PE & gambling: Ante up

Crown Resorts is a mess. The Australia-listed casino operator saw profits tank 80% last year due to government-mandated closures to contain COVID-19. Meanwhile, an ongoing scandal has swirled around anti-money laundering investigations, junkets with links to organized crime, a withheld gambling license in one state, and an exodus of company leadership. Still, The Blackstone Group is unfazed, having bumped up a takeover offer in May to about A$8.3 billion ($6.5 billion).

The understood play here is that new control and new management will set a pillar of the local economy back on track – and the opportunity is no secret. In April, Oaktree Capital Management offered to acquire a 37% stake in Crown for A$3 billion. Blackstone’s biggest competitor may be Star Entertainment Group, whose bid values the company at A$9.4 billion. Star hopes to create a dominant gambling entity worth A$12 billion but could run into anti-competition roadblocks.

Less enthusiastic reactions from other industry participants say much about the complicated nature of this sector, however. Indeed, given how it has exposed the cracks in the local regulatory regime, the Crown episode could end up repelling investment in Australian gambling.

In 2012, the state of Victoria, the epicenter of Crown’s woes, consolidated its liquor and gaming regulator into one entity, which effectively channeled 80% of its resources into liquor. Over time, and for reasons that remain unclear, the regulator jettisoned its senior gambling staff. This, along with weakened management at Crown, is seen as having allowed unprofessionalism, if not criminality, to fester.

Crown’s suitors rightly expect a toughening up of the industry watchdog next year – a process for change is already underway – but a pattern of shortcomings has become undeniable. The staff and structure of the gambling regulator for New South Wales, for example, has been in flux for a decade with much of the leadership considered insufficiently experienced. In Western Australia, the chief casino officer recently stepped down after criticism about his social relationship with Crown staff.

“You would not find us investing in a casino that conducted itself the way Crown has,” says one private equity investor. “Dealing with the types they were dealing with in VIP rooms would have been much more closely watched and called out in Vegas – and subject to massive fines and likely loss of license. Until the regulatory regime in Australia improves in rigor, follow-up and tracking of what the casinos are doing, it will be difficult for us to enter the country.”

Stick or twist?

It remains to be seen how regulatory and operational problems in Australia will impact appetite for the local gambling space, but the fact that investors are still angling for a piece of the action amid sporadic pandemic-related closures and grounded flights offers a hint. As a case in point, Apollo Global Management offered A$4 billion for Tabcorp’s sports betting and lottery business in May, topping an offer from UK counterpart Entain and matching a bid from local rival Betmakers.

Peter Cohen, former executive commissioner and CEO of the Victorian commission for gambling regulation and a director at Melbourne-based consultancy The Agenda Group, is tracking opposing forces in this space with optimism. He sees holes in the regulatory reforms proposed and expects continued instability in the New South Wales regime. But this is juxtaposed against an annuity-like business model with steady dividends and a decades-long history of government support.

“Rather than being a deterrent, the regulatory concerns in Australia will probably be more of an opportunity for private equity because it depresses prices, and investors can come in with an expectation that regulation will improve,” Cohen says. “We also know that the performance of the casinos improves as a result of that. People tend to think that if regulation is weak, casinos can make a lot of money, but it actually works the other way around. There’s also a level of maturity and security in Australia that you don’t get in jurisdictions like Macau.”

This view feeds into the idea that much of the broader Asia Pacific gambling opportunity boils down to regulation, enforcement, culture, and regime stability – and therefore geography. While Australia has a complicated mix of pros and cons on this front, the wider regional picture is arguably more straightforward.

Developed markets with predictable compliance and legal environments have naturally proven more attractive in terms of land-based models such as casinos. Developing markets, meanwhile, have seen greater relative traction with digital businesses. This is in part because most Asian countries – developed and developing economies alike – have yet to regulate online gambling, implying opportunity to establish a first-mover presence as rules are gradually defined.

Clairvest Group, a Canadian private equity firm that has invested in at least 12 land-based and digital companies globally, offers a useful demonstration of how jurisdictional due diligence is the name of the game across the gambling spectrum. Its most recent activity in the region includes a $40 million investment in Indian online rummy platform Head Digital Works and a proposal to develop a $4.3 billion casino resort complex in Japan.

