Delaware Disaster

Squeezed in between East Coast saturation, the state gropes for solutions

Delaware Disaster

In 2013, when Delaware lawmakers granted a .9 million economic relief package to the state’s struggling racinos, one investment banker likened it to “applying a Band-Aid to a bullet-shot wound.”

The bloodshed continues. Last October, Ed Sutor, vice president and chief operating officer of Dover Downs Hotel & Casino, said the property—which reported a paltry $13,000 in net revenues in 2013—was heading for a new low. “This year it’s been worse,” said Sutor. “We’re negative $900,000.”

That bad news was allayed somewhat by third-quarter results. Thanks to the legislative aid plan, which shifted part of the cost of maintaining and running slot machines to the state, Dover Downs saved about $1 million in expenses for the quarter. But there was little reason for cheer. Having operated at a loss for the first nine months, the property was still in the red by $190,000.

Racinos in the First State have been hit by a double whammy: new competition in surrounding states (with more to come), and a crushing tax rate, the percentage of gaming revenues that comes off the top for the government and the state’s horse industry. In 2008-09, when newly elected Governor Jack Markell inherited an $800 million budget deficit, he “raised the business taxes, raised the personal income taxes, cut back the salaries of state workers, and hit us with the biggest tax increase we ever experienced,” Sutor says.

After the economy stabilized, Markell rolled back the business and income taxes, Sutor says. State workers got back pay and raises. “But nothing ever happened with the high share of (racino) revenues.”

An Unfair Share?

When casinos first opened in Delaware in 1996, they operated under a tiered tax structure. The sliding scale based on revenues began at 12.5 percent and could not exceed 30 percent. “But over the years, every time there was a downturn in the economy, the state increased their share,” says Sutor. “And they did it seven times.”

The racinos now pay an effective rate of more than 60 percent (Nevada, by comparison, collects a 6.75 percent tax on gross gaming win, the amount casinos keep after paying customers’ winnings). The operators have implored lawmakers to reduce that burden so they can remain competitive and avoid layoffs.

The Delaware Lottery and Gaming Study Commission is considering ways it can help, and will announce its recommendations this month. Meanwhile, the operators say they cannot grow—and in fact may not be able to sustain—without some accommodation.

‘Border Wars’

Bill Fasy, president of Delaware Park Horse Racing & Slots in Wilmington, says Delaware “used the Chicago casinos as an example when they were looking at a higher tax rate—and we all know what happened in Chicago.” In the mid-2000s, Illinois’ graduated tax rate peaked at 70 percent; it has since been capped at 50 percent.

The numbers just don’t add up for Delaware racinos, Fasy says. “You can’t cover costs in the tax environment we’re in. If you have a dealer working for $7 an hour plus benefits, that’s $10.50 just for payroll. When you add that in from the standpoint of overhead, it’s more than you’re making on a $5 game. And that includes nothing else—not paying for lights or the electricity, not marketing or fixed costs like real estate taxes and insurance.”

When the three racetracks first added slots to bolster the horse industry, their only competition was almost three hours away, in Atlantic City. Though Pennsylvania legalized casinos in 2006 and has since opened 11 gaming halls, the impact on Delaware has been a ripple compared to Maryland. Delaware Park did not post its first year-over-year revenue loss until December 2010—less than two months after the Hollywood Casino Perryville opened in Maryland.

In recent years, gaming revenues in Delaware have fallen off a cliff, dropping from a high of $300 million in 2007 to $192 million in 2012. That’s when Maryland Live! opened in the Baltimore-Washington area, once a key feeder market for Delaware gaming.

“That was the real killer,” says Sutor. “They do a phenomenal amount of business. We’ll do $150 million in slot revenues in a year, and they do $600 million-plus.” In October 2014 alone, the casino at Arundel Mills Mall reported $50.3 million in revenue.

“Now we’re dicing it up to the point where we’re having border wars, trying to get people not to take their money out of state,” says Fasy. The sluggish jobs market hasn’t helped. “When people have less disposable income, then it’s a choice: Do I buy food for the family or go out to the movies or do I go to gamble? All these things compound on top of each other.”

