The United States’ legal online gaming experiment is now in its third year, and in that time it’s produced a mixed bag of results. The three states that were part of the first wave of licensed and regulated online gambling in the U.S. have, on the one hand, exceeded regulatory expectations, but on the other hand, fallen short, to varying degrees, of the envisaged windfall the industry was expected to heap on the states in the form of tax revenue.
All the while, the gaming industry’s powers that be remain divided on the issue, as powerful factions within the American Gaming Association have lined up on opposite sides of the issue, pulling in opposite directions, and forcing the industry’s leading voice and lobbying arm to remain neutral and sit on the sidelines as the issue plays out without their involvement.
Despite being able to point to the regulatory successes and strong consumer protections licensed online gaming has put in place, this lack of a unified message from the industry, coupled with what can best be described as underwhelming early revenue results, have led to online gaming expansion falling into a proverbial holding pattern for the better part of the past two years.
“The map for U.S. regulated online gambling in 2016 looks much like the map from 2014, populated by Delaware, Nevada and New Jersey,” Chris Grove, a partner at Narus Advisors, says of the current situation. “The bright spot is certainly the performance of online casinos in New Jersey, where double-digit growth was the norm throughout 2015, driven by product improvements and a surge in consumer interest. The road for online poker has been a rougher one, with limited player pools severely hampering the ability of sites to generate growth.”
Setting aside online poker’s struggles, the performance of New Jersey’s online casino operators—and their declarations that far from being a cannibalistic product, online gaming has served to bolster their brick-and-mortar properties—interest in online gaming legalization was renewed in several states.
Over the course of 2015 and into early 2016, several states have emerged as potential candidates for online gaming expansion, which has given the industry hope that the long-awaited second wave of expansion is now beginning.
“Prospects for expansion into additional states are limited, but promising,” Grove says, citing Pennsylvania as the most likely state to legalize and regulate online gambling. “With both casino and poker on the table, the (Pennsylvania) market would be an attractive one by any measure.”
Grove also points to several other potential locales where legal online gaming could soon become a reality. “The debate over online poker continues to play out in California, but measuring true progress is a difficult endeavor,” he says. “On the fringe, we find a handful of states like New York, where legislative movement is occurring, but where the path forward for passage in the short term remains cloudy.”
Different Paths
Each of the three states that currently offer legal online gaming has gone about it in its own unique way.
For instance, Nevada legalized only online poker, while New Jersey and Delaware legalized online poker and online casino games. In all three locales, only brick-and-mortar casinos can apply for an online gaming license, but in Nevada and New Jersey, the state’s licensed casinos are free to partner with any acceptable online gaming partner of their choosing, whereas Delaware’s lottery brokered the deal that selected 888 Holdings and Scientific Games as the state’s singular platform to be shared by its three racinos.
Each of these different models has brought about distinctive trials and tribulations that the industry has had to overcome, but all three states have done yeoman’s-like work when it comes to the all-important aspect of regulating their online gambling industries, and reining in the corner-cutting that was/is rampant among unregulated U.S. online gaming sites—and for the first time, giving U.S. online poker and casino customers consumer protections with real teeth.
It should also be noted that while Nevada, Delaware and New Jersey were legalizing online gaming, several states also began selling lottery tickets online, utilizing the same consumer protections and regulatory oversight that we see in Nevada, Delaware and New Jersey.
Furthermore, those states—Illinois, Georgia, Minnesota (although the state’s legislature later rolled back the sale of lottery tickets over the internet) and Michigan—have all generated significant revenue through the sale of online lottery tickets, and like their online gaming brethren, have avoided any scandals thanks to the tough regulations imposed on the industry.
Jersey Sure
Without being dismissive of what Nevada and Delaware have managed to accomplish, neither state (singularly or even combined) has a population capable of sustaining a vibrant online gaming market, and neither state is viewed as a viable testing ground for the U.S. online gaming market.
On the other hand, even though it’s a relatively small market, New Jersey, with nearly triple the population of Nevada and Delaware combined, has proven to be a self-sustaining market, allowing analysts to create online gaming models for different states by extrapolating on the results in New Jersey.
New Jersey’s online casino operators are currently in the midst of a 16-month growth trend that saw CY2014 vs. CY2015 revenue increase 21 percent, with online casino up over 33 percent during that same period.
On the flip side, the state’s online poker operators saw the floor fall out from beneath them, as the industry shrank by 18 percent from CY2014 to CY2015, with monthly revenue tallies having leveled off at a level nearly 50 percent off peak numbers due to a lack of liquidity.
Regulatory Victor
The robust regulations are often pointed to as a reason for the industry’s slow start, but this is a tradeoff operators and regulators are more than happy to make, as the regulations have proven extremely effective.
One person who is quite happy with the state’s results on this front is New Jersey Division of Gaming Enforcement Director David Rebuck.
“We are now almost two and half years into authorized internet gaming in New Jersey,” he says, “and most in the industry are familiar with the main challenges we faced, such as regulating the development of strong KYC (know your customer player verification checks), geolocation and payment processing protocols. I believe we have shown the industry can be successfully regulated and, of course, those areas remain critical as the industry evolves.”
