Poker machines: Super profits or a new way?

(An abridged version of this blog was published in The Mercury here)

 

The odds on Federal Hotels retaining an exclusive license to conduct gaming operations in Tasmania after 2023 lengthened considerably after the Tasmanian Hospitality Association (THA) publicly aired a rift with its hitherto close ally and largest member.

It was reported here that THA members wanted a bigger share of the spoils from gaming losses that currently go mainly to the exclusive license holder.

What exactly are the spoils up for grabs?

A snapshot of pokie (EGM) numbers show the current split up of machines between locations.

 

All EGMs are owned by the sole current license holder Federal Hotels. The numbers is governed by Clause 5 of the 2003 Deed now included as Schedule 1 of the Gaming Control Act 1993. (see here) Federal Hotels have 1,180 EGMs in its two casinos. There were 2,310 in pubs and clubs at 30^th June 2015, 330 of which are owned by Federal Hotels.

The casinos and Federal Hotels’ pubs attract relatively larger player losses than other pubs and clubs as the following, based on 2014/15 figures, indicates.

 

This suggests average losses per EGM vary considerably.

The following graph shows the average losses/earnings per machine across the State as $55,000. That’s not a misprint. That’s the average player losses per machine for the latest year 2014/15 as per the TGC report.

 

Federal Hotels’ EGMs in casinos averaged $68k in player losses for 2014/15. Even better/worse(?) was the performance of its 11 pubs each with 30 EGMs. Publicly available figures suggest they managed to extract an average of $88k from player’s wallets during 2014/15.

Given some variability there must be machines out there that collect $100k pa. A machine worth maybe $18k new, can, over its life of 5 years, collect booty of $500k which is quite extraordinary.

Player losses in other pubs and clubs averaged $46k per EGM.

All player losses belong to Federal Hotels in the first instance. Other pubs and clubs receive a commission then in turn pay an EGM hire fee and promotions levy of approximately $4k per EGM per year back to Federal Hotels. This reduced their 2014/15 gross profit to an average of $9k per EGM. Wage costs are tiny; the marginal costs of bar staff attending to EGM recalitrants are negligible. A bit of electricity and cleaning is all that’s needed.

$9k pa is not a bad return from one machine when there are possibly another 29 in the same room.

Collectively other pubs and clubs made gross profits of $17 million on the EGMs in their establishments.

The return is quite simply a return on the investment required to tart up a room to conform to TGC rules. The machine costs were taken into account.

It is well in excess of the normal rate of return in the hotel game. It represents super profits. There is no prima facie reason why super profits should accrue to an operator in a regulated market.

If it’s occurring then license fees are too low (whether up front or ongoing) or punters are getting robbed.

Or both which is likely in this case.

What is Federal Hotels’ position?

 

Total EGM player losses across the State for 2014/15 were $194 million. In addition Federal Hotels receive hire fees and promotions levies from other pubs and clubs.

After outlays of $128 million including commission to other pubs and clubs, EGM taxes and community support levies to the state government, Federal Hotels ended up with a gross profit of $73 million from EGMs.(Further details about outlays is included in a footnote below). As we saw above other pubs and clubs ended with $17 million. When the latter two figures are combined the gross profit after direct costs per EGM across the State averaged $26k.

In a nutshell therefore, roughly half of player losses goes to the license holder, about one quarter to the government, with the remaining one quarter covering machine costs, monitoring and reporting.

The THA has made it plain it wants a bigger slice of the pie for its members.

It begs the question, perhaps the size of the pie needs a review?

Other pubs and clubs’ average gross profit figure of $9k per EGM represents a return to venue owners after machine costs have been considered. It represents a return on the venue facilities. Some venues spent as little as $1k per EGM to upgrade existing underutilised space to accommodate the electronic bandits.

Others have spent more. Some have bought venues after the introduction of EGM and paid a multiple of up to 10 x EGM gross profits to get access to the EGM income streams. There is no doubt that most pubs and clubs are getting more than adequate returns based on the original investment in the venues. In most cases the returns are excessive.

All amounts invested in EGM facilities were made in full knowledge that the exclusive license could run out in 2023 and even during the intervening period required continuing permission to operate from the license holder. Everyone knew the good times mightn’t last forever. So there’s no reason that changes can’t be made, and there’s certainly no case for compensation should any changes lead to reductions in the share of spoils.

Federal Hotels have always been at pains to stress that EGMs are just part of its business model which includes casinos. This was the line taken during the 2003 Parliamentary Public Accounts hearings which rubberstamped Operation Fait Accompli, the backroom deal with Federal Hotels overseen by the BLT serving of Bacon Lennon and Treasurer Crean.

Federal Hotels are persisting with the myth that EGMs need to considered in tandem with casinos by linking the upgrade of casinos to an extension of the EGM license.

Table gaming at casinos contribute very little to Federal Hotel’s coffers. Player losses for 2014/15 were $10 million. Licence fees and taxes of $4 million saw gross profit from table gaming shrink to $6 million. Overheads are much higher than with EGMs.

Federal Hotels are not basking in table gaming profits.

Which makes the recent announcement of the $70 million ‘transformational change’ of the Wrest Point casino a little odd when there’s not much money to be made from table gaming in casinos based on recent figures? The price to be paid for an extension of the EGM license appears to be the only logical explanation?

The expression of interest by MONA’s David Walsh to build a casino has effectively questioned whether a coordinated public policy is needed for table gaming and EGMs.

The THA are in little doubt as they’re out campaigning for their members, seemingly abandoning the old adage of what’s good for Federal Hotels is good for Tasmania.

