Monday, July 8, 2019

Does NYRA Owe Jerry Hollendorfer Due Process?

On June 22, soon after the fourth horse this year from Hall of Fame trainer Jerry Hollendorfer's barn was fatally injured at Santa Anita, the Stronach Group, owners of the Santa Anita track as well as Golden Gate Fields in Northern California, announced that Hollendorfer was being ejected and would be denied stalls and entries at all their tracks. On June 23, the New York Racing Association, where Hollendorfer had a few horses stabled at Belmont, said, in a statement from NYRA's communications director Pat McKenna, that his horses would be welcome at the upcoming Saratoga meet. But on June 29, NYRA, without any public or private hearing or any other element of due process. reversed position and told Hollendorfer that he could no longer enter horses at NYRA tracks. NYRA's McKenna and its Vice President for Racing Martin Panza, declined comment on the reversal.

In the event, the owners of Hollendorfer's New York-based horses, OXO Racing, promptly contracted with Hollendorfer's New York-based assistant, Don Chatlos, to train its horses; Chatlos was given stalls at Saratoga; and several OXO horses ran at Belmont on the closing weekend of that track's Spring-Summer meet.

The Hollendorfer issue poses an early challenge for new NYRA CEO Dave O'Rourke, who was confirmed in the top job only a few months ago, following the firing of former NYRA CEO Chris Kay for using NYRA personal for gardening and other chores at Kay's private residence.

O'Rourke, who came to NYRA a decade ago without any racing background, has been a quick and effective study in his decade at the track. He's been primarily responsible for overseeing the growth of NYRA's ADW betting arm, NYRABets, and for expanding the track's television presence, as well as for gaining control of its finances. Two areas that he hasn't ventured into, though, at least before his appointment as CEO, were legal affairs and racing operations. The Hollendorfer ban will require that he take charge in these arenas as well.

Hollendorfer's exclusion by the Stronach Group and by NYRA raises an important legal issue. Can a race track take away a trainer's livelihood without any sort of due process. Certainly, if a state agency were to suspend or revoke a trainer's license, it would have to provide some sort of due process. In fact, in New York, a trainer's appeal of a license suspension can drag on for years, muting the impact of the suspension; by the time a final appeal verdict is rendered, most people in racing will have forgotten what the original cause of the disciplinary action even was.

Did Hollendorfer use illegal drugs on his horses? Neither the Stronach Group nor NYRA made that accusation; they just said go away. But if one race track owner controls a significant share of a regional market, as Stronach does in California, Florida and Maryland, and as NYRA does in New York, isn't saying go away tantamount to depriving a trainer of his or her livelihood, and, if so, shouldn't the trainer have some sort of recourse?

In New York, the courts, both state and federal, have consistently held NYRA, in all its various pre- and post-bankruptcy permutations, to be so significantly entwined with the State of New York that NYRA's actions should be held to the same due-process standards as those that apply to state agencies.

As far back as 1973, New York's highest court held, in the case of trainer Buddy Jacobson, that NYRA was required to provide at least some justification before revoking or suspending the right of someone who held a New York State racing license to pursue their profession on the track. Similar decisions have required NYRA to provide due process in the case of veterinarians (Michael Galvin), jockeys (Larry Saumell) and other backstretch workers who hold state licenses. The cases distinguish NYRA, on the one hand, from small privately owned harness tracks, because NYRA has a near monopoly on thoroughbred racing in the state and because NYRA and its finances are so thoroughly intertwined with the state. In addition, NYRA has certain powers (such as appointing its own police force) that are typically held only by government entities, and ultimately any profit that NYRA is left with reverts to the state.

NYRA was reorganized once again in 2017, and no cases have decided whether the current incarnation should still be treated like a government agency for due-process purposes, but the earlier cases all dealt with versions of NYRA that were considerably less government-like than the current one. So is NYRA still a public agency? If the issue ever goes to court, I think the answer is inevitably, yes.

From the time "new NYRA" was established in 2011 until mid-2016, it conducted itself as if it were a governmental entity, acting in ways that were consistent with New York State's open meetings law and freedom of information law. As well it should have. "New NYRA" was a creation of legislation in 2011 that rescued old NYRA from bankruptcy, transferred the land under NYRA's race tracks to the State, and gave the state, and in particular, Governor Andrew Cuomo, effective control over appointments to the NYRA Board of Directors, and subjected NYRA to close oversight by the State Budget Department's Franchise Oversight Board. In the wake of the legislation,  "new NYRA" live-streamed its Board of Directors meetings and made them open, if somewhat inconvenient to the public, and posted its annual and quarterly financial reports on its website. In other words, it acted like a state entity.

