitous decline in field size, making it ever more difficult for the bettor to find value in a race? Back in the glory days of racing, field size was a healthy nine-plus (9.09 in 1950). That number held up pretty well until about 1990, when average field size was still a solid 8.91. Then it declined rapidly, dropping 8% to 8.20 by 1995, and remained at that level through at least 2010, when it was still 8.19. By 2015, however, field size had once again shown a sharp drop, as the effects of the decline in the annual foal crop worked their way through the system. Average field size in 2015 was only 7.82, a drop of 4.5% in just five years. It’s well established that, at least up to a field size of 10 or so, handle increases more or less proportionately to the increase in field size, so that a continued decline in the latter would inevitably reduce betting, all other things being equal.

Even without that impact, of course, handle has been disappearing even faster than the aging population of horse race bettors. Measured in current dollars, total US thoroughbred handle has apparently risen a bit, from $9.385 billion in 1990 to $10.675 billion last year. Even without adjusting for inflation, though, that 25-year span masks a more recent and precipitous drop, from a high (again in current dollars) of $15.062 billion in 2002, just 13 years ago, to the 2015 total. That’s a drop of nearly 30% in just 13 years. And the figures look MUCH worse if one adjusts for inflation. Measured in constant 1990 dollars, total US handle has declined from the $9.385 billion in 1990 to just $5.887 billion last year, a drop of more than 37% over then entire period and, more ominously, a drop, in constant dollars, of 46% from the high water mark for handle in 2002. And even these figures understate the impact on race tracks and horse owners, as an ever-greater part of total handle comes from off-track simulcasting, ADWs and other outlets that return less to the track presenting the races than does on-track (and, in some cases such as NYRA, in-network) betting. As betting declines, and returns from betting decline even further, most tracks have come to depend on slot machines or other non-racing gambling revenue. When cash-hungry state politicians start to raid that particular cash cow, the prospects for tracks and horsemen will become even bleaker.

Purses, thanks to slot machine largesse, haven’t declined nearly as much as total handle. In fact, even adjusting for inflation, the average purse per race has actually increased by more than 50% over the past 25 years. Total purses, measured in then-current dollars, were $714.5 million in 1990, rising to $1.074 billion in 2002 and then more slowly to $1.094 billion last year. Measured in constant 1990 dollars, that’s a decline of 15.5% over the entire 25-year period.

But for those owners who stayed in the game, the situation looks a lot different if one examines the average purse per race. Remember, the number of races has declined even faster than the number of foals born each year (declining field size, therefore, is a function of each horse running a bit less often than in earlier years). So if we look at the average purse per race over the period, there’s a substantial increase. Measured in current dollars, the increase is huge, from $9,832 in 1990 to $28,086 last year. Even correcting for inflation and measuring in constant 1990 dollars, there’s been a 57% increase, from 1990’s $9,832 to last year’s $15,488. For those of us who own race horses and are used to the old rule of thumb that the average horse earned about half of what it cost to keep it in training, that feels about right. The influx of slots money over the past two decades means that the average horse now earns about three-quarters of what it costs to keep it in training. Hey, progress is better than the alternative.

One last set of figures to suggest that perhaps in one sense the racing industry has already reached a point of some equilibrium. Back in 1990, the median price for a yearling sold at public auction was $7,000, and the total amount of purse money per foal born that year (an admittedly unscientific measure, but bear with me) was $17,715, or 2.53 times the average cost of a yearling. Fast-forward to 2015, and the inflation-adjusted median cost of a yearling was $12,430, while the purse money per foal was $23,820, or 2.65 times the median yearling price. In other words, buyers are, perhaps unconsciously, keeping the amount they pay for horses in some very rough proportion to the purse money available, even as the number of foals has substantially declined and overall purse money has declined. In fact, during the entire 25-year period from 1990, his purse-to-yearling price ration has moved in a fairly narrow band, between a low of 2.29 and a high of 2.75. That’s a pretty stable market over time.

