Tuesday, April 11, 2017

From Horse Racing to Gummy Drop! – The Continuing Evolution of Churchill Downs Inc.

Only six years ago, Churchill Downs Inc. (CDI), then the operator of five serious race tracks, accounted for 8% of all US thoroughbred races and earned 88% of its corporate revenue from horse racing. Reading through CDI’s annual report for 2016, its apparent that things have changed in a big way in those six years.

Having shed Hollywood Park and Calder, CDI’s is left with just three tracks – Churchill Downs, Arlington and Fair Grounds – that, together, ran 222 race days in 2016, totaling 2,073 races, or merely 4.9% of the US total. That’s a bit more than the New York Racing Association (NYRA) runs in a single state, but not a whole lot more.

The shrinkage may be part of CDI’s master plan, but it is a plan propelled by market forces. We all know that horse racing isn’t exactly a growth industry. As CDI points out in its annual report, US parimutuel handle, although steady the last few years, had declined 27% from 2007 to 2011. The number of Thoroughbred foals born each year has dropped in half, and, belatedly, the number of races run each year is declining.

So racing is not likely to be a big source of growth for CDI, and, as the only player in big-league horse racing that’s a public company listed on the stock exchange, CDI is under relentless Wall Street pressure to show bigger and bigger revenue and profits. The other major players don’t face the same savage capitalist forces. NYRA is  for all practical purposes a not-for-profit corporation, as is Keeneland; the Stronach Group is privately held and insulated from short-term market pressure, and all the rest are, frankly, minor league. Thus, because it is exposed to raw market forces, CDI is perhaps an early harbinger of racing’s future. If so, that future isn’t bright.

CDI’s response has been bad for racing, but smart for CDI’s bottom line. Despite the reduction in racing, CDI’s net income as a corporation and its share price, continue to climb. Operating income in 2016 for the corporation as a whole was $194 million, more than double the 2014 total of $90 million. And the CDI share price tripled between the end of 2011 and the end of 2016, outperforming the broad stock market indexes by more than 50%.

So what’s making money for CDI? It’s not the stagnant or even declining racing segment of the company; that’s for sure. In a (few) words, its (a) casino gambling; (b) the Twin Spires ADW wagering platform; and (c) online games – a sector in which CDI is now a major player through its 2014 acquisition of something called Big Fish Games, the maker of, inter alia, Gummy Drop! and Dungeon Boss.

Here’s what each of CDI’s four principal business segments contributed in 2016:

CDI accounts for its Twin Spires online betting platform separately from its live racing business. Included in Twin Spires, at least in CDI’s accounting, is its Bloodstock Research and Information Services (BRIS), purveyor of (to my mind, overpriced) handicapping and racing data. Twin Spires is the largest ADW in the country, eclipsing Frank Stronach’s ExpressBet, Betfair’s TVG, and NYRABets, among others. Twin Spires handle for 2016 was $1.1 billion, or 10.2% of total US handle, a substantial increase in both dollars and market share from the previous year.

Because nearly 90% of the money bet on racing is bet off-track, the net takeout retained by a track that actually stages racing tends to be lower than the handle retained by the ADW bet-takers, who pay only a fraction of that takeout to the sending track. For example, CDI’s live tracks reported only a net profit margin, or takeout, of 10.1% in 2016, while Twin Spires reported a margin of 18.4% on its handle. If this is true across the industry, then either (a) there’s room for substantial takeout reductions, since ADW margins are way too high, or (b) the tracks that actually put on racing should increase their fees to the simulcast outlets. Or both.

CDI’s casino business represents a small, but growing sector of the gaming world. The company owns five casinos and two hotels with gambling attached, and has ownership stakes in the Miami Valley casino and harness track in Ohio as well as the Saratoga casino and harness track across the street from NYRA’s Saratoga Race Course. In addition, it has 25% or greater stakes in a new casino in Colorado and in the casino and harness track in Ocean City, Maryland. Altogether, CDI has 9,000 “gaming positions,” about double the size of the slot-machine palace at Aqueduct.

No single casino operation under the CDI umbrella earned as much as $100 million last year, but in the aggregate, those 9,000-plus slots and a few table games accounted for earnings of $332 million.

And then there are those video games. Big Fish Games downloaded 2.8 billion games to customers in 150 countries in 2016. It’s the seventh biggest publisher of games for the mobile iOS and Android platforms in the US. These games are typically free, but make money when gullible players fork over real money to get an edge in the game, like extra moves or extra weapons. In 2016, Big Fish pulled in $486 million in revenue, up 7.3% over the prior year.

But video gaming is a volatile business. Just ask Atari. In the long run can the clash of the CDI corporate suits in Louisville and the Big Fish millenials in Seattle, Oakland and Luxembourg produce stable or, even better, growing, profits? It’s not an odds-on sure thing.

Here’s how the four segments contribute to CDI’s revenue last year:

Twin Spires
Big Fish Games


Even combining live racing with Twin Spires, barely a third of CDI’s revenue these days comes from racing. Despite the aura of the Kentucky Derby, the company’s core business is watching wheels spin on slots and gumdrops slide down iPhone screens. What would Matt Winn, the man behind Churchill Downs and the Kentucky Derby, make of it?

