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.

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