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.