Future Gaming Market reform: A windfall for pubs.

 

Everyone including Federal Hotels accepted the reality that the days of its money making machine Network Gaming were numbered. With the exclusive license to run electronic gaming machines EGMs due to expire in 2023, assuming the government has given Federal Hotels the requisite 5 years notice, pubs and clubs were eying off a bigger share for themselves. Both parties, Federal Hotels and THA representing the pubs, cobbled together a proposal in 2017 for a new division of the spoils which the Government has adopted and rebranded as Future Gaming Market reform.

At the time, on 18^th August 2017 Federal Hotel’s boss Greg Farrell told a Parliamentary hearing:

“The Vantage Group's viability would be enhanced as a result of this, as would every other licensed hotel and club. The average value of a Tasmanian hotel and club, post 2023, on this basis, would improve by about $1.5 million. That has been our model and it has been independently verified.” (Note: The Vantage Group is part of Federal Hotels with 12 EGM pubs and 21 bottle shops under the 9/11 banner).

A couple of points. Greg talked about the ‘average value’ and how it will ‘improve’. That pre-empts the question, what is the current situation? And how will the proposed changes impact the value of pubs?

Capital values are determined by profits. Whilst EGM losses in pubs and clubs have been in slow decline, the latest financial year 2020/21 has seen the highest level of losses since 2011/12. Losses totalled $117 million in the 95 venues, twelve of which are owned by Federal Hotels’ Vantage Group. EGM losses in the two casinos also picked up, to the highest since 2015/16 at $75 million.

Some 3 years ago Andrew Wilkie obtained leaked data showing the losses for each pub in the 2015/16 year when EGM losses were $114 million. Needless to say punters lost more on average at Federal Hotels’ pubs than elsewhere. Applying the same ratios to the 2021/21 turnover of $117 million, Federal Hotels’ EGM averaged $84,700 in losses compared to other pubs’ losses which averaged $44,600 . Average losses across all venues were $50,900 per EGM.

Under current arrangements pubs get a commission equal to 30 per cent of player losses. Machine hire costs (fixed per EGM) and variable costs including wages equal to 10 per cent of player losses result in a gross profit figure for each EGM.

Current
	All pubs	Pubs excl FH	Fed Hot pubs
No venues	95	83	12
No EGMs	2,305	1,945	360
Average turnover per EGM	$50,900	$44,600	$84,700
Commission @ 30%	$15,270	$13,380	$25,410
less direct exp
EGM hire/ promo levy	$4,500	$4,500	$4,500
Wages& other variable costs	$5,090	$4,460	$8,470
Gross profit per EGM	$5,680	$4,420	$12,440
Gross profits per venue *	$170,400	$132,600	$373,200
Gross profits total                                                 $ million	$13.1	$8.6	$4.5
Capital value multiple**	7.5	7.5	7.5
Capital value attributable to EGMs                      $million	$98.2	$64.5	$33.6
Average capital value attributable to EGMs         $ million	$1.03	$0.78	$2.80
Super profit per EGM***	$3,680	$2,420	$10,440
Super profits per venue *	$110,400	$72,600	$313,200
Super profits total                                                 $ million	$8.5	$4.7	$3.8

* To enable a comparison across the 3 venue types it is assumed all have 30 EGMs.

**A capital multiple is used to calculate a value for a given income stream depending on the desired rate of return. A return of 12.5 per cent implies a benefit multiple of 8. One is the inverse of the other. A rate of return of 20 per cent implies a benefit multiple of 5. The chosen multiple here is 7.5 which implies a targeted rate of return of 13 per cent which is an accepted benchmark in the hospitality industry.

***Super profits are profits in excess of normal profits. Normal profit is an estimate of what a normal return would be in the hospitality industry from the space occupied by gaming machines. For a 30 EGM venue a normal profit for the hospitality industry providing meals and bar services might be $60,000 and hence normal profits of $2,000 per EGM is assumed. For most gaming rooms this would be a reasonable estimate of the gross profit from the area occupied by EGMs, in other words, gross profit after cost of goods sold, direct wages and consumables. The purpose of introducing a normal profit benchmark allows us to estimate super profits from gaming which determine a venue’s capital value. 

After deducting normal profits, a figure for super profits can be calculated, $8.5 million across all pubs of which $3.8 million relates to the Federal Hotels’ pubs. This figure is the amount that could be removed via taxes and still leave EGM operators with a return similar to the rest of the hospitality industry.

Average capital value for pubs attributable to EGMs is $1 million. This is derived by applying the capital value multiple to gross income from EGMs , in other words  income after payment of all direct expenses. But this is not evenly spread across pubs. The average capital value attributable to EGMs for Federal Hotels’ pubs was $2.8 million because they have 12 of the best performers. Excluding Federal Hotels’ pubs, other pubs had an average capital value of $780,000 attributable to EGMs. It must be stressed this is an average. Small turnover venues with fewer EGMs had little or no capital value from EGMs but the average to above average EGM turnover venues all had significant capital values attributable to EGMs.

