Legalized Online Gambling: Beneficiaries From State Rulings Allowing Online Wagering

by: Arthur Goldgaber

If you bet on growth for online gambling in the U.S. seven years ago, the odds would have been stacked against you. That's because the U.S. online gambling industry nearly drew snake eyes after the Unlawful Internet Gambling Enforcement Act of 2006. The law prohibited online gambling, and the federal government targeted online-gambling companies and their partners with criminal and civil lawsuits. But in 2011, the Department of Justice reversed that stance and issued a letter stating that the Federal Wire Act of 1961 only applies to sports betting - that gave the green light to online gambling.

An effort by Congress to pass a federal law allowing online poker stalled last year, but online gambling with real money has been approved by Nevada, Delaware and New Jersey. After Delaware legalized online gambling, it has been entertaining bids from companies that will run the service to oversee online gambling. Bills have already been introduced in several other states, including California, Iowa and Mississippi, to legalize online wagering.

There's a good reason for the market enthusiasm about the potential revenues from online betting. The mobile research and analysis group Juniper Research revealed in a study that the biggest segment of online sports betting by 2017, or even as soon as 2014, will be mobile sports betting. Juniper estimated that the mobile sports betting market will reach annual revenues of $45 billion by 2017. However, mobile gambling in general - poker, casino and sports - is expected to generate around $100 billion annual revenues by 2017, according to Juniper's estimates.

Nevada's new law authorized online poker, and on May 2, the nation's first legal, pay-to-play poker Web site (run by Nevada regional company Station Casinos) began a 30-day trial period. Just online poker will be played - with bets as little as a penny - on personal computers from accounts funded by MasterCard, checks, wire transfers or person-to-person at any Station casino.

Nevada's Gaming Control Board will monitor if the company can verify that the site's users are older than 21 and in Nevada, using identification and geolocation software, among other tools. Visitors to Nevada can register to play before arriving in the state.

Nearly 24 companies have obtained licenses to participate in some aspect of online gambling, including MGM Resorts International (NYSE:MGM), Bally Technologies, Inc. (NYSE:BYI) and Caesars (NASDAQ:CZR), often through subsidiaries or in partnership with other companies. Zynga (NASDAQ:ZNGA) has also applied for an operator license in Nevada.

New Jersey's law allows Atlantic City's casinos to run websites that take bets on games such as blackjack, slots and poker, and also requires bettors to be physically present in the state.

Potential Size on U.S. Online Gambling Market

The first question is determining the annual revenues that will be generated by the online gambling market. One estimate is that online gambling in New Jersey will generate revenues of $410 million the first year (2013 or 2014) and increase to $590 million per year after a few years, according to H2 Gambling Capital, a firm that tracks online-gambling markets. Of the total, the state of New Jersey will collect a 15% tax.

However, the bigger opportunity for gambling companies could come from interstate gambling if and when more states legalize online wagering, and then sign compacts to permit gambling to extend beyond state borders. Both Nevada and New Jersey online gambling laws allow the states' gambling regulators to sign compacts with other states.

The other important consideration is whether social gamers will transition to betting real dollars, a topic explored in a recent Morgan Stanley report, "Social Gambling: Click Here to Play." The report estimates that about 12% of the world's population, or 800 million people, plays one or more form of online social gaming every month. Of these players, just over 20% play some form of casino-style game. This suggests that 173 million people (2.6% of the population) are involved in "soft" social gambling of some sort.

That number is almost three times larger than the approximately 50 million who are betting real money online. So the Morgan Stanley report points out that the conversion from social gambling to real money gambling could be a significant driver of revenue growth. Morgan Stanley analysts also think that many social gamblers could begin to play real money games, with the prospect of real rewards.

Companies to Benefit from Online Wagering

Finally, the crucial question is "which companies will benefit most from the laws allowing online gambling?" Analysts and industry experts mention that both the brick-and-mortar casino companies based in the states that have passed legislation to permit online wagering, such as Caesars Entertainment , Boyd Gaming (NYSE:BYD) and MGM , and also high-tech companies such as Zynga and Glu Mobile (NASDAQ:GLUU) with online games expertise may be poised to benefit from the new laws.

As far Glu, Piper Jaffray analysts do not think the firm will be an immediate beneficiary. They wrote that game players using real money will eventually provide Glu with incremental growth opportunities. However, they don't think it will happen for some time because Glu only has one game in the highly competitive UK market now, and they do not expect the U.S. market to be a near-term (in the next 12-18 months) opportunity for the firm.