New legislation in 2017 changed way NYRA Directors are appointed -- creating an essentially self-perpetuating Board instead of one appointed by Albany -- while at the same time giving the Franchise Oversight Board even greater powers. That legislation was signed by Cuomo as part of the State's 2017-18 budget, but did not go into effect until the fall of 2017, when "new" Directors -- who in fact were virtually the same as the previous Directors -- were appointed.

In 2017,  NYRA ceased posting the financial reports and stopped streaming Board of Directors meetings. It has not issued any sort of formal statement rejecting its status as a quasi-governmental entity, but it (or at least the people who decide how to treat Board meetings and financial reports) is certainly acting as if it believes itself to be a private corporation, not subject to the higher standards placed on government.

On balance, NYRA was right when it decided back in 2011 that it should act like a public entity. Nothing of legal significance has changed between then and now, except for the change in the way NYRA Directors are appointed. But Michael Del Giudice, a longtime Cuomo adviser, in both official and unofficial roles, remains chair of the NYRA Board. The current Board is a mix of people with multiple state jobs on their resumes (Del Giudice, Joe Spinelli and Vincent Tese), Jockey Club grandees (Stuart Janney, Ogden Phipps II and Earle Mack) and new members appointed by those same primarily government appointees who were on the old Board after 2011. Because of the self-perpetuating nature of the new NYRA Board, where the old, government-appointed Directors select their replacements and fill other vacancies, nothing much has changed. It's inconceivable that a Board nominee whom Andrew Cuomo opposed would be chosen.

I suspect that new CEO Dave O'Rourke did not play a major role in the Hollendorfer decision(s). And in practical terms, the one case probably doesn't matter a whole lot. OXO Racing's half-dozen or so horses based in New York won't be deprived of the opportunity to run. Don Chatlos, a veteran trainer, will get a turn in the spotlight, and the impact on Jerry Hollendorfer will be far less than the impact on him from the Stronach Group's ban in California. And Hollendorfer probably doesn't, at age 73, have the time or inclination to pursue a multi-year legal action in New York.

But if NYRA takes no further action, the denial of stalls and entries would set a very bad precedent and set up potentially embarrassing challenges in the future. NYRA has been recognized as a state actor for nearly half a century, and thus has been required to provide some minimal due process before depriving racing license holders of their livelihoods. Due process isn't so hard. A notice of charges, an opportunity for a meaningful hearing, and a right of appeal will do the job very nicely. As I suggested six(!) years ago at the Saratoga Racing and Gaming Law Symposium, it wouldn't be that difficult. And it would be a good model for other tracks around the country to follow.

I trust Dave O'Rourke will rapidly get a handle on the legal and racing decision-making at NYRA and that he will use the goodwill accompanying his rise to the top to make NYRA a model, not just for good racing but also for good citizenship, by enshrining due process for those who make the show possible.

Thursday, April 12, 2018

F-T Gulfstream 2YO Sale -- Picky, Picky

The movable feast that is the Fasig-Tipton Florida two-year-old sale (at Calder for many years, then Palm Meadows, now Gulfstream) moved on the calendar this year as well. Long the first of the juvenile sales, F-T Florida was moved back to March 28th, leaving the debut spot to Ocala Breeders Sales Co.'s March selected sale. (For my analysis of that sale, see here.)

Did the change in timing make much of a difference in results? If you look at the typical indicators, the sale can be reported as a success. Both the average price for the 61 horses sold ($385,000) and the median ($295,000) were comfortably above last year's numbers at the same sale, although the buyback (RNA) rate was 33%, more than double last year's 14%.In a sale that typically produces multiple million-dollar babies, there were three this year.

But on some other measures, not so much. Originally, there were 166 horses catalogued for the sale. Of those, 75 were scratched before the auction began, in many cases because their breezes weren't fast enough to attract buyers' attention. Including those scratches in the calculation means that the sale's clearance rate -- horses sold as a percentage of the catalogue -- was only 36.7%, well below last year's 44%. So, as has become the pattern in these select sales, buyers concentrated on the very best prospects, leaving a bunch of potentially good but not great race horses to head home without a new owner.

At the very top of the sale were the usual suspects. Barbara Banke of Stonestreet went to $1,200,000 for Hip 9, a Medaglia D'Oro filly out of the stakes-placed Distorted Humor mare Mi Vida. New shooter Larry Best of OXO Equine also spent $1,200,000, in his case for an Into Mischief colt. Best entered racing only two years ago, spending at the top of the market. So far, his most successful purchase has been the three-year-old colt Instilled Regard, who won the LeComte Stakes at the Fair Grounds earlier this year and who has earned in purses about half the $1 million-plus that Best paid for him last year. The third million-dollar horse was Hip 31, a Scat Daddy colt out of New York-bred stakes winner Risky Rachel. In the absence of Coolmore's usual Irish buying crew, Todd Pletcher signed the ticket for the colt.