So how does all this relate to the predictions that we started with, namely, the ongoing decline in racing? My own sense is that the number of races per year, and the number of active race tracks, will continue to decline, slowly if things don’t change, faster if the states start removing slot subsidies, but that the market for thoroughbreds will, as it has since 1990, continue to adjust so that race horse owners’ expected losses stay in a manageable range, in some proportion to the amount of purse money that’s available.

All this, of course, assumes more or less a continuation of the status quo. Bold moves, like significant takeout reductions, improvements in the tote system, free data, an integrated viewing and wagering system, etc., could boost handle and either grow the industry or at least ease the pain of its declining years. But, looking around at the folks who are in charge, I wouldn’t bet the rent on the likelihood of any such change coming soon. If you’re more hopeful than I, you can get in the mood here.

Thursday, December 1, 2016

Takeout - What's Optimal?

Everyone knows that the takeout -- the amount of total bets that the track holds onto before paying out the balance to holders of winning tickets -- is too high.The competition -- slot machines, casino table games, poker, sports betting -- typically sets takeout somewhere between 5% and 10%, while US racetracks have a blended takeout, averaging the different levels on different types of bets, of somewhere just over 20%. It doesn't take a genius to see that we're pricing our product too high.

Sure, if you have a better product, you can often charge a higher price. But is our product so superior to that of the slot parlors, casinos, poker rooms or sports books? Those of us who love Thoroughbreds and who admire the athleticism and competitive spirit of the horses and the skill and courage of the jockeys might say so, but we're probably not a very big slice of the population. And even then, we should question whether the product offered on a Saturday at Saratoga or Keeneland is no better than the Tuesday card at Finger Lakes, even though we may charge the same price (i.e., takeout) for all of them. It's no wonder that thoroughbred racing handle has stagnated over the past few decades -- actually, measured in inflation-adjusted dollars it has decreased -- while the amount bet on alternative forms of gambling has increased. The competitors offer a product that many people find to be just as good -- in the eyes of some even better, because it doesn't have the steep learning curve that betting on horses does -- and they offer it at a cheaper price.

So, with the exception of some horsemen's groups that are oblivious to the economics of betting and some track owners who don't care that much about profits from racing, because they're really in the ADW business or in slot machines or in producing games for smart phones (see Churchill Downs, Inc.), most people in horse racing who think about the takeout issue agree we should do better. The more difficult question is how to adjust our prices. There have been lots of economic studies of "optimal takeout," but, like most economists' studies, these incorporate unreasonable assumptions that ignore where bets are placed and what kinds of bets they are. Some practical experimentation is needed.

Recently, some tracks have introduced "low takeout" (i.e., 14-15%) bets, typically multiple-race wagers like the Pick 5. A few (Canterbury, for example), have tried reducing takeout across the board.  So far, these experiments haven't demonstrated that price-cutting really pays. But have we done the kind of analysis that would suggest more effective approaches? I think not.

As an example, let's take the takeout structure and the distribution of bet types at the NYRA tracks -- Aqueduct, Belmont and Saratoga. Single-horse bets (win, place and show) have a 16% takeout, two-horse bets (exacta, quinella and daily double) are 18.5%, and multi-horse bets, from a trifecta or Pick 3 through the Pick 6, are 24%, except that the Pick 5 (all the time) and the Pick 6 (on non-carryover days) are 15%. You can see the overall effect by looking at the NYRA financial reports. For example, in the second quarter of this year, NYRA's "on-track" handle was $165 million, and its gross revenue, i.e., the takeout, from that amount was $33 million, almost exactly a blended takeout rate of 20%.

In addition to that "on-track" handle (half of which, by the way, was bet through NYRA's own "NYRABets" online and phone betting app, rather than actually being handed across the teller windows at the track), NYRA's 2nd-quarter handle also included $460 million from simulcast and ADW revenue, from which it earned another $33 million. So its share of the takeout from exporting its signal was only about 7% -- better than for lower-class tracks, but a far cry from the 20% it makes on its home turf (or dirt as the case may be). And then NYRA also counted $56 million from bets placed on NYRA races at the various OTBs across New York State, on which it netted $6 million, or just under 11%. The difference between the overall 20% takeout and the 7% or 11% that NYRA actually receives from off-track and off-network bets represents money that is available to the entities receiving the NYRA signal to use for their operations or, importantly, use for rebates to big players. NYRABets' own rebate plan, according to its financials, costs less than 1% of the amount bet through its network, but for some single-purpose ADWs, especially those effectively owned by the bettors themselves, it can be as high as 10%.