Clairvest relies significantly on Canadian embassies for guidance on business practices and finding credible local partners when it reaches beyond North America. This process is measured in years, rather than months. In developing markets, financial upside needs to be at least twice that of similar opportunities in developed markets to make it worthwhile.

“We have to be very mindful about the political, bureaucratic and legal systems in Asia. We are particularly focused on how the business is conducted, the government oversight, and any criminal activity elements and general concerns of the probity,” says Jeff Parr, a managing director and vice chairman at Clairvest.

“That’s a challenge and frankly why we’ve avoided investing in most Asian markets, including Australia. We want to be in jurisdictions where oversight, compliance and rigor are in place so all competitors will be top-tier and properly managed with respect to compliance and probity. We believe Japan’s approach will be consistent with our criteria.”

Legal ambiguities

David Clifton, a director at London-based Clifton Davies Consultancy, a gambling specialist, notes that the logical way to begin regulatory diligence for both land-based and digital models is to establish whether the target company is operating lawfully. “This is nothing like as simple as it sounds,” he says.

In Ireland, for example, premises trade openly, but technically illegally, as “casinos.” In Cambodia and Egypt, only foreigners are permitted to gamble in casinos. In Asia, where much regulation is yet to be hashed out, so-called “gray markets” have emerged where it is unclear whether online gambling can be lawfully provided. Sub-national rule variations add to the complexity, especially in the US and India.

“Very thorough due diligence inquiries and careful risk assessments for business planning purposes are essential when considering whether to invest in a jurisdiction where legal and regulatory uncertainty surrounds the target asset,” Clifton says.

“Examples of gambling bans imposed in Ukraine in 2009 and Kyrgyzstan in 2015 bear witness to this. The potential for imposition of considerably more onerous regulatory restrictions, including gambling advertising bans, has created considerable uncertainty for those investing in online gambling businesses in a growing number of jurisdictions in Europe in very recent times.”

Velo Partners, a UK-based private equity firm that specializes in gambling, provided a lesson in Asian frontier market risk last year when it was forced to exit Nepalese land-based casino operator Silver Heritage after an eight-year holding period. A significant Nepalese family investor in the Hong Kong-based, Australia-listed company got cold feet when COVID-19 brought operations to a standstill, precipitating a fire sale to Philippines-based online gaming technology provider HatchAsia.

Along the way, there were complications related to stalled regulatory support and various controversies, including land-use disputes and allegations of bribery, improper tax calculations, and misuse of bank loans. Nevertheless, Velo founder Evan Hoff says the business was on the cusp of being cash flow break-even when it began to unravel and remains upbeat on land-based developments in spite of frontier and pandemic-related risks.

“With the right product, land-based casinos don’t suffer long term as a result of COVID,” Hoff says. “The offering is so unique, entertaining and immersive, it really doesn’t compare to an online experience. As more casinos come online, it remains to be seen whether that cannibalizes the land-based environment. So far, it doesn’t look like that’s happening.”

Games of skill?

Silver Heritage was Velo’s first investment in Asian land-based gambling; it has stabler exposure to the space in the UK with Hippodrome Casino. But the firm’s preferred approach to the region is Indian sports and online gaming, where it has at least seven active investments. Its first was Adda52, a poker website acquired by Delta Corporation in 2016 for about $27 million.

Hoff observes that while casino apps are not taking much market share from land-based businesses, there is significant channel shift in sports betting, where brick-and-mortar kiosks represent decidedly less social and engaging physical experiences. In India, the boom is polarized by two equally compelling forces: First, smart phone usage and micro-spending online is surging among a sports-crazed youth demographic. Second, it’s illegal.

Indian apps in this space have made it work to date by concentrating on player-to-player competitions such as fantasy sports, whereby users create their own virtual teams based on real-life players participating in actual matches. Point scoring is based on on-field performance, and cash prizes are earned. The concept has been consistently upheld as a game of skill by the Supreme Court, and therefore legal, but state-by-state challenges have kept a sense of uncertainty in the air.

“It’s a set of risks that’s very binary, but that risk has been around for a decade, and operations have managed to navigate it,” Hoff adds. “If India decides to regulate sports betting – and I think people are starting to believe they will – the country might go through the same thing as the US. The laws are different, so you don’t want to make too many analogies, but I believe that’s where it’s going.”