Coolmore and its longterm rival, Sheikh Mohammed's Godolphin operation, were very low-key at the Gulfstream sale, compared to their very visible presence some years past. It was Coolmore's Demi O'Byrne, remember, who went to a ridiculous $16,000,000 some years ago for a colt that became The Green Monkey, who's now 11 years old and still a maiden. Coolmore is in the business of making stallions, and this year's purchase might be seen as an attempt to find a replacement for Scat Daddy, who died at the early age of 11 and whose final crop are two-year-olds this year.

As usual, buyers concentrated on the horses that breezed the fastest. One consignor who tried to buck the trend was Kip Elser of Kirkwood Stables, who sent five horses to the sale and, instead of breezing against the clock, just had them gallop through the stretch -- the way two-year-old sales used to be done. Elser sold three of the five, although for relatively modest prices, and the other two were RNAs.  Some years past, Frank Stronach tried a similar approach at his Adena Springs sale, but never managed to wean the major buyers away from their stopwatches. Since horses breeze faster at the juvenile sales than they'll ever run in their racing careers,  and since there's only the most tenuous correlation between horses that breeze fast and those that do well on the race track, it would be good to see some other important consignors follow Elser's lead and reject the time-trial competition.

There were some nice horses that were scratched out of the Gulfstream sale. You might look for them at Fasig-Tipton's follow-up at Timonium in May.

With Barretts' California sale out of the way already, and with Keeneland no longer hosting a juvenile auction, the next big two-year-old auction will be OBS's April extravaganza, from April 24th through the 27th, with some 1222 horses in the catalog. Usually lots to choose from for buyers at all levels in that sale, so one would expect the clearance rate to be a lot higher than in the select sales. We shall see.

Monday, March 19, 2018

2YO Sale Season Gets Started

The two-year-old sale season has returned, with neither a bang nor a whimper. In contrast to prior years, when the Fasig-Tipton South Florida sale led off the calendar, this year the Ocala Breeders Sales Co.'s March sale was first, with the elite Fasig-Tipton sale, now hosted by Gulfstream, moving to the end of the month.

Whether the timing change affected results is unclear. Overall, the OBS results were pretty similar to last year's OBS March sale: 261 of the 573 horses originally catalogued were sold, for a 45.5% clearance rate. Those 261 include 44, an unusually high 17% of the total number sold, that were bought privately after failing to attain their reserve in the auction ring. Those "post-sale" purchases, as the sales companies describe them, are almost all for a price less than the sellers wanted, i.e., below the reserve, but were enough to convince the sellers not to take the horses home and try again later.

One hundred and two of the horses that actually went through the sale were listed as RNAs (reserve not attained) and did not sell privately before they left the sales grounds. That number was 17.8% of the total catalog. Using the sales companies' preferred measure of success, that meant that the "buy-back" or RNA rate was 28% of the horses that actually went through the ring. But another 210 horses originally catalogued for sale were scratched, many after poor breezes or after they failed to attract enough potential buyers to take a look at them in the days before the sale. So, looking at the catalogue as a whole, of the 573 horses originally listed, 45.5% sold (including "post-sales"), 17.8% were RNAs and 36.7% were scratched. Those numbers are roughly in line with the higher-quality sales in 2017.

The average price for horses sold at OBS March was $164,854, a decline of more than 12% from last year's $187,741, but the median price increased from $95,000 in 2017 to $105,000 this year, a 10.5% jump. The decline in the average reflects a slight weakening at the top of the market. At last year's OBS March sale, five horses sold for $1 million or more, and another four went for between $900,000 and $1 million. This year, the top price was $875,000 (for a Scat Daddy filly).Those million-dollar babies pulled the average up last year, but this year there were comparatively more sales in the $200,000-$400,000 range, pulling the median up.

As always at the two-year-old sales, blistering quarter-horse speed was at a premium. An astonishing 95 horses breezed an eighth of a mile in 10.0 seconds or less, 17 of them recording a time of 9.4. Another 11 "stretched out" to a quarter of a mile in less than 21 seconds. Reminder: a dozen years ago, The Green Monkey recorded one of the first-ever 9.4 breezes, at the Fasig-Tipton then-Calder sale. He sold for a record $16 million -- after Godolphin's John Ferguson and Coolmore's Demi O'Byrne engaged in conspicuous displays of masculinity for some 15 minutes -- and never won a race.

Nine of those horses with sub-10 furlongs or sub-21 quarters ended up in the list of the top 20 highest-priced horses at the Ocala sale, including the $875,000 sale-topping Scat Daddy filly. While it's true that, in the aggregate, the horses that breeze faster at the two-year-old sales do better on the race track than those that don't breeze well, it's also true that pressuring a horse to run faster than it ever will again, at a time when some of the horses aren't even 24 months old, can't help but contribute to unsoundness and shorter careers. Everyone knows this, but the buyers -- and especially the agents -- with the big bucks still want to see speed. As the late Pete Seeger said in another context, when will they ever learn?