So cutting takeout overall would have different effects depending on where a bet is placed. For bets on-track or on-network, takeout could be cut 5% at each level, to, say, 11%, 13.5% and 19%, without necessarily bankrupting the track, and allowing time to see if the takeout cut would pay for itself in increased handle. But if NYRA cut takeout by that much and still charged the ADWs the 7% sending fee that its financials suggest, then what would happen to the big rebates that the "whales" get through their ADW bets? At present, these "whales," mostly using sophisticated computer/robotic wagering programs to exploit small leverage opportunities in the pools, account for perhaps 20% of total US handle, concentrated in the major tracks, because that's where the pools are large enough to accommodate their big bets. If, say, NYRA cut its win takeout to 11% and still charged the ADW 7%, that would effectively limit rebate possibilities to 3-4%. Would the whales still be at that rebate level? Maybe, because they would face the same net, post-rebate, takeout as at present. But we don't know for sure.

And the effect of a takeout cut also varies by the type of bet. One of the reasons groups like HANA (the Horseplayers Association of North America) favor cutting takeout is that it would increase "churn," the number of times a player can keep betting before her money runs out. But if takeout is cut on a Pick 5, then that money, even if low-priced, is tied up for five races. Better than all day, but perhaps not so much. If churn is a factor,one would expect the effects of low takeout to be greatest at the single-horse bet. Yet few tracks have tried it there.

NYRA's most recent quarterly financials don't include a balance sheet. (By the way, it's now December; where are the 3rd quarter financials for the period that ended two months ago?) But still, it's reasonable to assume that there's a bit of cash in the bank. While I think an overall reduction of at least 5% is probably the right number, it would be great to see one of the major players in the game, like NYRA, try an across-the-board takeout reduction at, let's say 3%, reducing win place and show bets to 13%, two-horse bets to 16.5%, and everything else to 22%, for a blended rate of 17%. Even though that's still way more expensive that the non-racing competition, it might be enough to move the needle and start pulling in additional handle, perhaps even enough to make up for the price reduction. And let's pledge to keep the experiment in place for at least a year, so as to give it a fair test. That would go a long way to settling some of the so far mostly theoretical arguments about optimum takeout.

I know, I know. Changing the takeout, especially in New York, isn't easy. One has to go to the Legislature, the Gaming Commission, etc. etc. But NYRA's authorizing legislation for converting back to a private entity will be coming up in Albany in the next session anyway. Why not use the occasion to free NYRA to adjust takeout as it sees fit and maybe, just maybe, answer the question about whether a significant takeout reduction would bring gambling money back to the races.

Wednesday, November 23, 2016

Transparency: Partnership Division

A couple of recent events have spurred my interest in transparency. First, there's the ongoing saga of Donald Trump's business dealings around the world and his not very transparent, or real, charitable efforts. And then there was an online exchange with Terry Finley, the manager of the West Point Thoroughbreds partnership operation. Terry was asking me about the finances of the New York Thoroughbred Horsemen's Association (NYTHA) -- which are in fact available to any NYTHA member who wants to see them -- but the question brought to mind my own concerns about the finances of horse racing partnerships.

As I pointed out about three years ago, partnerships are a big deal in racing. At this year's Saratoga meet, for example, some 41 different public partnerships made a total of 211 starts, and that's not even counting "partnerships" that are just groups of friends or business acquaintances and that don't market themselves to the general public. They range from high-end groups like Dogwood (now winding down as Cot Campbell, the inventor of the genre, cuts back), Centennial, West Point, Team Valor, Eclipse or Lady Sheila, where the buy-in cost is in the high five or even six figures, to operations like my own Castle Village Farm, aimed at the everyday racing fan, and where the buy-in is as little as $1,000, or even $500 for those signing up for a second partnership.

