Best of the Rest

How other segments of the gaming industry will perform in 2016

Best of the Rest

In our January column, we examined the outlook for casino companies in 2016. This time, we look at the rest of the gaming industry.

In one word, the outlook is cloudy.

Slot machine companies face a flat, and perhaps declining, base. And they worry about being left behind by emerging pastimes.

The fluid and uncertain legal outlook leaves the future of online gaming cloudy in the United States. Ditto daily fantasy sports and expansion of conventional sports betting.

Suppliers

As mentioned, suppliers face a tough market as casinos simply aren’t stocking as many slot machines as before, the big North American VLT replacement cycles are largely past and the recent wave of U.S. casino openings has crested.

Complicating life for the biggest suppliers, Scientific Games and IGT, is digesting their acquisitions and reducing debt taken on for those acquisitions. Meanwhile, upstarts are nipping at their heels. Compounding these problems is the fear of emerging types of gaming, such as eSports and variations of social gaming.

Slow slot machine demand might be ameliorated or even reversed if more states follow Illinois and allow slots in liquor-licensed establishments. But that won’t happen in a rush, and maybe in no state this year.

If they stay disciplined, SGMS and IGT still have huge competitive advantages like established systems businesses and cash flow to apply to debt reduction.

But focused competitors like Aristocrat, Ainsworth and Konami appear on track to continue their gains.

In terms of new kinds of gaming, the industry answer is skill-based games. We are skeptical, not seeing how a slot machine on a crowded casino floor can match the immersive experience or the peer-to-peer empowerment of other kinds of emerging e-gaming. And it is downright impossible for skill- based games to evolve with the lightning speed of non-gambling games given regulatory requirements.

Not that slot machines will disappear; there is clearly a big market of people who want the lone experience, and adding skill elements will certainly help. But the trajectory of the conventional slot business is not bullish.

If there’s a bright spot for suppliers, it is social gaming. That’s where the young people coveted by skill-based advocates are playing. And it’s where popular slot machine games thrive and where the game design prowess of slot companies is a competitive advantage.

Online

iGaming has not caught on in the U.S., either with state legislators legalizing it or with players where legal.

We expect the evolution will continue to be slow and, indeed, internet gaming itself might be somewhat passé as young players are drawn to empowered types of gaming such as eSports and fantasy sport exchanges.

Legislatively, iGaming might catch on if one or two big states break the ice, such as Pennsylvania or California. But politics is a problem. Until various industry factions unite behind a bill, enacting online gaming in any state will be like legalizing casinos in Kentucky, an annual bud that never blossoms.

Meanwhile, a small company worth watching is GAN, formerly Game Account.

London-listed GAN offers to casinos what it says is the best of both worlds—creating full online casinos for free play that GAN says generate higher daily average user revenues than social gaming, and the ability to cross-market to land-based casinos.

And as an option on the future, the sites can be turned into real-money gaming at the flip of a switch if internet gaming is legalized.

Sports Betting and Daily Fantasy Sports

Sports betting and DFS present fascinating and complex politics. On one side, the casino industry wants sports betting to spread throughout the country. On the other side, young DFS entrepreneurs have enlisted the world’s most powerful media companies as investors and historically anti-gaming Disney and the major sports leagues as stakeholders.

Casinos would like to see DFS declared gambling, thus requiring licensing and locking out the media giants and sports leagues. The best route for this strategy is in the courts, where attorneys general such as Eric Schneiderman of New York and Lisa Madigan of Illinois are heading.

For DFS, the best strategy is to ask legislators to legalize the contests, thus taking advantage of the lobbying power of investors such as Google, Fox, Time Warner and Comcast and of allies such as Disney and major sports leagues.

However, DFS legalization also can lead legislators to loosen bans on traditional sports betting, especially as resistance from major sports leagues is softening.

Our expectation: barriers to sports betting and DFS will begin to fall, faster first for DFS. It will be a hodgepodge of laws among the states, but legalized sports betting seems inevitable.

In this scenario, look for big casino operators such as MGM Resorts and Caesars to benefit, perhaps by buying DFS operators such as FanDuel and DraftKings. And expect established sports books such as William Hill and Paddy Power to prosper.

Horse Racing

Very quietly, 2015 was a good year for horse racing, with the industry stabilizing in many jurisdictions and handle actually growing in others.

Early-year improvement was weather-related as Old Man Winter wiped out fewer race dates. Then the first Triple Crown winner in 37 years was credited with piquing public interest in the Sport of Kings. And certainly, major events such as the Kentucky Derby and the Breeder’s Cup have become growth franchises.

We aren’t about to call an inflection point for racing, but racing isn’t dead yet.

For investors, racing offers one clear choice—Churchill Downs. CHDN has made a remarkable transformation from just horse racing to being a gaming growth company while still building the Kentucky Derby into an ever-bigger and more profitable franchise.

But the kicker is Big Fish. The social gaming company CHDN purchased is rapidly growing profitable business far beyond the bluegrass pastures of Kentucky.

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