Wednesday, March 7, 2018

CDI - The Darth Vader of Racing?

It's no surprise that corporations act in the interest of their shareholders top executives. Other constituencies or stakeholders -- employees, customers, cities and states where the corporations do business -- are just obstacles to be placated or overcome on the way to ever-higher profits. That's called capitalism.

But still. One hopes, dreams, deludes oneself that perhaps racing is different. So many of us are in the game for reasons other than profit-making. If we wanted to make money, there are a lot of better ways to do it. But we love the horses, we love the thrill of the race, we love the radical democracy of the racing world, where the opinion of a dark-skinned immigrant working a minimum-wage job has just as much value as that of a white male Wall Street lawyer. Yes, we need someone to run the tracks (although perhaps a not-for-profit model of some sort would be better than corporate ownership anyway), but this really isn't a game for unbridled (sic) capitalist greed.

So what happens when a corporation does own race tracks? The most egregious example is Churchill Downs, Inc. (CDI, to distinguish the corporation from the eponymous race track), about whose foibles I've written quite a few times. CDI's latest move, reported in the Paulick Report and on, is to obtain a jai alai permit for its Calder property in South Florida. That would allow CDI to dispense entirely with messy, inconvenient horse racing at Calder and substitute something that's a lot cheaper -- though of course no one bets on it -- as a means of retaining what it really wants, the slot machines and other "gaming" at the site. CDI has already demolished the grandstand and the barn area at Calder, and merely rents the track out to Frank Stronach's Gulfstream to keep the racing dates that are required for it to maintain its gaming license. But even that seems too much for a corporate executive suit(e) so narrowly focused on the bottom line their bonuses and stock options. To a corporation like CDI, racing is a necessary evil, because many jurisdictions foolishly, in CDI's view, condition the award of the slot machine and other gaming licenses on running actual real live horses at least a few days a year.

We've become inured to outrages from CDI. Buying and selling race tracks as if they were lifeless interchangeable machine parts, raising takeout on bettors, treating horse people as unwelcome interlopers in the horsefolk's's own world, etc. etc. But it wasn't always so. Perhaps a little history is in order.

Today's CDI is the inheritor of the fabled Churchill Downs track in Louisville created by one Kentucky Colonel, M. Lewis Clark, and made famous by another, Matt Winn, whose never-ceasing public relations efforts made the Kentucky Derby (presented by whoever this year's paying sponsor might be) into the one horse race that almost everyone in America knows about. While in its early years, Churchill was loosely affiliated with other tracks, especially Latonia (now Turfway) in northern Kentucky, it ran from 1875 until 1991 as pretty much a stand-alone operation whose business, whose only business, was horse racing.

Matt Winn

Starting in 1991, as full-card simulcasting seemed to be the industry's new savior, CDI went into expansion mode, buying the Louisville Downs harness track, which it converted into a simulcast and training facility. Then in 1994 it bought Hoosier Park in Indiana, in 1995 Ellis Park in western Kentucky, in 1998 Hollywood Park in California and Calder Race Course in Florida, in 2000 Arlington Park near Chicago (by way of merger) and in 2004 Fair Grounds in New Orleans. Just looking at the acquisitions, one might be forgiven for thinking that CDI was actually interested in horse racing.

Not so, and certainly not so after Bob Evans became the company's CEO in 2006. Evans does breed a few horses, as do most rich folks in Kentucky, but all his pre-CDI business experience had nothing to do with racing; he was an executive at Caterpillar and involved in a number of investment firms. (Rather like current New York Racing Association CEO Chris Kay, who also knew nothing about racing when he got the job, having worked at Toys R Us and Universal Studios.)

Beginning with Evans's reign, CDI stopped being a horse racing company and became what it is today, a casino and online betting company that still, because of those pesky state lawmakers!, has to operate a few race tracks. CDI sold Hollywood Park, which was later torn down to make way for a new football stadium. By the end of 2006 it had also sold Ellis park and Hoosier Park. At the same time, it started opening up race track slot machine parlors, beginning in 2007 at Fair Grounds and then in 2010 at Calder. In 2007, it also launched the Twin Spires online betting platform, which now makes more money for the corporation that does actual horse racing. CDI even bought a couple of stand-alone casinos in Mississippi between 2010 and 2012. And while it did acquire another race track, the Miami Valley harness oval, that was only because the Ohio legislature had just authorized slot machines at that state's tracks.