Expenses for each of the four CDI segments aren’t all that different from one another, as a percentage of revenue. Those expenses eat up 75% of racing revenue, 73% of casino revenue, only 67% of what Twin Spires brings in, and a surprisingly high 82% of Big Fish Games’ revenue (must be all those perks for the game developers). And the suits (i.e., corporate, general, marketing, administrative expenses, etc., plus whatever CDI tucks away under the heading of research and development) gobble down another 10% of total revenue. But still, CDI is comfortably profitable, with net income of $108.1 million last year, a gain of better than 50% over the previous year.

From the point of view of the stock market and CDI executive bonuses, the message is clear: continue to minimize racing and focus on way easier kinds of betting, like slot-machines and video games. From the point of view of racing, the message is equally clear: a publicly traded company, beholden to the demands of the market, will never save horse racing. If CDI is the industry leader, us troops better turn around before we’re neck deep in the Big Muddy.

Sunday, April 9, 2017

NYRA Privatization Plan Will Still Leave Cuomo in Control

Budget talks have ended in Albany. As a result, the compromise plan agreed on by New York’s Governor Andrew Cuomo and legislative leaders for “privatizing” the New York Racing Association (NYRA) is now the law. Thanks to Tom Precious’s report in the Bloodhorse, we now know the broad contours of the NYRA plan. From the point of view of racing fans, bettors, horse owners and other industry participants, it ain’t pretty.  In fact, it’s pretty much a continuation of the politically dominated NYRA structure that we’ve been living with for the past five years. A pity that the Governor and Legislature missed the chance to do something new and imaginative.

Back in 2012, when the state took over NYRA, it established a Board of Directors of 17 members – seven appointed by the Governor, two each by the State Assembly and State Senate, and the remainder holdovers from the “old NYRA” Board. The current acting NYRA Board chair is Michael Del Giudice, a longtime Cuomo family consigliere.

That 2012 legislation also confirmed substantial oversight power by a state agency called the Franchise Oversight Board (FOB), originally established in 2008 when NYRA was in bankruptcy proceedings. No surprise, Governor Cuomo’s appointees dominate the Franchise Oversight Board.

NYRA had originally been scheduled to return to “private” status by 2015, but that deadline was extended twice, most recently to October 2017. The state budget bill creates a “new NYRA” that will take over  from the existing NYRA Board this year. You can read the text of the bill here.

Initially, Cuomo – who apparently hates racing and has never so much as set foot on a NYRA track -- had wanted to continue to control even a “privatized” NYRA, through a combination of a plurality of Board appointments and increased powers for his Franchise Oversight Board. Under the compromise agreement with legislative leaders that is embodied in the budget, his control will be reduced, but by no means eliminated.

First, the new legislation sets up a Board of 15 members – a bit too big for effective governance, so the real power will rest with NYRA CEO Chris Kay or his successor and with the smaller executive committee. Of those 15, Cuomo will directly appoint two, the State Assembly and Senate leaders one each, and the existing NYRA executive committee, dominated by Cuomo appointees, will appoint eight. The remaining three slots will be filled by the NYRA CEO and by representatives of the New York Thoroughbred Horsemen’s Association (NYTHA) and the New York Thoroughbred Breeders. In exchange for those NYRA Board seats, the breeders and NYTHA agreed to put a NYRA Director on each of their own Boards. I’m not sure the trade-off was worth it; would a labor union want a management rep sitting in on its executive board?

So, counting the eight members appointed by the Cuomo-friendly executive committee, the Governor would start out with 10 of the 15 Board members owing their appointment to him. That may change over time, particularly if Kay or a successor CEO uses his influence to have his own supporters named to the NYRA Board as the terms of the original Directors expire, but it certainly sounds like continuing Cuomo control, at least for a while, since the existing NYRA Board executive committee, which Cuomo controls, will appoint a majority of the new Board.

As for the Franchise Oversight Board, Cuomo had initially wanted the FOB to have the power to impound NYRA funds – including purse money – and to appoint an outside financial adviser if the FOB found that NYRA’s finances were at “significant risk.” In the compromise version, the draconian impounding sanction would require a unanimous vote by the FOB, including the votes of FOB members appointed by the legislature. That may satisfy some Albany politicians’ desire for a slice of the power pie, but it doesn’t do much to calm NYRA’s and horse owners’ fears. Those fears were already high, given Cuomo’s statements earlier this year about reneging on the contractual deal that gave NYRA and the horsemen’s purse account a share of the enormous profits from the slot machine palace at Aqueduct.

Cuomo doesn’t like racing, and sees it as an untapped source of money for the things he does like. It’s dangerous to leave him in charge.

On the positive side, the bill mandates a negotiated agreement between NYTHA and NYRA over the number of winter racing dates at Aqueduct. Blue-collar horsemen depend on the winter season, when Pletcher, Mott and McGaughey are away, to get the purses that will tide them through the summer. NYRA has been pushing for years to reduce or even eliminate winter racing.

In a different world, where state policy wasn’t made by three men in a room, in the annual Kabuki play that is the New York budget process, a reprivatized NYRA might look very different. Instead of a Board of Directors appointed by or beholden to, the Governor, what about a Board with members elected by racing’s different constituencies – fans, bettors, owners, breeders, trainers, backstretch employees, etc.? Of course, that kind of Board might require a CEO who actually knew something about racing, but that wouldn’t be a bad thing, would it?

Instead, we’ve got what looks very much like business as usual, only now NYRA won’t even have to pretend to be a public agency and offer minimal transparency. And we know how well all that secrecy worked in the past, when old old NYRA was run by Dinnie Phipps and his pals. Worked so well that they ended up in bankruptcy court.

As the Tweeter-in-Chief would say, Sad.