Nevertheless, pub owners wanted more. Federal Hotels saw the writing on the wall. The government bowed to their collective wishes. The proposed changes means all losses will be received by the pubs from which they will pay tax of 48 per cent (GST equals 9.09 per cent of losses plus State tax and Community Service levy of 38.91 per cent).

Pubs will face additional costs, a new license fee, plus monitoring and other functions previously performed by Network Gaming.

 

Proposed
	All pubs	Pubs excl FH	Fed Hot pubs
No venues	95	83	12
No EGMs	2,305	1,945	360
Average turnover per EGM	$50,900	$44,600	$84,700
Tax & CSL @ 48 %	$24,432	$21,408	$40,656
Earnings per EGM $	$26,468	$23,192	$44,044
less direct exp
EGM license fee	$1,750	$1,750	$1,750
EGM lease	$4,800	$5,000	$4,500
Core monitoring	$730	$730	$730
Regulated fee functions	$750	$750	$750
Market based functions	$1,000	$1,000	$1,000
Wages& other variable costs	$5,090	$4,460	$8,470
Gross profit per EGM	$12,348	$9,502	$26,844
Gross profits per venue *	$370,440	$285,060	$805,320
Gross profits total                                                 $ million	$28.5	$18.5	$9.7
Capital value multiple**	7.5	7.5	7.5
Capital value attributable to EGMs                      $million	$213.5	$138.6	$72.5
Average capital value attributable to EGMs        $ million	$2.25	$1.67	$6.04
Super profit per EGM ***	$10,348	$7,502	$24,844
Super profits per venue  *	$310,440	$225,060	$745,320
Super profits total                                                $ million	$23.9	$14.6	$8.9

Notes: * and ** and ***same as for the Current table above

Super profits will skyrocket, from $8.5 million under current arrangements to $23.9 million under the proposed model. These are the super profits diverted from Network Gaming. On average a 30 EGM pub will earn gross profits of $370,000 from gaming. Federal Hotels pubs will earn on average $805,000 from EGMs. The capital value of pubs attributable to EGMs will be $213 million. Federal Hotels’ share for its12 pubs will be $72 million. The average pub’s value attributable to EGMs will be $2.25 million.

The changes from the existing to the proposed are best summarised in the following table.

Changes implied by FGM policy
	All pubs	Pubs excl FH	Fed Hot pubs
Average increase in gross profits per venue	$200,040	$152,460	$432,120
Average increase in capital value per venue         $million	$1.2	$0.9	$3.2
Increase in gross profits total                                $million	$15.4	$9.9	$5.2
Increase in capital value total                               $million	$115.3	$74.1	$38.9
Super profits                                                         $million	$23.9	$14.6	$8.9

In total profits will rise by $15.4 million. Federal Hotels’ pubs will each be $432,000 better off on average each year, with other pubs about $152,000 better off on average. It must be stressed these increases are the increases implied by FGM policy  compared to a hypothetical situation of continuing with existing arrangements. The proposals will result in $23.9 million of super profits to EGM pubs based on 2020/21 player losses. This is the amount that could be removed by higher taxes still leaving pub operators with normal rates of return. The average pub’s capital value will increase by $1.2 million, a little below what Greg Farrell’s independently verified model predicted back in August 2017. In total the capital value of EGM pubs will increase by $115 million to $213 million. Every time an EGM pub changes hands, the new owner will be granted a 20 year licence, making EGM licences, in effect, perpetual assets. Extremely valuable perpetual assets.

That’s what the Future Gaming Reform is about. To pretend it’s an unintended side- effect is disingenuous. Finance Minister Michael Ferguson was reported as saying it was “illogical” to compare an annual ongoing negative revenue impact on Federal Group with an estimated “effectively one-off” net present value based on a 20-year licence.

“It is comparing apples with oranges,” he said.

Few would agree. If what one loses on the swings is picked up on the roundabouts who cares. Doubly so if the plan is to sell the pubs as soon as possible. Industry insiders are already referring to the proposed Section 101D of the Gaming Control Act as the Endeavour clause which limits EGMs in common ownership to a maximum of 587, one quarter of the proposed mandated cap.

Endeavour Group is the newly listed group with pubs, bottle shops (BWS and Dan Murphy) and pokie places spun off from Woolworths. Via ALH it already owns 5 pubs with 150 EGMs in Tasmania, and it has been long been touted as either quitting the 5 EGM pubs or buying more to make it worthwhile. Another 360 EGMs from Federal Hotels would take them up to 510 EGMs, still under the requirements of Sec 101D. It certainly would make sense to Federal Hotels. With no obvious succession plan in place, evidenced by no new board members for 25 years, there doesn’t appear to be anyone to take over Greg’s torch for another generation of networking and political manoeuvring so vital for the gambling industry to protect its patch.

Riding off into the sunset on a Mulawa Arabian steed with saddlebags stuffed with newly minted capital gains might be a preferred alternative. Future Gaming Market reform as proposed will assist with that endeavour.

(Disclosure: The writer is a director of a tourism business with EGMs. This blog was amended on 31^st July to correct a couple of data errors and to revise the commentary.)