Experts see ‘racinos’ re-shaping gaming

By Liz Benston

Wednesday, Dec. 18, 2002 | 11:19 a.m.

TUCSON, Ariz -- Over the next five years, virtually all of the racetracks in the United States will offer banks of slot machines -- creating mini-casinos that could generate returns rivaling Las Vegas' most profitable megaresorts, a top Canadian government official says.

The instantaneous growth in profits witnessed by horseracing tracks that introduce slots will prompt casino companies to look at alternatives to full-blown casinos, Ron Barbaro, chairman and chief executive officer of the Ontario Lottery & Gaming Corp., told attendees at the Racing & Gaming Summit last week in Tuscon.

"For one-tenth the cost of Bellagio, we outfitted all of our tracks (with slots) and generate $20 million a week of gross profit," he said, referring to MGM MIRAGE's most profitable property and its crown jewel on the Las Vegas Strip.

So-called "racinos" have emerged in recent years to rescue an industry that has struggled to attract a new generation of customers to a sport perceived as complex, upper-crust and even boring.

They also offer tax revenue for needy states. Swelling budget deficits nationwide are prompting states to consider legalizing casino-style gambling. Yet the casinos legalized in the future will most likely be racinos, not the full-scale casinos and megaresorts that emerged in the 1990s, experts say.

For Las Vegas casino giants that have honed their skills building gambling palaces, racinos may present one of few opportunities to expand in the coming years, experts say. With many still opposed to Las Vegas-style wagering, adding slots to racetracks -- existing gambling operations with some cultural value -- is more socially acceptable to some than legalizing full-blown casinos. Aside from casinos offered by sovereign Indian tribes, only 10 states offer land-based or riverboat casinos. By contrast, nearly every state has racetracks where customers can gamble.

"I think we've seen the majority of the land-based casinos," said Lonny Powell, president and chief executive officer of the Association of Racing Commissioners International Inc., a Lexington, Ky.-based trade group representing racing states. "That window of opportunity is narrowing while the racino opportunity is widening."

"It's an easier sell to voters," Powell said. "It's an existing regulated facility -- and that's a much more friendly prospect."

New Mexico, Louisiana, Iowa, West Virginia, Rhode Island and Delaware have legalized slots at tracks over the last several years. In a move to plug a budget gap widened by last year's terrorist attacks, eight racetracks in New York will become eligible next year to introduce slots. About a dozen other states have discussed similar legalization.

In recent months, states from Texas to Massachusetts have reported being lobbied by racetrack owners as well as Las Vegas casino interests.

Foes mobilize

On the other side of the debate, gambling foes in various states are mobilizing to fight the trend. Racinos are a poor excuse to raise tax money and may open the door to even larger-scale casino gambling, they say.

Las Vegas gaming giants have largely been quiet about their plans. Public companies have a duty to scout out the profit potential of new gambling areas, they say.

Even MGM MIRAGE, which operates more megaresorts on the Strip than any other company, says it can't rule out the prospect of running slot machines at rural tracks hundreds of miles from the shimmer of Las Vegas, Atlantic City, Biloxi or other gambling meccas.

"As older ones expand and new jurisdictions open, we will review everything," MGM MIRAGE spokesman Alan Feldman said. "Our product is only legal when it's made legal. You have to stay on top of what's going on."

"Just because a new jurisdiction opens up doesn't mean we need to be there," he added.

Shareholder money may be better spent in established or other emerging areas worldwide, he said. The company cited similar reasoning a few months ago when it put a $1.5 billion casino resort in Atlantic City's Marina District on hold.

Racinos are relatively small-scale operations, often costing well under $200 million compared to billion-dollar megaresorts.

Still, their percentage return on investment can rival that of labor-intensive casino, said Barbaro, Ontario's lottery official.

On the other hand, racetrack revenues are divided among a greater number of beneficiaries, including horse owners and state agencies.

Last year, racinos in the United States generated about 8,000 jobs and about $2.1 billion in revenue -- close to the amount generated by Mississippi casinos, according to the American Gaming Association. Of that amount, $578 million in revenue went into state coffers. By comparison, Nevada's casinos generated only $110 more in taxes against $9.5 billion in revenue.

Only a few Las Vegas casino giants have made inroads in the racino business.

One is Harrah's Entertainment Inc. -- considered the country's most geographically diverse and also its most acquisitive.

Harrah's operates Bluffs Run Casino, a Council Bluffs, Iowa dog track it acquired in 2001 when it purchased Lake Tahoe-based Harveys Casino Resorts. In August, it announced a letter of intent to buy a controlling interest in Louisiana Downs, which is near Bossier City, La. Harrah's intends to spend about $157 million to acquire the track, install slot machines and make other renovations.

Harrah's hasn't disclosed returns for the Iowa track. But incoming Chief Executive Officer Gary Loveman has called the Louisiana Downs acquisition a "milestone" in the company's growth and a "significant growth opportunity."

"We're confident we can get a significant return (and) drive customers to the track at far less cost," Loveman told investors during the company's third quarter earnings call.

Harrah's, which is eyeing gambling opportunities in Massachusetts and Rhode Island, also recently requested a tour of Ontario's facilities, conference officials said.

Park Place Entertainment Corp. hasn't divulged specific returns for Dover Downs in Delaware. Park Place manages the track's casino, which features about 2,000 slot machines as well as dining, entertainment and a nearby hotel and conference center.

Park Place has acknowledged hiring a lobbyist to represent its interests in Massachusetts, which is considering racinos. The lobbyist, the company said, is part of the company's routine strategy for doing business in a regulated industry.