Evans's move away from racing has pretty much been endorsed by his successor, Bill Carstanjen, who took over in 2014. Carstanjen did reverse the 2014 purchase of Big Fish Games, which distributed such online hits as Gummy Drop!, and he did oversee the purchase this year of Presque Isle Downs in Erie, PA, but apparently that was to acquire Presque Isle's slots license more than for its under-the-radar racing program.
Does this look like a race horse?

Along the way, CDI has managed to enrage horsepeople, with its my-way-or-the-highway approach (something I saw first-hand after CDI bought Calder); bettors, by raising takeout; horse owners, by treating the owners of Kentucky Derby hopefuls as cash cows and not welcomed guests, and even other race tracks, as in  its ham-handed efforts to squelch the innovative Kentucky Downs track.

Carstanjen, the current CEO, has been with CDI since 2005. Before that, he was at General Electric, not known for its horse racing expertise, but well known for its executive pay packages. In 2016, he made a mere $5.5 million in cash and company stock (eat your heart out, Chris Kay!). The numbers for 2017 aren't out yet, but are likely to be higher.

Under both Evans and Carstanjen, Churchill Downs Inc. has acted like a corporation. And that's a pity.

Wednesday, February 21, 2018

So You Want to Buy a Derby Horse

It's that time of the year again. Kentucky Derby preps almost every weekend. Top 10/12/20 lists abounding. Rich folks without a horse on the Derby trail waving money around to try to buy a piece of one. So why not ask, if you want a Derby horse, what'll it cost you and where can you find it?

For a thoroughly unscientific study, let's look at the 21 horses with 10 points or more, as of February 22nd, on the Kentucky Derby leader board. I've omitted only one from the full list of 22, the filly Paved, who's not nominated to the Triple Crown and almost certainly won't be in the Derby starting gate.

Where did these 21 come from, what did they cost, and what does that say about the market?

Five of the 21 -- Noble Indy, Bravazo, Firenze Fire, Avery Island and Enticed -- are homebreds, with four of the five from the elite fields of Goldolphin, Calumet and Winstar (the fifth, Firenze Fire, was bred and is raced by Ron Lombardi's Mr. Amore Stable, and in any event has a bit more of a sprinter pedigree than one would like to see in a Derby contender). Back in 2014, when this year's Derby crop was being conceived, the homebreds' sires' published stud fees were:

Medaglia d'Oro (Bolt d'Oro) $100,000
Awesome Again (Bravazo) $75,000
Street Sense (Avery Island) $40,000
Take Charge Indy (Noble Indy) $20,000
Poseidon's Warrior (Firenze Fire) $6,500.

Not quite the top of the market, though Medaglia d'Oro's fee was in the top echelon. And generally proving, as California Chrome did, that a Derby horse can come from anywhere (but don't look for Firenze Fire to throw a lot of classic horses as a stallion).

What about the other 16 horses, the ones that are being raced by someone other than their breeders? One, Mourinho, was sold privately as a two-year-old, for $675,000, with the breeder apparently retaining a minority interest. The other 15 all went through public auctions, as yearlings, as two-year-olds, or in a few cases as both.

Fourteen of the Derby points leaders sold as yearlings in 2016, mostly at the Keeneland September sale, with a few selling at the Fasig-Tipton Saratoga auction. Prices ranged from $1,000,000 for Breeders Cup Juvenile winner and two-year-old champion Good Magic to $20,000 for My Boy Jack, winner of this past weekend's Southwest Stakes at Oaklawn, and $30,000 for Snapper Sinclair, second to longshot Bravazo in Saturday's Risen Star at the Fair Grounds. The aggregate sale price for all 14 horses that went through yearling auctions was $3,693,000, an average of $264,000.

Four horses were sold at two-year-old auctions last year, for prices ranging from $1,050,000 for Instilled Regard (4th in Saturday's Risen Star) down to $180,000 for the pinhooked Snapper Sinclair. In total, the four juvenile sales brought $2,190,000, an average of $548,000.

A decade ago, in a piece for the New York Times' "At the Rail" blog, I predicted that two-year-old sales would increase in prominence as a source of Derby Trail horses. That year (2008), six horses in the Derby field, including the winner, Big Brown, came through the two-year-old market and a seventh was entered in a juvenile sale but didn't meet its reserve. This year, assuming that some two-year-old sales grads don't jump up in the Derby points standings at the last minute, only four of the top 20 will come from juvenile auctions. What happened, other than my making a bad prediction?

