Background on Sports Betting in the U.S.
Congress enacted the Professional and Amateur Sports Protection Act (PASPA) or Bradley Act (in reference to Bill Bradley one of the bill's sponsors) and President George H. W. Bush signed the bill October 28, 1992. PASPA effectively prohibited any sports gambling in the United States, with some minor exceptions (e.g. Las Vegas). Bill Bradley, a former NBA star and NJ Senator, pushed for the legislation in order to "protect the integrity of the game". Ironically and some might say hypocritically, New Jersey was also granted an exception as Atlantic City casinos were given a lifeline, they foolishly demurred (to offer sports betting within one year) until ironically two decades later when state residents and lawmakers made a big push to legalize sports betting in their state.
New Jersey, behind Governor Chris Christie, enacted a law allowing sports betting in January 2012 at certain racetracks and casinos. Amateur and professional leagues protested almost immediately and ultimately prevented sports betting in NJ from ever happening by effectively arguing it violated PASPA. The back and forth continued for 5 years culminating in the Supreme Court deciding to hear the case.
Supreme Court's Game Changer
On May 14, 2018, the Supreme Court sided with New Jersey, reversing PASPA and opening the door for each state to independently determine whether they would allow sports gambling and the specifics therein. On June 14, 2018, the first legal sports bet was placed in NJ at Monmouth Racetrack.
Since then seven states have joined NJ and approved sports betting with many more in various stages. Similar to the legalization of marijuana, states generally are moving forward but are at different stages with the debate focusing on the number of licenses, cost of license and tax rate. Of the eight states to legalize sports betting, tax rates range from 6.75% of gross revenue in Nevada to revenue sharing (i.e. basically 50% to the state) in Rhode Island and Delaware. The cost of a new license ranges from $100k in West Virginia to upwards of $10 million in Pennsylvania.
In the end, the most important number to an operator is the "hold" or revenue after paying out all bets while to the state it is the total tax dollars generated. The key is to examine the hold on a percentage basis (i.e. % of the total handle or total $ bets placed). A general fallacy is a bookmaker strives to achieve 50/50 action on all games, locking in a 10% profit margin or hold based on the 10% "juice" charged for hosting and netting the wagers. However, in practice a bookmaker rarely achieves a 50/50 split in a given game, never mind an entire season. The standard rule of thumb for a bookmaker is the hold should exceed 5% over a large enough of a sample.
How Have States Performed Thus Far?
Nevada who has the largest total handle of all states logged a 6.0% hold (equating to $300 million in revenue) for the calendar year 2018 on a total handle (i.e. dollars bet on both sides) of $5 billion, experiencing only 3 months with a hold under 5%. New Jersey took in the second largest handle of $1.6 billion for its first 8 months (through January 31, 2019) with a hold of 6.7% (equating to $100 million in revenue). Pennsylvania, while only reflective of 3 months of data but during the lucrative football season, took in a total handle of $50 million but cleared a hold of 10.3%.
The state of Nevada collected $20.3 million in 2018 taxes on sports betting on a handle of over $5 billion while New Jersey collected $10.4 million on $1.2 billion in just its first 7 months. Operators made $300 million in Nevada vs. $94 million in New Jersey. New Jersey's quick ascent exemplifies the burgeoning demand for sports betting especially in the final three months of the year when football is at its peak.
Low Tax Rate and Limited License Composition= Keys to Success
The two most important decisions a state must decide after legalization involves tax rate and licenses. Part of New Jersey's success must be attributed to Nevada like low tax rate (i.e. 8.5% at retail, 13% online) and modest initial license fees ~$500k+ that vary based on whether it is a casino or an Internet-based entity. Following the initial sports gaming permit, the licenses need to be renewed annually for an additional $100k to $250k.
CT On the Near-Term Horizon
Given Connecticut's close proximity to states like New Jersey who have already legalized sports betting and others who are moving forward aggressively like Massachusetts and New York means a competitive tax and license rates are a necessity. One unique characteristic of CT involves the presence of two Native American reservations (Mohegan Tribe and Mashantucket Pequot Tribe). Currently, those two casinos pay 25% of their slot revenue to the state equating to $263 million in 2018 but down 43% since 2006. In return, CT has promised both casinos an exclusive to casino games (e.g. Blackjack, Craps, Poker). The tribes are adamant that if sports betting does, in fact, become legal in CT that they each receive a license, threatening to upend the current compact if excluded.
I would say it's highly unlikely for there to be legislative support that would allow for exclusivity for the tribes on sports betting.
- Rep Joe Verrengia, the House Public Safety and Security Committee chair
Momentum Picking Up
Joe Verrengia, the House Public Safety and Security Committee chair, has been leading the charge for a comprehensive sports betting bill that picked up steam over the last two weeks. Informational sessions kicked into high gear in late February and then in an update released by the Legal Sports Report last week, Matthew Kredell in the Legal Sports Report:
Following on an 11-hour committee hearing during the week of February 25 on multiple gambling expansion bills, a new Connecticut sports betting bill will be heard Tuesday morning in the House Public Safety and Security Committee. But this is the sports betting legislation in the state with the best chance, as it comes from Rep. Joe Verrengia, the committee's chairman. He expects the bill to move quickly, possibly within a week.