Chris Capra, the U.S. marketing manager for 888 and the All American Poker Network, adds, “New Jersey has proven to be a well-regulated, legitimately successful market for online gambling.”
In addition to geolocation, KYC and anti-money laundering and payment processing protocols, regulators in New Jersey, Nevada and Delaware can also hang their hat on the seamless unwinding of Ultimate Gaming in both Nevada and New Jersey when the company decided to pull the plug on its online operations. Yet another regulatory success was the creation of an interstate online poker network between Nevada and Delaware, which required regulators in both states to work together.
Remaining Challenges
Despite their successes, Rebuck notes that there is still plenty of work to be done. “As with any new endeavor, there are always lessons to be learned,” he says.
“Some of the lessons involved getting everyone on the same page in terms of our licensing, technical and customer protection requirements. However, I believe our continual dialogue with the industry has helped everyone to successfully adapt to this new chapter in authorized online gaming without compromising our high regulatory standards.”
Rebuck also notes that one of the current challenges is “encouraging the industry to innovate in areas such as skill-based gaming.” This is something the DGE tried to kick-start by introducing temporary regulations for skill-based games (both live and online) in February.
Capra points to the improving but ongoing payment processing problems operators have run into as a continued obstacle, but one he hopes can be solved with further expansion.
“One challenge that all licensed operators face is the lack of acceptance of legal online gaming by the credit card companies,” Capra says. “As we wait for other states to legalize and regulate online gaming, we have to make more headway with the banks and credit card companies to allow legal transactions… We need to see wider acceptance of the new credit card transaction codes that were released last year.”
Catching the Next Wave
Because of the New Jersey online gaming market’s growth in CY2015 and the continued successes of all three markets on the regulatory front, several states have come out of their holding patterns, and the second wave of online gambling expansion is gaining modest momentum.
There is no sure thing, but Pennsylvania appears close, and California continues to be a wild card.
One way to help push a state such as Pennsylvania across the finish line would be to mitigate the cost of setting up its online gambling industry, through measures such as adopting New Jersey’s regulatory model wholesale.
“I believe hands-down New Jersey offers the best, most comprehensive model for online gaming,” Rebuck says, noting that other states would have a difficult time duplicating what New Jersey has done in a short period of time, and would likely incur great cost in doing so.
“New Jersey has clearly laid the groundwork for a well-regulated internet gaming industry,” he says. “Any state that utilizes our regulations, which we continue to hone as the industry evolves, will absolutely save a tremendous amount of time and effort.”
Going a step further, the DGE director makes the case for states to not only copy New Jersey, but to partner with the Garden State to cut down on the time and energy they would expend going from passage of a bill to launching online gaming sites. “In addition to our regulatory structure, we also have the infrastructure in place that would enable other jurisdictions to partner with New Jersey so they would not have to start from scratch,” Rebuck explains. “Those jurisdictions running their operations through what New Jersey already has in place could be up and running very quickly.”
However, if further expansion remains elusive, it could create a persistent, albeit non-fatal issue for the current operators.
“I think 2016 is going to be a critical year in the long-term viability of the U.S. market,” Capra says. “Without a second or third market opening up, there is going to be increased pressure for operators to justify their investments in the U.S. markets. I don’t know how many would just cut their losses and leave, but I do suspect that you would see a sizable decrease in spending to gain new players, as the market cap will be significantly limited.”
Capra points to the current situation in Nevada, where there are only two operators, despite dozens initially applying for a license, and where the Caesars and 888 online poker site, WSOP.com, has a 99 percent market share. Essentially, Nevada’s decision to only legalize online poker has left current and potential operators with no realistic model to turn a profit in the small market, and as Capra suggests, no way to justify the cost.
Cost-Effective?
But even in larger markets, where online casino and online poker are legalized, the cost of doing business could still prove to be a major barrier. The state-by-state approach to legalization has led to operators and service providers voicing concerns as licensing and vetting costs continue to mount.
Matthew Katz, the CEO of the geolocation and KYC company CAMS, says there are very few markets where the cost to receive a license and absorb the cost of vetting can be justified, and suggests that new states could ease this burden by forgoing the vetting process (the cost of which falls on the company) and recognizing companies already licensed in New Jersey or Nevada.
Still, most people in the industry remain sanguine about the future of online gaming in the U.S., particularly if Pennsylvania comes through this year and ignites Wave 2 of online gaming expansion.
“I do believe, however, that it won’t take much to significantly move the needle for the U.S. market,” Capra says.
“If, for example, Pennsylvania was to work out the remaining issues and legalize online gaming in 2016 with casino and poker, it could have a big domino effect on other states.”
If Pennsylvania legalizes online gaming, says Capra, “it more than doubles the entire market size overnight with more than 10 million adults in the state. Secondly, its proximity to New Jersey and 888’s success in creating interstate liquidity compacts will help move this forward very quickly to the benefit of the player base. And finally, it will put enormous pressure on New York to pass its own legislation. That tri-state region has more than 33 million adults, and would create a very viable market.”
Beyond Capra’s coveted Eastern triumvirate, the online poker industry will no doubt continue to chase its white whale, as California and its coveted market of nearly 40 million residents continuously flirts with online poker legalization each and every year before leaving the industry despondent and mumbling “there’s always next year” to themselves.