Whatever the size or level of a partnership, a prospective partner should be able to look at its financial reports and get a sense of what her money is going for. Later in this piece, I'll review a few financial reports that Castle Village Farm distributes to its partners each month and that our team (business manager Jean Zorn and sales manager Joe Wall as well as myself) thinks give the right level of transparency, so the partners can see what their money is being used for. But first, let's look at the many ways that a partnership promoter can make a profit. That's important for a prospective partner, since, as we've seen, the typical race horse doesn't earn enough to pay for itself. To the extent that the partnership promoter makes a profit, that increases the likely loss for the other partners. Sure, some horses do well, but, for every Twilight Eclipse or Ring Weekend in West Point's stable of more than 70 horses, how many are there that have not come close to earning their keep, much less repaying their purchase price? A fair division of income between promoters and partners is necessary to keep the partners in the game long-term; people who feel they're being cheated are unlikely to return, even though they understood from the outset that race horse ownership is not exactly a safe investment.

So how do the promoters make money? There are only a few proven and oft-repeated approaches (leaving aside for the moment the tactic of simply stealing the partners' money, as notoriously practiced by the late, unlamented Karakorum Racing Stable).

First, a partnership can mark up the price of a horse that it has purchased. It's not uncommon for the high-end partnerships to pay, say $100,000 for a horse at auction and syndicate it to partners at a value of perhaps $250,000 ($25,000 per 10% share). Certainly, there's risk and expense involved in making the purchase. The partnership will typically hire a bloodstock agent (for a fee of 5% of the purchase price), pay vets and others to evaluate the horse, and carry the risk from the fall of the hammer at the auction until the horse is fully syndicated. And the partnership has (mostly) legitimate marketing costs, tailored to their intended clientele. For example, I once attended a Centennial marketing event at a Palm Beach club, complete with wine, hors d'oeuvres, Bill Mott and Jerry Bailey. None of that comes cheap. But whatever the markup is, it should be fully disclosed.

Alternatively, a partnership can take a percentage of each partner's initial capital contribution in lieu of or in addition to marking up the price of the horse. At Castle Village Farm, for example, we take 10% of that initial partnership contribution to pay our sales manager, 5% for the expense and expertise involved in selecting horses, and 3% for our thoroughbred retirement charity, Castle Village Cares (which also gets 1% of all our horses' earnings). That's a  modest 18% in total, and it's fully disclosed in the partnership business plan and partnership agreement.

Second, a partnership can take a percentage of a horse's earnings off the top, before distribution to the partners, or it can retain a percentage of the horse, without the obligation to pay that percentage of the horse's expenses. These amount to the same thing. Again, to use an example I'm familiar with, at Castle Village Farm, we take 5% of the first $100,000 in gross purses earned by each partnership, 10% of the next $100,000, and 15% of anything over $200,000.

Next, a partnership can charge a management fee, in addition to or instead of a percentage of purse earnings. The management fee may, or may not, have any relation to actual overhead costs. At Castle Village farm, for example, that fee is $535 per partnership per month, and reflects actual costs like office rent, preparing annual tax returns for each partner, etc., but does not include any compensation for the management team. Other partnerships do it differently; the important thing for would-be partners is that they know whether a fee is charged, what it's for, and how much it is. Similarly, some partnerships, including ours, charge for additional out-of-pocket expenses that are outside the scope of what's covered by the regular management fee. At Castle Village Farm, we call that "partner liaison" expense, and it is whatever it is each month, and is fully disclosed.

Finally, a partnership can take a percentage, either of the gross or of the profit, when a horse is sold. A percentage of the gross seems to me to be problematic, for why should the partnership promoter get, say $5,000 when a $250,000 yearling is dumped in a $50,000 maiden claimer? In my opinion, the better practice is to take a percentage only of the profit, if any, on the sale. Most times there won't be any, but that's the nature of the game.