First, the collapse of the thoroughbred market after the 2008 financial crisis meant that there were just fewer good horses. The North American foal crop declined from more than 38,000 in 2005, when the 2008 Derby horses were born, to just under 23,000 in 2015, a drop of 40%. While the decline primarily meant that fewer not-so-fast horses were being born, as unproductive mares were retired, it had at least some impact on the top of the market as well. Anecdotally, agents and high-end buyers say that it's tougher now than it was a decade or two ago to find a real classic horse, and that they have to pay more to get it. So perhaps, once someone buys a top yearling, the buyer may be a bit more likely to hold onto it rather than pinhook it into a juvenile sale. Logical, even if I haven't done the studies required to prove the hypothesis.

Second, buyers of elite horses may be learning that the two-year-old auctions are a mixed blessing. On the one hand, a buyer can see how a horse runs on the track and how it has developed from a yearling and have a much better idea of what it will look like as a race horse. On the other hand, the rigorous training necessary to get a yearling two the two-year-old sales, where they breeze an eighth or a quarter of a mile faster than they ever will again, may put too much pressure on young, developing bones and lead to later soundness issues. Here's what I wrote ten years ago, all of it still unfortunately true:

As the importance of these sales grew, so did the role of “pinhookers,” who buy yearlings and then train them over the winter in Florida and sell them as two-year-olds. And so has the importance of the “breezes,” when these young horses run an eighth or a quarter of a mile before the sale. A difference of a few fifths of a second in a breeze time can be worth hundreds of thousands of dollars when the horse enters the auction ring, and the difference between profit or loss for the pinhooker who risked millions buying those yearlings.
Horses at the sales routinely run an eighth of a mile in 10 seconds flat, with the occasional breeze in 9.8 seconds, which will bring the seller millions. That’s a lot faster than horses run in races, and no indicator at all of how they might do going a mile and a quarter in May of their three-year-old year. If you go to the breeze shows before the sales, you’ll see dozens of trainers and bloodstock agents clocking not just the breeze, but also the “gallop out,” how the horse runs for the eighth or quarter of a mile after the wire. Not to mention the extra-slow-motion videos that the truly serious buyers and agents use, the vet exams, heart scans and similar attempts to separate the very best from the merely good.
Perhaps some buyers have learned the lessons provided by two-year-old sales graduates and have decided that buying a yearling and controlling its training on the horse's own timetable rather than that of the sales is the best way to get to the Kentucky Derby. We shall see.

Wednesday, January 3, 2018

No More Gummy Drops for Churchill

Last November, Churchill Downs Inc. (CDI), the slot-machine and bet-taking company that happens to host the Kentucky Derby, announced that it was selling its largest single asset, something called Big Fish Games. Superficially, as the story in the Lexington Herald-Leader and other media outlets suggested, it appears that the Churchill suits had made a nice short-term profit. They bought Big Fish, whose best known offering is something called Gummy Drop!, a game apparently played by millions on their phones, for $885 million less than four years ago. The sale of Big Fish, to a subsidiary of the Australian-based Aristocrat Leisure Ltd., is for an announced price of $990 million, which would represent a profit of $105 million, a 12% gain, over what CDI paid for Big Fish, not counting whatever profits Big Fish contributed to the CDI bottom line over the past few years. Lots of potential adjustments to the price, according to the contract, but still, CDI is making a nice bit of change.

The reality is a bit more complicated. For one thing, the sale of Big Fish seems to represent a sharp U-turn in CDI's corporate strategy. Just a few months ago, when I looked at CDI's annual report for 2016, it appeared that the suits (including pant suits; Churchill's CFO is a woman) in Churchill's executive suite were committed to a strategy that downplayed racing and that focussed on people mindlessly watching video screens, whether those screens were on their phones or on slot machines in CDI's casinos. Now, if one is to believe the press release announcing the sale, CDI "will refocus our strategy on our core assets and capabilities including growing the Kentucky Derby, expanding the casino segment, and other forms of real money gaming, and maximizing our thoroughbred racing operations." For a company that has a well deserved reputation in the industry for its cavalier treatment of bettors and horsemen, focusing on racing seems, well, odd.

In addition, Big Fish Games, if not responsible for all of CDI's profits, has certainly been a big element in leading the company's stock to ever greater heights in the market. In December, 2014, just before the acquisition, Churchill stock was selling at $93 a share.  Today, the price is nearly $240. That's an increase of more than 150% in just three years, way better than any of the major market averages. Must make the bean-counters in the CDI executive suite proud -- as well as seriously enhancing the value of their stock options. So why jettison a piece of the company that has been an integral part of the stock price run-up?

Theory No. 1: One possible reason is to take CDI at its word; maybe they really do want to refocus on racing. Well, actually they don't say racing. They say Kentucky Derby. I suspect they'd happily dump all their other racing dates, whether at Churchill Downs itself, the Fair Grounds or Arlington, just as they've already dumped Calder, if only they could keep two days for the Derby and the Kentucky Oaks.