One advantage of the current licensing system is that monitoring and reporting is all done by Federal Hotels’ Network Gaming. It’s hard to know whether this has created efficiencies or not. In any event having two or more monitoring and reporting entities would then allow for a little more competition and could pave the way for licenses and EGM ownership to shift to individual operators.

Another advantage of the current system from a public policy viewpoint is that there is only one major rent seeker/stakeholder with a license agreement and that agreement has a sunset clause. All others are just bit players.

It is therefore incumbent on the government to adjust the size of the pie before new interests are created, say for example by pubs and clubs becoming license holders. The move if not done correctly will lead to windfall gains to some, the entrenchment of cross subsidies to the detriment of operators without licenses and the creation of a much more powerful interest group who will inevitably have a greater say in future public policy discussions.

Leaving aside the option of removing EGMs in one fell swoop, what size should the pie be?

EGMs are not tourism assets so it requires a long bow to argue the pie should allow for spin off benefits that may come from rewarding EGM operators with extra income to spend on tourism ventures. Federal Hotels is a spectacular example of this failed approach where for a while it expanded its regional tourism business and helped promote the State via its Pure Tasmania label but which has now been abandoned following the sale of the regional assets and the retreat to Hobart to take advantage of the Mona inspired accommodation boom.

EGMs are just another offering by pubs and clubs to locals so it is difficult to see regulators granting an abnormal return.

The world has moved on a lot since the exclusive Deed was signed in 2003. Two things come to mind.

First we now have a very detailed picture of how EGMs work in Tassie, both from income and cost aspects. It would be very easy to confirm the uncertain bits like network monitoring and reporting costs.

Second the development of markets requiring a regulator to determine prices has developed considerably. For instance Tas Networks which owns all the State’s electricity transmission and distribution assets gets told every 5 years what prices it is allowed to charge. This happens in all States which form part of the National Electricity Market. Regulators determine a price designed to cover approved operating expenses for each company plus a return currently 6%, on each company’s Regulated Asset Base (RAB)

A similar approach could easily work in the regulated EGM industry. The State government could set out the parameters, machine numbers, location , tax take etc, and the regulator could then make a determination as to the maximum % an operator can remove from players (currently about 15%) so as to allow an operator to cover operating expenses plus give a return on its RAB.

The RAB is what the Regulator determines to be fair, not what an operator has spent. Gold plating glitzy palaces wouldn’t result in a larger % take.

Provided the government doesn’t want more, the take from players would reduce significantly whilst allowing operators to earn ‘normal’ rates of return from what they tell us is just another product demanded by willing punters to satisfy their hotel entertainment expectations.

Why should EGM punters be treated less equitably than electricity consumers? And why should EGM operators be guaranteed such extraordinarily high rates of return?

There is no reason why we should mimic other States. We needn’t fear being labelled closed for business. If normal rates of return are guaranteed then the market clearing mechanism will always ensure someone will take up the opportunity.

An alternative could be to leave the level of take as is but try to secure an upfront amount for a license(s) over a certain period. Smaller players would be disadvantaged and a whole new set of property rights created which will introduce a whole new bunch of rent seekers ensuring the social needs of the population will continue to be trampled upon. With rent seekers comes distortions. That is one major criticism of the current exclusive license. The cross subsidy implied by the exclusive license to Federal Hotels is inequitable. If ever there was justification for a cross subsidy because Federal Hotels was a market leader and a rising tide lifts all boats as they say, the justification disappeared when the tide went out on Federal Hotels a few years ago following the relentless dividend gouging by shareholders and the abandonment of its regional tourism strategy.

For once, those who oppose the generous concessions given to Federal Hotels by the current Deed have all the orthodox economic and financial arguments on their side. They needn’t rely solely on social arguments. They should ensure the opportunity is not squandered.

A golden opportunity confronts Will Hodgman with competing interests now revealing their hands. There will never be a better time to reform the system and deliver sensible public policy. The public are ready for such an experiment. The Labor Party have been slow to adapt to the new reality. Get Treasury and the Economic Regulator (OTTER) to prepare a public discussion paper covering the options? Ignore private consultants who invariably shape recommendations to enhance their own future prospects. It’s a straight forward public policy matter. Those expecting a greater share of the spoils need an introduction to how prices are set in a regulated world.

The outing of David Walsh’s moves to gain a casino license and then his temporary withdrawal from the process has led to a tsunami of feeling against the current exclusive license holder.

With erstwhile ally the THA now in the saddling enclosure with a separate runner, one nevertheless from the same prolific sire Self Interest, if Public Interest manages a start, gets cover in the field and then a split in the home straight there may be a chance to salute the judge ahead of the tiring leaders. To paraphrase the late Ken Howard, at this stage it’s not worth punting London hoping to win a brick, but the odds have shortened.

Punters live in hope.

(Disclosure: The writer has a small interest in a pub which operates EGMs)

 

 

Footnote re expenses:

·       Commission equal to 30% of player losses.

·       EGM tax equal to 26% of player losses.

·       Federal Hotels consistently buys/leases an average of $13 million worth of new EGMs every year. They have a life of 5 years. Given EGM numbers the new price appears to be $18k per EGM which seems quite high seeing as it’s just an electronic box and prices of other electronic gear have plummeted over the last 10 years.

·       The State government levies a Community Services Levy of 4% on player losses in pubs and clubs only, including those owned by Federal Hotels. Losses from EGMs at the casinos are excluded from the levy. Half of the levy is used to assist chronic players. It doesn’t make much sense to exclude casino patrons who appear to exhibit the same failings as their colleagues in the suburbs.

·       Estimates of the costs of running the monitoring and reporting network vary from$500 to $1,500 per machine. A figure of $1k was applied to 3,500 EGMs.