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China To Resume Internet Lottery Sales?

|Includes: AGTEF, Alibaba Group Holding Limited (BABA), BIDU, TCEHY

Summary

Past weekend, an article in the official Chinese Newspaper talked about the fallout from the Internet Lottery Sales Ban.

This article was unusually critical of government decision.

Government had no choice but to ban the Internet Lottery Sales.

This report may be used to gain public support for reopening of Internet Lottery Sales.

The CCTV special

A fascinating article appeared this weekend in People CN which is connected to Xinhua, the official newspaper of China.  Some industry experts believe Beijing might be using this report to gather public support to resume Internet Lottery Sales and Sports Betting ahead of the World Cup.

The article (attached) talks about an expose CCTV ran on the underground lottery gaming activities by the criminal element.  CCTV is China's official Television station.  This expose was so explosive that lottery officials were required to watch them.

The CCTV report revealed just how out of control the underground lottery business has become since the government banned the Internet Lottery Sales in March 2015 after two years of the industry-wide audit.  These illegal operators are making so much money from running lottery betting sites that they don't know what to with it.  Even before the ban, the underground lottery market was reportedly at least 5 times bigger than the regulated lottery market. ($300 Billion)  Now they are even larger.

Unusually harsh

People CN was unusually critical of the government's decision to shut down the Internet Lottery Sales activities and allowing the business to go underground exposing Chinese citizens to high risk of abuse by these criminals.  Also, the report talks about all the tax revenue the local and the Central Government is not collecting that would have gone to support local welfare and sports programs.  This article falls short of calling for the government to re-open the Internet Lottery sales to chase away illegal operators and protect the citizens but that is heavily implied. 

No Choice

Back in 2015, the Chinese government had no choice but to shut down the Internet Lottery Sales activities. The two-year lengthy industry-wide audit before the ban revealed a broken system. Without a national back-end platform, there was no way of tracking each transaction and the flow of money. It was easy for the unscrupulous players to bribe politicians to look the other way while stealing from the citizens and not pay taxes to the government in tune of billions of dollars.  

But Now

I am hearing that the government is finished building the national platform needed to run the Internet Lottery Sales.  This time, the government is looking to work with just a handful of mega-technology/e-commerce giants to distribute lottery products online.  

Government is maybe sifting through political ramification to weigh the pros and cons of reopening the Internet Lottery Sales.

Pros 

1. Reduce or eliminate illegal activities

2. Regulate the market to protect the consumers

3. Collect tax revenue for the Local and Central Government 

Cons

1. To be seen to promote gambling. 

2. To be seen to bury their head in the sand and hoping the problem will go away.

Timing

This is the World Cup year.  Many Chinese citizens will be wagering billions on each match.  If Internet Lottery Sales & Sports Betting is not resumed, the betters will turn to illegal sites. This exposes Chinese citizens to a lot of unnecessary risks.  Provincial Governments are also strapped for revenue and this will go a long way towards relief.  So, the question is, what is Beijing's political priority and an appetite?

My read

If you asked me last week what I thought of the odds of Internet Lottery sales resuming this year, I would have said 51%-49%. But, after watching the CCTV report and People CN article appear over the weekend, I believe the odds of resumption have improved markedly.  

The lottery is a highly politicized industry. The government does not want to be seen to promote Gambling.  But if you don't resume the Internet Sales and regulate the industry, you are effectively giving permission to the illegal operators to continue to rip off consumers and the state.  Doing nothing is worse as this CCTV report shows. That is why I believe the government is trying to drum up public support to reopen the Internet Lottery.

$65 Billion worth of lottery tickets were sold last year through 200,000 stand-alone lottery shops located throughout the country.  It's not as though the government is setting up the lottery business for the first time. Also, you are reaching a segment of the population that is wealthier, more sophisticated and better educated.  Arguably less susceptible to making a poor decision to gambling your entire life savings on a lottery game. 

Who Benefits

If my understanding is correct and that the government will choose to work with a handful of mega-technology/e-commerce companies, Alibaba, Tencent, and Baidu are the clear listed favorites.  They certainly have the technology and customer base to attract the new breed of lottery players.  Of the three, Alibaba and Tencent would be the clear winners given their consumer-driven technology infrastructure and robust payment system in place. AGTech (8279 HK, AGTEF) will be the biggest beneficiary of the resumption of Internet Lottery Sales.  For Tencent and Baidu, lottery revenue will represent a fraction of their primary business, but for AGTech, it will be their most significant contributor.  AGTech is also tiny compared to the two giants with market cap. of only $1.7 Billion.  AGTech is Alibaba's lottery/gaming arm, having access to everything Alibaba & ANT Financial has to offer.  After the acquisition of a controlling stake, Alibaba transferred their Online lottery business to AGTech, giving them control of the team and the resources that generated $200mil in pre-tax profit in 2014 before the Internet Lottery sales were banned.  The market will pay handsomely for that kind of number.  If the resumption were to happen, the approvals need to happen fairly quickly to give the operators time to set up before the World Cup begin in June.  I guess we will know soon enough, one way or another.

Quantifying the opportunity

Before the ban on Internet Lottery Sales, Alibaba reportedly made at least $200 million in pre-tax profit in FY 2014. Even if AGTech only duplicates that number, the market will be happy to pay 20X-30X $200 million because it is a highly profitable business with 65% gross margin and growing fast.  Internet Lottery sales rose 60% CAGR before the ban. I sense that AGTech will gain more significant market share than what Alibaba Online lottery did back in 2014. 

Click below for the CCTV report and People CN article.

CCTV Expose report

People CN newspaper article

Disclosure: I am/we are long BABA, AGTEF, TCEHY.