Thursday, 22 December 2016

Future of gaming

Submissions to the Joint Parliamentary Inquiry into Future Gaming Markets in Tasmania have now been posted on line. My full submission which includes an analysis of gaming losses and Federal Hotels’ profits since 2003, how the spoils have been divided, a review of Federal Hotels’ promises and outcomes, discussion of the economic and accounting features of gaming as practised in Tasmania and suggestions for the way forward can be found HERE.

The executive summary is provided below.

Executive summary

One of the key terms of reference of this inquiry is to report on the potential structural features of the Tasmanian gaming markets from 2023 onwards. As a prerequisite, it is incumbent to fully understand the current arrangements, the size of the pie and how it is distributed. The primary focus of this submission is to cover the financial aspects of current arrangements.

All government licences and permits by their nature regulate and restrict participation thereby affecting the size and distribution of profits.The current gaming model in Tasmania centres on the sole licence holder Federal Hotels. Its licence was awarded without competitive tender in 1993, as was the agreed extension in 2003. The government passed up the opportunity to maximize its return from granting the exclusive licence, preferring instead to impose a few conditions. The less than onerous conditions and the tax regime adopted have allowed a private operator to generate substantial profits in excess of normal rates of return in the hospitality industry.

In thirteen years since 2003 Federal Hotel shareholders have received $199 million in dividends (up to 30th June 2016). These were fully franked or tax paid dividends, equivalent to $284 million before tax, or $22 million per year.  

It is likely that the amounts paid as dividends which represent 64% of earning after tax, comprise the profits from gaming. No other capital intensive tourism business can afford to pay dividends as Federal Hotels does.

One advantage of the system is that there is a sunset clause where the rights and obligations of all parties can be extinguished at the discretion of the Treasurer, the earliest end date being 2023.

Resetting the gaming landscape, even limiting EGMs to casinos, won’t be traumatic as there are no obligations beyond 2023 that licence holders and other participants  can use to invoke sovereign risk and demand compensation or quid pro quos to offset any effects of policy changes.

The government is contemplating a market based tender for allocating licence(s) beyond 2023. Any such solution first requires the government to determine what the parameters are, the number of venues and gaming machines, locations, the house percentage, taxes and levies, the speed of gaming machine, betting limits etc. Only then will it be possible to determine  what level of profits will exist, if at all, and then whether to sell the right to future profits for a lump sum up front payment or to increase taxes and levies to divert super profits as they are earned.

For Federal Hotels, the period since 2004 has seen:

·       A downward trend in profits.

·       A constant pattern of dividends averaging 64% of profits after tax.

·       A fourfold increase in borrowings from $56 million in 2003 to $200 million in 2011 needed to fund the business.

·       Further pressure on cash flows with repayment of borrowings since 2011.

·       Abandonment of the regional tourism strategy, the walkout from the West Coast Wilderness railway and the sale of accommodation properties at Strahan, Cradle Mountain and Freycinet.

·       A fall in casino gambling.

·       Continued acquisition of pubs with lucrative EGM patronage

·       Expansion of bottleshops with the acquisition and expansion of the 9/11 chain.

·       The building of Saffire at Coles Bay as mandated by the 2003 Deed as the only new piece of tourism infrastructure. Remaining capital spending used to acquire existing assets.

·       Its demise as the undisputed tourism leader in Tasmania which in the past arguably led to spill over benefits for the whole industry.

After watching all profits either paid to shareholders or spent acquiring existing land, buildings, brand names and goodwill of bottleshops and pokie pubs, in 2015 we were treated to the most extraordinary display of chutzpah when Federal Hotels requested an extension of its sole licence so that it could fund $100 million of capital upgrades to its casinos and a new venue at Port Arthur that’s been on the drawing board for years. With memories of the 2003 extension/Saffire deal it was a déjà vu moment.

If funds are needed to upgrade existing facilities they should be sourced from retained earnings, borrowings or shareholder contributions just like every other business. The same applies to new infrastructure at Port Arthur. It shouldn’t require another special deal. This is not a start-up company that may require encouragement. This is a major player in a mature industry competing with many others who aren’t given the same advantages.

Linking licence arrangements for EGMs and Keno with supporting the tourism industry should be resisted.

It is clear that excess profits are also accruing to third party operators in pubs and clubs. The concentration of groups with multiple sites with above average EGM losses is unlikely to be a coincidence. If EGM gaming is to continue in pubs and clubs post 2023 it should be in full knowledge of the spoils and how they are to be divided. Any move to market based solutions to allocate licences should be resisted as it will only create a another interest group whose needs over the term of the licenses will inevitably be prioritised as licence holders seek to achieve the necessary returns to justify the cost of the acquired licences. Oligopolies won’t necessarily deliver better outcomes than a monopoly.

Arguably it will be better public policy for excess profits, if any, to flow back to the government/ community. The government should regularly tweak the parameters so that consumers aren’t exploited and operators make normal rather than usurious returns. In the case of EGMs and Keno further investment is not required so there is no need for the government to pander to anyone by allowing above normal rates of return.

One significant feature of gambling operations, at both the venue and network level, is the split between fixed and variable costs. Variable costs, including taxes, are lower than bars and much lower than for bottleshops. Gambling operators are always involved in the three areas. Once fixed costs are covered the amount added to the bottom line is more than for bars and significantly more than bottleshops. Yet lower marginal returns haven’t discouraged activity in those areas.

If it’s the non-problem and low risk gamblers who help operators cover fixed costs and make normal profits, it’s probably the moderate risk/problem gamblers who make the bottom line as profitable as it is.

Given the split up of costs faced by operators and the license holder, gaming provides significant economies of scale. In other words costs as a percentage of turnover falls as turnover/losses increase. In an area of public policy with heightened social risk, the current gaming system is perversely structured. Once fixed costs are covered tax removes only part of the bountiful booty.

Accordingly if tweaking existing parameters doesn’t remove the excess profits then a system of stepped rates based on EGM revenue per machine will do so. Stepped tax rates are not new in gaming. A simple three step system could remove a further $13 million from the $114 million of EGM revenue in pubs and clubs in 2015/16. Only the network operator and venues with above average EGM turnovers would be affected.

Whatever is decided for gambling in pubs and clubs should also apply to casinos.

There is no prima facie reason why Keno commissions and tax rates should be so much less than for EGMs. Nor is there any reason why different licencing arrangements shouldn’t apply to EGMs and Keno, should that be considered to be in the public interest.

With the expiry of current arrangement few if any will be able to argue they haven’t achieved an adequate return on their investment.

It may be better to continue with the current arrangement of one licencee, whether or not that is Federal Hotels if gambling is to continue outside casino walls. Two or more licencees may offer competition, but because of the heavily regulated nature of the industry, such competition would largely be a charade. The sole licence system has had advantages. The sole licencee finances, reports and monitors all EGMs which arguably suits below average, average and single venue operators. If there was a move away from the current sole licence there would be transitional problems particularly with the ownership and financing of EGMs. At any time a 30 EGM venue would have approximately $300,000 owing on its EGMs. Currently these are Federal Hotels’ liabilities, but in a revised arrangement they might need to be shifted to the venue level. A reshuffling of this nature may well increase the further encroachment of a few well resourced groups into areas where smaller owner operators now operate. It is difficult to see how this would improve the system.

Returns to gaming don’t have to be higher than other areas of hospitality. There is no chance that lowering returns to gaming will cause an interstate flight of capital.

Why should Tasmania adopt the practices of other State unless there was a fit and proper reason for it? Why shouldn’t Tasmanians decide the size and split up of the gambling pie without the need to follow other States?

A unique chance to reform the landscape beckons.


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