What they actually said was that they were refocusing on the Derby, their in-house ADW, Twin Spires, and on casinos, with an afterthought of "maximizing our . . .  racing operations." Maximizing what, exactly? If it's profit, then a two-day Derby and Oaks season would be ideal; racing probably loses money for CDI over the balance of the calendar. And not having to deal with those irritating horse people would be a big plus.

So, on that theory, What CDI is really doing is focussing on Twin Spires and on its casinos around the country. Could be a good strategy; with online betting on all sports, not just racing, looking ever more likely, Twin Spires and its well developed betting technology would be in a good position to capture a significant share of that emerging market. As for casinos, well, they're showing some signs of market saturation, but it's still a highly lucrative sector for CDI, producing just over 25% of the company's net revenue in the nine months ending September 30, 2016. (CDI's annual figures for 2017 won't be available until sometime in February.)

Theory No. 2: The execs want to boost the stock price, and getting a bunch of cash that can be used to buy back shares (a tactic that normally increases the prices of the remaining outstanding shares) is a quick and effective way to do that. The CDI press release announcing the Big Fish sale says that up to $500 million of the cash they'll get in the sale can be used for stock repurchases. That's almost 14% of CDI's current market capitalization of $3.6 billion. Enough to move the share price and, not so incidentally, the value of the executives' stock options. Never underestimate the power of short-term personal gain.

Theory No. 3: The traditional corporate suits in Louisville finally realized that they would never domesticate the video-game millennials in Seattle. Before CDI bought the company in 2014, Big Fish had been around for a dozen years, part of the West Coast computer culture. All the photos I've seen of CDI execs seem to include white shirts and ties; not many of those in evidence at Big Fish. Sometimes it's just too difficult to keep the children in line. It wouldn't be the first time that a corporate merger foundered on the shoals of clashing cultures.

Theory No. 4: Get out while the getting's good. In 2017, for the first time since the CDI acquisition in 2014, Big Fish's net revenue declined (from $370 million for the first nine months of 2016 to $342 million for the corresponding period in 2017, a drop of 7.5%). The video game market is notoriously volatile, and Big Fish itself is no stranger to ups and downs; it suffered a severe retrenchment in 2013, perhaps precipitating the sale to CDI. Is the revenue decline in 2017 a sign of worse to come? If the CDI execs thought so, now would be a great time to divest.

I don't have an inside source in the CDI boardroom (or, for that matter, in any other racing industry corporate headquarters), so I don't know which of these theories is right, or if, perhaps, they all are in some degree. I lean toward Nos. 2 and 4, enhancing the CDI share price and getting out ahead of potential disaster. But, then, I'm oh so cynical when it comes to corporate motives.

Thursday, December 21, 2017

The GOP Tax Bill, Horses, and the Rest of Us

Someday soon, the ignorant, incurious, lazy, lying, racist, sexist, narcissistic, sociopathic, kleptocratic dotard who, incredibly, is President of the United States will sign the Republican tax bill, making it, at least until the 2018 election, the law of the land.

For those still reading, I don't intend to rehash here the many odious features of the bill. They have been analyzed well by experts here, here and here, among many other places. A complete summary of the bill, by the usually reliable lawyers at my former firm, is here. In this piece, I just want to consider (1) what the bill does for (mostly rich) thoroughbred breeders and owners; (2) what it does for, or perhaps to, gamblers; and (3) what those of us in New York, California and other Blue states targeted by the GOP with its limit on state and local tax deductions can do to sabotage the bastards.

I. Impact on Breeders and Owners

Like every one of the 535 members of Congress, I have not read every word in the new tax bill. I have, however, read the horse-relevant sections, and my conclusions are much the same as those of the National Thoroughbred Racing Association, which lobbied hard for the provisions and whose analysis can be found here.

First, the bill accelerates what was already a favorable depreciation regime for owners and breeders. Under the new legislation, the maximum "Section 179 deduction," which permits immediate deduction of capital expenses -- rather than having to depreciate them over a period of years -- is increased from $500,000 to $1 million, and eligibility for the deduction is extended to businesses with up to $2.5 million in income, increased from current-law $2 million.

Second, for operations that are too big to benefit from Section 179, the bill expands "bonus depreciation," which allows 100% expensing of both new and used property in the first year it is placed in service -- including yearlings, breeding stock and farm equipment.

Third, the bill shortens the depreciable life for farm machinery and equipment from seven to five years and allows farms to use a faster depreciation schedule that front-loads the tax deductions in the first couple of years. Race horses already benefit from an accelerated three-year depreciation schedule.

Taken together, all these provisions significantly increase the ability of breeders, and to some extent owners, to write off their capital expenses faster, thereby reducing their tax bills in the short term. And in the long term, as economist John Maynard Keynes said, we're all dead.