The US experience does suggest a titillating outlook for India. Prior to the repeal of the anti-sports betting legislation known as PASPA in 2018, fantasy sports operators in the US strenuously insisted they were only in it for non-gambling entertainment. When PASPA was axed, they quickly fired up apparently ready-to-launch betting models, creating the segment’s first runaway investment successes.

DraftKings and Skillz were among the biggest winners in this story. Both received significant venture funding prior to IPOs last year and are now worth around $20 billion and $9 billion, respectively. India’s Dream Sports, which has raised some $725 million in VC funding and is valued at around $5 billion, is the natural analogue for DraftKings. Mobile Premier League (MPL), which has raised $225 million and is valued at almost $1 billion, is seen as the Indian version of Skillz.

Telstra Ventures had one of its biggest returns yet when it exited Skillz last year and bounced off the experience by joining a $95 million round for MPL in February. The twist here is that Skillz has not pivoted to sports betting following the repeal of PASPA; it merely leveraged the boost in overall sports-themed gaming sentiment to attract new investors and expand market share.

MPL’s operations are nevertheless exposed to anti-gambling risk. Some Indian states have blocked the app, citing bans on rummy and disputing previous decisions on the constitutionality of fantasy sports. To some degree, hedging this risk has been about diversification, with the MPL offering spanning dozens of casual games in addition to fantasy.

“The risk was there, but it wasn’t any different from what we saw with Skillz in the US. If you have a strong regulatory and legal team to help council, like any tech start-up should, we are very comfortable there,” says Yash Patel, a general partner at Telstra Ventures.

“What we thought was a bigger factor was what we saw in terms of retention and engagement metrics. The cohorts of users that continued to play and the whales [big-spending app users] that emerged were consistent, so there was a lot of predictability of revenue, effectively stacking an annuity stream. We saw that with Skillz and we have started to see that with MPL.”

ESG alerts

Still, it’s an open question what will happen to India’s competitive gaming and fantasy sports space if US-style online gambling regulations materialize. For start-ups such as Dream Sports, which claims around 80% of the local fantasy market, the explosion in growth could be difficult to exaggerate. But in the age of stricter environmental, social, and governance (ESG) compliance, would a sudden shift from “game of skill” to gambling in the portfolio be a problem for private equity?

“It could be, but I’m sure there’s enough people who would want to invest,” says Kshitij Sheth, a director at ChrysCapital, which joined a $225 million round for Dream Sports last year and re-upped as part of a $400 million round in March. “Some private equity funds may have to find an exit. We would have to have a conversation with our LPs to figure that out.”

The responsible investment question appears destined to become increasingly pronounced in online gaming in India, given the faster rise of transaction-based games such as fantasy, rummy, and poker versus casual games. EY estimates the transaction-based category grew by 21% in 2020, outpacing the broader market and more than quadrupling the value of the casual games segment. The fantasy market alone is expected to grow from $4 billion to $18 billion in the next five years.

“At the end of the day, the company has to do what’s best for the company. If that means certain shares must change hands, then so be it,” Sheth says, adding he is skeptical about sports betting becoming legalized and regulated in India. “You can’t block a company from achieving its true potential, but ChrysCapital always adheres to high standards of ESG.”

It could be argued that ESG is a more pressing concern in the land-based end of the sector, where the biggest funds and most institutionalized underlying investors are at play. In these scenarios, however, there tends to be alignment with local governments, which are necessarily supportive of the industry. Ultimately, ESG issues in casinos are about addiction and the idea that the venues can facilitate crime, which are seen as highly visible but statistically fringe negatives.

“Gaming is entertainment for 99% of people. If one is responsible with helping all enjoy gaming as entertainment – which is our job as an investor and operator – there’s nothing wrong with it,” Clairvest’s Parr says. “I would say the vast majority of LPs see it that way as well. As ESG has become a more elevated issue, we have certainly seen a heightened focus from LPs on measurement and reporting in our portfolio. But that hasn’t translated into more carve-outs or more declines.”

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• Topics
• Australasia
• South Asia
• Consumer
• Regulation
• Australia
• India
• Nepal
• Telstra Ventures
• ChrysCapital Management
• gaming
• Due diligence
• ESG
• covid-19