CT Proposed Bill Details
In the recently proposed bill HB7331 dated March 8th to be debated publicly on March 12th, CT would charge a 9.89% state tax on gambling revenue and assess fairly modest license fees of $100k for a non-refundable application fee plus $250-500k biennially upon issuance or for renewal. Of course, these are only proposed, and much can happen before legislation occurs, however it is clear that CT is following the path of successful states like Nevada and New Jersey by not burdening operators with high fees such that they can invest in the business for long term success.
If successfully licensed, each operator will be able to offer sports betting online to an individual after he/she has successfully registered in person at the retail location. One thing CT has learned from NJ is to not provide undue competition through issuing additional individual skins or brands (i.e. 3 per license in NJ) per license. In CT as per the proposal, there will only be one online presence per license issued limiting the number of de facto operators.
How to Invest in CT Voting 'Yes'
The key part to Verrengia's bill with respect to the investment idea herein is as follows: "authorization for tribal casinos to offer sports betting as well as commercial casinos, off-track betting parlors, and the Connecticut Lottery."
Sportech PLC (OTC:SPOZF), listed on the London Stock Exchange, has the exclusive OTB license in Connecticut via its Autotote acquisition in the 1990s and been licensed for 18 years, operates 16 OTB locations, provides their betting technologies to 293 licensed operators in 37 countries and 36 US states, and has 27,000 betting terminals deployed that account for $12 billion in annual handle. Sportech has spent millions developing cutting edge software and hardware to set-up betting accounts, manage cash in/out, manage risk, and accept high volume wagers whether in-person through a teller, a self-service kiosk or digital with their mobile software.
Source: Sportech website
In Connecticut, Sportech owns and operates 2 Bobby V's sports bar (25,000 square foot landmark one in Stamford, CT) and Winners upscale sports bars and OTB's that resemble an upscale sports book in Las Vegas with an enormous bar and dining room downstairs and an OTB Teletheater on the second floor. Further, the facility has innovative attractions like a full 18-hole golf simulator and private meeting rooms that resemble NFL Draft Day war rooms, perfect for fantasy drafts. More importantly, when sports betting is legalized in CT, Sportech will be ready on day one to accept sports bets at either of their facilities with their current technology infrastructure and further monetize customers through their mobile software.
Source: Sportech website
Sportech (SPO, traded on London Stock Exchange) sports a market cap of $85 million, EV of $65 million (based on 1H'18 numbers). Even after heavy investments in sports betting technology development (1.1-1.2 million pounds in 2018). Sportech still sports a strong balance sheet (15 million pounds cash with no debt). While only 1H'2018 results have been reported, annual revenue the last two years has remained steady around 65-66 million pounds and on an adjusted basis for the recently sold business, I expect the number to be in that vicinity. The company generates solid cash flow (7-9 million pounds adjusted EBITDA in 2016/2017 and likely 2018 to be reported in late March).
Sports Betting Potential for Sportech
Using New Jersey as a model for Connecticut is most appropriate given the similarity of tax and license fees. As per demographics, NJ has a 2.5-times larger population but roughly 10% lower GDP per capita relative to CT. As for brick and mortar licensed sports operators, 3 New Jersey racetracks and 9 Atlantic City casinos were issued licenses. But due to the 3 additional individual online brands per license, the ultimate potential supply of operators is a multiple of that. Assuming CT issues a license to the two casinos which is a given plus one to the Connecticut Lottery Organization and one to the OTB license holder (i.e. Sportech), the rough math would appear as follows:
Source: Author's calculations
Conclusion Quite Simple = Sportech Dramatically Undervalued
There is roughly $20 million in EBITDA contribution assuming 4 licenses and a handle 10% below that of New Jersey, however, I think there is upside given that the number of licensees could only be 3 in the near term as the CT Lottery will be hard-pressed to make the case that unregistered, minimally trained convenience store workers are equipped to handle complex, big-ticket sports wagers when all other sports betting cashiers need to be regulated. That would increase the per-license potential EBITDA windfall towards $30 million annually. (Note all Sportech's tellers are registered by the various gambling regulatory authorities).
Given the vast majority of bets are made online after initially setting up an account at a brick and mortar facility, Sportech has an enormous lead here as the CT Lottery isn't even equipped to accept lottery bets online and the two casinos have no prior investment nor expertise in this arena.
One Caveat to Monitor - Profit Share
As part of Sportech's acquisition of the U.S. racing from Scientific Games in 2010, they contracted with Shoreline Star LLC (see page 11) for a profit sharing (50/50) in CT if when sports betting is legalized. The payment is after all costs and taxes and includes a ratchet down to 40% after year 5 and 30% after year 10. The contract clearly trades away some upside.
Valuation - A Potential Triple from Here
Sportech currently trades at around 9-10x Enterprise Value to EBITDA. A 10x EV/EBITDA seems overly conservative to me, especially in the context of the growth story surrounding sports betting.
Applying a modest multiple expansion as the company returns to growth, at 15x EBITDA ($10 million +50% of $20-30 million sports betting) the company could trade at $300-350 million or roughly 3x where it is trading currently. Note the stock had a $200 million market cap only last year when there was initial talk about CT legalizing sports betting. Now with it imminent and little attention on the stock, the risk-reward is compelling to say the least.
Disclosure: I am/we are long SPOZF. 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.