Last year, Boyd Gaming Corp. bought Louisiana track Delta Downs from Las Vegas casino investor Shawn Scott for $125 million after voters approved slots. The track, which opened in February with about 1,500 slots, reported revenue of $31.6 million and cash flow of $5.8 million for the third quarter. Cash flow improved from $5.2 million in the second quarter and cash flow margin -- an indicator of casino performance -- improved from 15.2 percent in the second quarter to 18.4 percent in the third quarter. The company is considering adding hotel rooms to further boost performance.

Casino magnate Steve Wynn is also interested in a piece of the action. Wynn has talked of launching a racetrack casino resort in Maryland, an established horseracing destination that is considering legalizing slots at tracks. Wynn grew up in Maryland, where his father ran a bingo parlor.

Other large companies are also scouting out racetrack facilities nationwide, industry watchers say.

"They are (considering racinos), very quietly," said Walt Hawkins, president of public gaming at International Game Technology.

IGT poised to profit

Reno-based IGT, the world's largest slot machine maker, has also met with state officials considering legalization. The company probably has the most to gain from the expansion of slots at racetracks in the immediate future, experts say.

A few years ago, racing companies like Magna Entertainment Inc. and Churchill Downs appeared the most likely to buy and renovate racetracks, the racing association's Powell said. Now, gaming companies are also likely candidates.

"There's no doubt that there might be an 800-pound gorilla out there that has even more resources and more hunger to acquire tracks."

Legalization will also fuel competition between states, he said.

"Racinos are really dominating the landscape in terms of (funding) better races and horsemen. The have-nots aren't going to be in good shape if they don't have racinos ... it's going to be a matter of survival."

Not everyone is convinced that slots will overtake the nation's racetracks.

Pressed by worsening deficits, as many as 15 states could pass legislation legalizing slots at tracks in the next few years, says a report issued last week by Wall Street investment firm Bear, Stearns & Co.

Still, higher gambling tax rates proposed for racinos may make them unprofitable, the report said.

Slot machine revenue that is taxed at 25 percent could still yield a return on invested capital -- a key indicator of casino performance -- of more than 50 percent given a variety of other factors. Yet revenue taxed at 55 percent, all other factors remaining even, would only yield a return of 17.5 percent -- below what many casino companies typically expect. Taxes of 60 percent, similar to a racino proposal in New York, would only yield returns of 3.4 percent.

On the other hand, states may consider funding part of the slots' startup costs. In New York, for example, the state Lottery Commission is financing a centralized reporting terminal for the slot machines and will contribute funds for racino construction.

States already depend on the revenue. According to the American Gaming Association, taxes in established racino areas such as West Virginia and Delaware already make up 10 percent and 8 percent of the state budget, respectively.

Though virtually identical to slot machines, gambling devices regulated by lottery agencies are called "video lottery terminals" to comply with state laws. Many so-called VLTs also are set up similar to lotteries in that they receive outcomes electronically from a centralized computer rather than from computer chips implanted in each game, such as those allowed in Nevada.

For the most part, Las Vegas casino giants have remained fairly silent on the prospects for racinos, Bear Stearns analyst Christa Short said.

Racetracks are outside their core markets and target different kinds of customers than casino resorts, which offer a "richer gaming experience," she said.

"In the future it may become a potential opportunity," however.

For now, the companies most likely to benefit from the trend are slot makers like IGT and Las Vegas-based Alliance Gaming Corp., as well as track operators in the two states that appear closer to legalizing racinos, according to the Bear Stearns report.

Penn National Gaming Inc. operates two racetracks in its home state of Pennsylvania. In Maryland, where legalization is less certain, Ontario-based racing giant Magna Entertainment has majority control of two tracks and has snapped up a dozen more nationwide.

Using slots to salvage the racing industry may backfire, however, said Bill Eadington, a professor of economics and director of the Institute for the Study of Gambling and Commercial Gaming at the University of Nevada, Reno.

Government officials may become unwilling to subsidize an ailing industry with dismal long-term prospects, he said.

The racetrack industry may continue to shrink, making the subsidy even more inefficient, he added. Politicians could press for a reallocation of slot profits to more pressing social needs than saving racing, such as health care and education. Communities may also fight legalization if they view slots as an excuse to turn tracks into casinos rather than enhancing the appeal of racing, he added.

"If the racing industry is going to survive it's going to have to ... create sustainable demand."

Track upgrades

Slot machines have done more than just subsidize tracks, operators and regulators say. In some cases, they say, the devices have boosted track betting by increasing the size of the prize money for winning horses -- which in turn attracts better horses and jockeys. Slot profits also have funded track upgrades that help them better compete with casinos, they said.

More could be done to improve returns at racetracks by introducing more non-gambling attractions such as hotels, Las Vegas-style entertainment and fine dining, some say. Spicing up broadcasts and educating bettors about the nuances of the game could also boost play.

Ontario, already steeped in racing culture, has emerged in recent years as one of the largest racino jurisdictions in the world. Since Ontario's Windsor Raceway launched slots in December 1998, 14 other racetracks have followed suit. The province's three remaining racetracks also expect to introduce the machines. The Ontario Lottery & Gaming Corp. is a government agency that operates the gambling facilities and collects revenues that are divided among horse owners, track owners, host cities and various charities.

The racetrack slots are responsible for 7,000 jobs in rural Ontario, $74 million for host cities and $400 million for track and horse owners, the agency says. Pari-mutuel wagering increased by more than 4 percent in 2000 from 1999, when the majority of slots were introduced, and purses paid out increased by an average of 41 percent during that period. Since 1999, the agency has contributed about $79 million in slot revenue from tracks and a handful of government-owned charity casinos to problem gambling treatment.