Now, as for transparency. At a minimum, prospective partners should know how much they're on the hook for, and in what categories. As the West Point website says, the most common question new folks ask is "how much does it cost?"(Although at that site, you have to sign up for a sales pitch to get the information.) Most partnerships are limited liability companies or limited partnerships, not sold on public markets, so there are few, if any, legal disclosure requirements. In some cases, the financial disclosure provided by partnerships is excellent, in others, it reminds me of the Wall Street law firm where I once worked, which sent each client a monthly bill that simply stated  "To our fee" and listed a (quite large) dollar amount.

As an example of what I think is adequate transparency and disclosure, here's a summary of what Castle Village Farm provides its partners and makes available to anyone asking about the possibility of joining us.

First, we provide a capital account for each partnership, showing the total amount of money that came in as partner contributions, the amounts deducted for sales costs, finder's fee and thoroughbred retirement (see above) and the cost of the horse (actual cost, no markup). In a new partnership, any excess is used to pay the horse's expenses, thus delaying any potential cash call. In our claiming partnerships, if a horse is claimed, we typically retain any excess of the claim proceeds over the amount used to buy a replacement horse in the capital account, in case that next horse in the partnership ends up being sold for less than we paid for it.

Second, each time a horse runs, we send partners a purse statement. To take an example, on October 17th this year, our mare Lemme Rock won an optional claimer at Finger Lakes. The race was worth a total of $17,400, so our 60% win share was $10,440 (gross purse). Then the statement shows that there were a lot of deductions: (1) fees deducted by the track -- principally for the local horsemen's organization and for jockey insurance -- totaled $361.30; (2) the jockey, the trainer and Castle Village Farm management each got 10%, or $1,044 each; (3) the mare's groom got $100; (4) Castle Village Cares, our thoroughbred retirement arm, got $104; (5) the trainer charged $25 for the raceday groom and pony fee; and (6) getting win pictures for each partner and mailing them cost $350, for total deductions of $4,072. So, from that $10,440 purse, the partners were credited with net of $6,368 -- more than enough to pay the bills at Finger Lakes and put aside something for the mare's winter vacation, but not really a bonanza. And each partner received a statement at the end of the month showing exactly the amounts just described.

Third, these purse statements then become part of the basic financial document sent to partners each month -- our Accounts to Partners. To continue with the same example, our Accounts to Partners for the Lemme Rock partnership for October showed that we'd started the month with $8,031 in the bank. Added to that was the $6,038 net from the October 17th race. So the partnership's available cash was a total of $14,399.

From that the statement shows deductions of $1,798 for training fees (we pay $58 a day at Finger Lakes); $373 for expenses paid out of pocket by our trainer such as the farrier, feed supplements, etc.; $265 in partner liaison expenses (see above); and $535 for our administration fee, for a total of $2,971. Obviously, keeping a horse at Finger Lakes is a lot cheaper than at Belmont, and there were no vet expenses that month, but still, keep in mind the winner's share was only $10,440.

So that left a total of $11,428 in the Lemme Rock partnership's operating account. Normally, at that point we'd retain two or three months' projected expenses and distribute the excess directly to the partners. But since the Finger Lakes season ends in November (if it hasn't already with multiple bad-weather cancellations) and we want to give Lemme Rock, who has four wins this year, some well-deserved time off, we retained that in the partnership so partners won't have to pay any cash calls before she starts racing again in the spring.

Just to be fair, let's also look at the Account to Partners for a horse that wasn't as successful. Our NY-bred colt Proletariat, winner of two races and $71,683 from 13 lifetime starts, had been on an injury rehab assignment in South Carolina and returned to Belmont in October. So, no purse earnings at all. Instead, here's what the Accounts to Partners for that partnership, consisting entirely of expenses, looked like.

(1) $770 for the first 11 days of the month training in South Carolina at $70 a day; (2) $883 for expenses, including van rides to the vet, shoeing, feed supplements, etc.; (3) $1,900 for training at Belmont (at $95 a day); (4) $185 for trainer expenses at Belmont; (5) $286 for vet bills in South Carolina; (6) $720 for the van from Camden to Belmont; (7) $265 in partner liaison expenses; and (8) $535 for the Castle Village Farm administrative fee, all for a total of $5,544. That's about as expensive as it gets for a horse in a month, but at least the partners know where the money went. Then each partner is billed her pro-rata share of that total. There are 42 partners in Proletariat, so the average cash call was $132, and specific partners' shares ranged from a high of $298 (5.38%) to a low of $23 (0.42%). I guess that's why we say we're an affordable partnership.