Several social gaming operators have been introducing betting games in the U.K. to gain more knowledge in managing regulated online gambling. In fact, Apple modified the iPhone software for U.K. users to accommodate them. Facebook began allowing online gambling for British users last summer with Jackpotjoy, a bingo site; and other deals are in the works. Zynga, the company that developed FarmVille, Mafia Wars, Words With Friends and many other popular casual games, signed an agreement with Bwin.Party Digital Entertainment to open the door to the U.K. markets for it, but MGM also has a deal with Bwin.

Many Wall Street analysts give the edge to online gambling companies in terms of who will benefit most from the legalization of online gambling in U.S. states because they enjoy specific skill sets and regulatory advantages over social gaming operators. As a result, Morgan Stanley analysts stated that these skills will enable them to benefit from passage of online gambling laws growth just as much, if not more, than social gambling operators. Converting 10% of the existing social casino paying players into online gambling players could drive 30% growth in the online gambling industry.

For example, analysts who are bullish on Boyd and Caesars say that passage of legalized online gambling at the state and federal level has the potential to lead to a significant increase in revenues for these companies - in Caesars' case, its interactive division, Caesars Interactive Entertainment. As a Morningstar analyst wrote in a report, "Caesars is plagued by a mountain of debt and intensifying competition in the U.S. casino industry." However, Caesars is the number 2 operator in market share terms in the social gambling industry after purchasing Playtika, the developer of Slotomania, the popular Facebook game, for about $180 million in 2011.

To reduce its $21 billion in debt, the company recently announced a plan to spin off several assets, including Caesars Interactive Entertainment a - plan it hopes will generate $1.2 billion. Credit Suisse analysts wrote that "The company's positioning with social gaming and for-money gaming, along with powerful brands (WSOP, Caesars, and others) continue to make it the most direct bricks and mortar player in this evolving opportunity."

Another strong player is Boyd. Morgan Stanley analysts Thomas Allen and Amir Moskowitz recently upgraded the stock, mainly due to the passage of the online gaming laws. They wrote that "expansion of U.S. online gaming" is a key upside driver for the company. They argue that Boyd is well positioned to benefit from the new laws because of its properties in Las Vegas, New Jersey and seven other states, along with its agreements with

In their estimates for online gambling growth (now factored into their BYD estimates), they project that the legal U.S. online gaming market will be worth $670 million in 2014, increasing to $9.3 billion in 2020 (at a 55% compounded annual growth rate). Put into context, by 2020, they estimate that online gaming in the U.S. to be the same size as the current Las Vegas Strip ($6.2 billion of gaming revenue in 2012) and Atlantic City ($3 billion in 2012) markets. To bolster their estimate, they mentioned that the U.S. online gaming market was estimated to be $5.3 billion ($7.5 billion adjusted for inflation) before it was banned in late 2006. MGM should also benefit because of its joint venture in Atlantic City's Borgata casino/hotel.

However, Morgan Stanley analysts think that in the final analysis that both sides, social gaming companies and traditional online gambling companies, have something the other wants. Online gambling companies have regulatory expertise, strong customer relationship management (NYSE:CRM) skills, years of data of player behavior with real money and direct marketing skills. Social gambling operators have a more accessible product that attracts a wider customer base (and broader demographic), greater skills at harnessing social media to improve customer acquisition and retention, and a more modern look and feel.

While investors crunch the numbers to discern if companies like Zynga or Caesars are positioned today to maximize return on investment (NYSE:ROI) from legalized online gambling, they may want to go outside the box to companies like Google, Lumus or Infinity Augment Reality, Inc. (ALSO) to examine what is coming down the road as a disruptive technology in the industry.

Augmented Reality Gambling

Gamblers will be able to get the full experience of being at a card table, or a slot machine, or standing at the end of a craps table ready to throw the dice in whatever casino they want anywhere in the world, without being there at all. That is truly the ultimate gambling experience. Like to play a game of Texas Hold 'Em with Johnny Chan in Atlantic City? It can happen. Want to bet on a basketball game and then transition apps to "virtually" go to the game and sit in the front row? That will be available too. It's the collision of real world and the web, representing the next technological advance that can take online gambling by storm.

For starters, augmented reality gambling won't be like staring at a computer screen, smartphone or tablet. While the technology has the capability of greatly enhancing the experience through those mediums, it can also feature glasses that allow users to become fully immersed in the environment with views and scenery changing with the turn of the head, or what could make augmented reality the real game changer.

Infinity Augment Reality is one of the only pure AR plays in the public domain. Being the only pure augmented reality play sets Infinity apart from the outset, but what they are doing to help build-out the industry is notable as they are developing a platform that can interface with augmented reality glasses being built by companies like Google, Vuforia and Lumus. This platform would open the door for partnerships and revenue streams, either before or after commercialization. In the context of online gambling, there is going to be a shortlist of companies that have products available in the near term, allowing for application and IP owners to command a premium for licensing, a fact that should bode well for companies establishing an early footprint.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.