Regulus Partners returns to action this 2022, examining the hazardous playing field of the high tax and compliance New York sportsbook marketplace that made its debut this weekend. Investors and stakeholders await to see how NY’s nine licensed incumbents will proceed in a market that holds a visibly flawed model for participants…

While the New Year has been marred by the Omicron variant, at least New York promises a new online betting market in the USA’s continuing drive to expand sports betting. However, much like Covid-19, the New York market reinforces the danger that the ‘cure’ of commercial and policy responses might prove far more costly than the ‘situation’ of a rapidly spreading new variant.

There are a number of concerns which temper our enthusiasm for the new market beyond the obvious issues of high taxes and restricted access. While we have warned of these issues before, we believe that they may cause greater levels of disruption on many levels now that they are live.

New York’s aggressive 51% tax rate falls upon GGR, which means incentives are included in the calculated liability. In structure, therefore New York broadly copies competing New Jersey (which taxes the first U$90m of promotional credits per annum per licence), if not a growing number of states which allow much more generous bonus deductions. When a GGR tax is 14.25% (as in NJ), this implies a manageable 24% underlying tax rate on revenue when incentives represent 40% of GGR. If NY licensed operators were to adopt this ‘normal’ level of customer incentivisation for the US market, then the implied tax rate on net revenue would be a completely unworkable 85%. This is likely to drive three very significant market distortions, in our view:

• Without the ability to print bonuses to anything like a ‘normal’ amount on a sustainable basis, the reported TAM will suffer; most NY market forecasts seem to treat GGR as an input variable that will remain the same even without the ability to print bonuses; benchmarking NY to US$25 per capita net revenue rather than US$40 gross and then assuming a 10% bonus rate (to get to an underlying tax rate of 57%) suggests a GGR TAM of US$550m rather than US$800m with no other variables changing
• Incentives have been a key driver of customer expenditure if only to meet aggressive T&C criteria to unlock them; without this stimulant being offered sustainably it is possible that the market will be materially slower to mature
• Without sustainable competitive incentives there are fewer reasons for more dedicated NY customers to stop going to the NJ border to place their bets (c. 20% of NJ bets by volume, likely materially more by value given the effort involved and the logic of placing parlays and ante post bets when travelling to wager), while the comparative tax rates place a strong incentive for operators to actively encourage betting-commuter behaviour; ironically NY customer acquisition may therefore be a boon to NJ sports betting revenue as VIPs are discovered and routed across the Hudson

One thing that will not be distorted, however, is the initial engagement of New York citizens with the newly licensed in-state product. Sports betting is now visibly available from a number of brands which are already household names in the state, with a lot of the awareness legwork having been done by DFS and marketing the neighbouring NJ offer. Further, early signs are that bonuses are as generous as anywhere else as brands inevitably hope to counteract an initial aggressive tax hit with hoped for ‘normalisation’ later. In other words, operators are being driven to take unsustainable tax losses by adopting their unworkable standard business model out of a fear of losing initial market share.

The sporting calendar also encourages a ‘hard launch’ into guaranteed customer engagement in the hope of more sustainable behaviour coming later: the New York Giants, the New York Jets (AFL), the New York Knicks, the Brooklyn Nets (NBA) and the New York Rangers (ice hockey) all play this weekend.

The volume of bets placed in NY is therefore likely to be impressive since high taxes and low incentives do not materially shape this KPI. Indeed, early publicly released data from GeoComply suggests that NY is already 2.5x bigger than PA in terms of transactions, outperforming its population advantage by 64% (NY also has proportionately more young men, a more pronounced urban cash economy and a much greater level of ethnic diversity than PA, which turbocharges the population advantage from a betting engagement perspective). The problem with high taxes and low incentives is with attracting VIPs to specific brands and ensuring that they bet big: high volumes are a problem if they are incentive-driven, which early data and market comparisons suggests they are.

However, the distortions to customer expenditure vs. betting volumes is quite hard to articulate at the policy level, and so as an additional trap NY is likely to see big volumes being presented as a sign of ‘success’ rather than a more nuanced direction of travel, in our view. Ironically, early aggressive bonusing to try to gain share will even drive ‘encouraging’ GGR and tax levels vs. underlying revenue trends, which is basically the industry digging a hole for itself faster. With nine brands currently or soon to be in action, there is just enough competition for the industry to engage in Mutually Assured Destruction. Indeed, January may see New York GGR of US$50m – making a US$600m run-rate market and under ‘normal’ patterns easily supporting a US$1bn TAM with some growth. However, factoring in an early bonusing rate of 60%, this would imply a real run-rate revenue figure of US$240m and a tax rate of 130%: a market that is dead on arrival in underlying terms.

None of these distortions, or their optical absence in the initial scramble for share, make for a well-functioning market. Further pressure is applied by pre-maturity business models that practically guarantee structural losses for a betting-only product even without taxes comprising more than half of revenue. As we have suggested before, in the long term this should force a focus on product and customer service over marketing which will be a ‘good thing’, but a lot of damage can be done getting to the long term and not all operators are likely to make it.

Since this is true of most markets, at least NY State will take a large proportion of tax as it goes. However, given that expectations of c. US$500m per annum seem to be based on dodgy GGR assumptions, even absolute success (c. US$200m) would look like relative failure.

There is a worm in New York’s constitutional apple which may yet save all constituents from themselves. New York’s laws require a public vote to expand the provision of gambling, much like Florida. The sports betting law which is now live relies upon sports betting being allowed in the four upstate casinos and tribal lands to get around this, with servers placed in those areas. This ‘point of supply’ legal position also mirrors NJ (without the tribal element or need for a public vote), but for obvious reasons nobody has challenged the underlying legal basis in a state with a partial dependence on gaming. New York is different, however: a lot of stakeholders can feel aggrieved about being left out of the cut or be concerned about the expansion of gambling ‘into the pockets of the people’.

If politicians disappointed by tax returns are added into this mix, then the potentially dubious constitutional grounds of New York’s online sports betting expansion, so simply explained over the Florida Seminole case, may provide a useful excuse to rip up the whole experiment. It is nevertheless likely that before that happens, over US$500m of cash flow will be moved from licensed operators to media companies and the state government. A watching California legislature is also likely to take note of the commercial sector’s willingness to sign up to almost anything that promises superficial progress – a dynamic cynical politicians will exploit while more cautious ones run away or become more vocally sceptical. That is a very expensive way to test an obviously flawed model, in our view, and reinforces the dangers of strategic optimism which is not grounded in operational reality.

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Featured article edited by SBC from ‘Winning Post’ Sunday 09 January  2022 (click on the below logo to access a full unedited version). NB Winning Post will return for 2022 on Jan 9th.