The important thing about these numbers is not the amounts, but rather that we disclose them, clearly and promptly. I may love our horses and hang out with them, but I never forget that it's the partners' money that pays for them.

So, Terry and everyone else out there: I hope you'll all be equally forthcoming about the finances of your partnerships. All of us, from Castle Village Farm to Centennial, Dogwood and Team Valor, provide good customer service. We (not speaking for the others, just CVF) take our partners to the barn and the training track to see their horses, we let them know when the horses are running, assist with licensing, get paddock passes for friends and family, and otherwise help partners enjoy the racing experience. How much a partner should pay for that experience is a matter for each individual to decide. In our case, the support and the experience comes at a pretty low price. For some other partnerships, a lot more.  But how can prospective partners decide if it's worth it unless the financial aspects of a partnership are transparent? I'm hoping that many of the partnership managers will join me in opening the books. Perhaps we could even set up a reference library on OwnerView. In any event, transparency is almost always the right thing to do. As most economists will tell you, markets only work efficiently when there's sufficient knowledge. Let's not keep partners and prospective partners in the dark and let's not feed them horse manure instead of facts.

Tuesday, November 15, 2016

Trump -- Horseplayers Shouldn't Have Been Surprised

Donald Trump's Electoral College victory last week shocked, shocked the mainstream media punditocracy and, apparently, both campaign staffs and the candidates themselves. After all, Clinton had maintained a steady lead in the opinion polls ever since the summer party conventions, and the received wisdom was that any other result was inconceivable.

So when Trump actually won, the first reaction, at least in my deep-blue part of the world, was incomprehension. How could the polls have been "wrong"?

But, in fact, the polls weren't wrong. If one followed, the premier poll-aggregation site, one saw that the election was, in fact, looking more and more like a horse race. And, whatever the odds, they are no guarantee. As some say, that's why they run the race.

When I began to be one of those who compulsively checked fivethirtyeight a dozen times a day, it was reporting that Clinton had about an 80% chance of winning the election. In horseplayer terms, that made her a 1-4 favorite. Pretty safe, but, as we all know, heavy favorites do on occasion lose. Still, not too much cause for alarm; most of us would be willing to single a 1-4 shot in our Pick Six or Pick Four bets.

[An aside re the odds: the election odds derived from the fivethirtyeight percentages are "true odds," based on 100% of the probability of the event. If Clinton was 1-4 (80%), then Trump was 4-1 (20%). That's different from the situation in horse racing. In New York, the takeout on a win bet is 16%, so the total probability reflected by the odds is 120%, not 100%. In a race, a 1-4 horse would have a crowd-determined probability of only 67%, and the 4-1 shot would have a 16.7% chance. But you all knew that already.]

As the election got closer, Clinton, while still an odds-on favorite, began to look more vulnerable. Her implied odds slipped, from 1-4 to 2-7, then to 1-3, 2-5. 1-2 and, on the eve of the election, to 5-9, implying only a 64% chance. If you ran the election a thousand times, yes, Clinton would win most of them. But, for better or worse, we run the Presidential election only once each cycle, and the 9-5 shot is going to win an appreciable percentage of the time.

So, distaste, fear and loathing, fine. But not shock. It could happen, and it did. Let's move on to the next race

Why is this so hard for the media and the party insiders to understand? There seems to be something about statistics and probability that baffles otherwise perfectly intelligent people. That difficulty served me well when I was a high school bookie, setting a line that added up to 150% and that wasn't questioned by my gullible classmates. But pillars of the media, even if self-designated, should know better.

The new Common Core standards that are being adopted by American schools include what looks to me like a pretty sensible unit on statistics and probability. Perhaps, with time, probability literacy will become more common. But we have a long way to go when even the elites don't understand.