Fourth, the bill reduces the nominal corporate tax rate from 35% to 21%. For those breeding operations organized as corporations, that means an immediate cash windfall. Trump and his sycophants say that will lead to increases in jobs and wages. More likely, it means that the farm owner or corporate CEO will be driving that new Maserati SUV.

Fifth, for the majority of breeders and racing stables that are organized as partnerships, limited liability companies and "S" corporations, the bill exempts roughly a quarter of income from tax, under the "pass-through" provisions that have been in the news. Coupled with the reduction in the top personal income tax rate, that means a successful breeder or owner would pay tax at less than a 30% rate, compared to nearly 40% under current law.

Sixth, the bill doubles the estate tax exemption from $11 million to $22 million, resulting in a windfall of more than $4 million (at the 40% estate tax rate) for the heirs of those who are smart enough to die before the Democrats retake Congress and return (I hope) to a sensible, progressive estate tax that makes deserving heirs like Paris Hilton or Donald Trump Jr. actually work for a living.

All of this, I guess, is good news for the country-club set and other richies, a few of whom do in fact participate in racing. And, while their new-gotten gains are unlikely to be translated into wage increases for their employees, they may be tempted to spend more for high-end race horses. Whether that does any good for the rest of the industry is quite another question.

II. Effect on Gamblers

As we all know, the tax treatment of gambling on horse racing has been unfair for years. The NTRA scored a major victory earlier this year, when the Treasury Department revised regulations to reduce withholding and the issuance of W-2G income-reporting forms with respect to exotic bet payoffs. There's already some, as yet inconclusive, evidence that the change has increased "churn," the amount that horseplayers put back into the mutuel pools.

The new tax bill leaves intact another unfair piece of tax law affecting gamblers, by requiring that gambling losses be used to offset gambling winnings only by way of an itemized deduction. With the elimination of the personal exemption and the doubling of the standard deduction to $24,000, fewer taxpayers will itemize deductions and, therefore, fewer will be in a position to offset their gambling winnings. Balancing that, perhaps, is the fact that, as a result of the regulations change, fewer taxpayers will receive W2-G forms at the end of the year and therefore feel that they have to report gambling winnings at all. So in this, as in many of its provisions, the new bill actively encourages tax cheating. Good work GOP.

In addition, for the relatively small number of people who can convince the IRS that they are in the "trade or business" of gambling, the bill effectively eliminates the possibility that they could have a loss in one year carried forward or back to reduce taxes in other, profitable years. It does so by lumping in such a gambler's ordinary expenses, like travel and lodging, along with winnings in the amount that can be offset by losing tickets, so that those additional expenses cannot be used to create a tax loss in any year. Nobody's going to win an election campaign by promising to make things better for professional gamblers, but, still, it ain't fair. If you trade in pork bellies or Bitcoin futures, you can deduct those expenses, but not if you trade in the chances of number 6 in the feature.

III. The Bill's "Fuck You" to Blue States

As we all know by now, the bill limits the deductibility of state and local taxes (SALT) to $10,000, with no doubling for a married couple's joint return. This is just pure vengeful payback aimed at states like New York and California that have (a) lots of Democratic voters, (b) relatively high property values and, hence, property taxes; and (c) high state and local income taxes that support decent public services. For ordinary middle-class taxpayers in these states, the bill will mean a significant loss of itemized deductions and, therefore, a significant increase in the amount of federal tax that they'll owe. Every taxpayer's situation is different, but broadly, taxpayers with household income of between $75,000 and $600,000 in New York City, where I live, are virtually certain to face federal tax increases because of this one provision.

(The bill also reduces the amount of a mortgage that will qualify for the mortgage interest deduction from $1 million to $750,000. I'm less outraged by this, though it will affect some homeowners in New York and California; people with million-dollar homes aren't the most deserving objects of our concern.)

But, because the bill was rushed through Congress, there's a gigantic loophole that, with the cooperation of state and local governments, could completely eliminate the SALT limitation. The estimable Martin Sullivan, chief economist of Tax Analysts and a former Treasury and Joint Committee on Taxation staff member, laid out the strategy yesterday on Twitter. A state or local government sets up a charitable fund to carry out government functions, then gives a taxpayer a 100% credit against state taxes for "contributions" to that fund. The state gets just as much money, the taxpayer gets a reduced state or local tax bill and can come in under the Republicans' punitive $10,000 limitation. Such a system is already partially in place in Arizona and Maryland and has been endorsed by the IRS in its taxpayer publications and in an IRS chief counsel's memorandum and a Tax Court case, both dating to 2011. 

So now it's up to us to make sure that our state and local officials know about the loophole and that they promptly take steps, in the 2018 legislative sessions, to provide relief for their endangered taxpayers. Let's fight back against the rape of Blue states by the troglodytes in Washington.