And the competition is only getting steeper. In August, the new Horseshoe Casino opened in Baltimore, and out of the gate generated $1 million per day. In 2016, MGM Resorts’ $925 million casino and resort will open at National Harbor, about an hour’s drive from Baltimore and about two hours from Delaware.

“To this day about 40 percent of our customers come from Maryland, about 20 percent from Virginia—the majority of our business is south and west of us,” says Sutor. A smattering of patrons hail from New York, New Jersey and Pennsylvania. But as Atlantic City learned—the hard way—even loyal players will switch their allegiance if there’s a casino closer to home.

The ‘B’ Word

What rankles racino operators is the widespread use of the word “bailout” to describe their efforts to reduce the state’s share. Reporter Larry Mendte, writing in the July 2014 issue of Philadelphia magazine, said casino bailouts stink like “horseshoe crabs decaying on the beaches of the Delaware Bay.”

State aid for racinos, wrote Mendte, “may be the worst deal in the history of bad state government deals”—worse, he said, than New Jersey Governor Chris Christie’s $300 million tax break for Revel (which was never realized since it was a tax on profits, something Revel never produced), the $2.4 billion Boardwalk casino that closed last year. Moreover, he said, the industry “produces nothing and leaches off the hopes and sometimes desperation of its citizens.”

With press like that, no wonder the public is riled up at the thought of a reduction in the tax rate.

“You know and I know bailout is a bad word for the common citizen,” says Sutor. “Chrysler was bailed out. GM was bailed out. We’re not looking for a bailout or a change in the income tax rate; we’re happy to pay our taxes like any other business. Our problem is the revenue share. The public doesn’t understand that 62 percent of my revenues go straight to other people.”

State Finance Secretary Tom Cook, head of the commission studying relief for the racinos, says the term bailout “does not fairly represent an adjustment to the revenue distribution model. At the end of the day the state, the casinos and the horsemen are partners in this. The goal is for all three of us to be successful.”

Sutor agrees. “We’re looking for our partner to put back the model that worked when we opened this facility in 1995, to put in a graduated rate. Because the more money we make, the more we pay. Under the current model, with the big percentage we pay, it doesn’t work any more—not at these levels, and not with this much competition.”

If the tax rate cannot be altered, he adds, “Give us some credit for capital expenditures. In West Virginia the state has given back over $100 million to the casinos to help offset the cost of their capital expenditures. We don’t get that here. In the state of New York they give 8 percent of their gaming revenues back to the casinos for marketing purposes. We don’t get that.”

In fact, Dover Downs now carries more than $40 million in debt from capital expenditures incurred in 2006-07, when the property doubled the size of its hotel and added retail, restaurants and a nightclub, says Sutor. The racino has breached its bank covenants three times, causing interest rates to soar.

“No sooner did we do that major capital expenditure, borrowing $100 million, than we got hit with the big increase,” Sutor says. “That’s sucked out more than $20 million a year in cash flow over the past six years. We should have been debt-free by now.”

“That’s the tough balance we need to strike here,” says Cook, “understanding that the casinos need to be in an environment that allows them to take their profits and put them back into the facilities to stay competitive.”

Ending a ‘Monopoly’

Despite this hyper-competitive environment, some developers and lawmakers are pushing to bring Vegas-style, non-racetrack casinos to Delaware. Investors have testified before the commission that too much of the racinos’ profits have gone to dividends and bonuses for executives. More revenues, they say, could be mined from casinos in better locations, possibly in the city of Wilmington and the resort community of Rehoboth Beach.

State Rep. Charles Potter of Wilmington has been pushing the idea for years. The racinos “had a 15-, 20-year head start,” he says. “They should have reserved some of their dollars for growth and development and hard times, and not continued their dependency on the state.”

But who’s dependent on whom? According to Sutor, Dover Downs, Harrington Raceway and Delaware Park have funneled $5.5 billion to the state over the last 15 years, money earmarked for public education, Medicaid and other budget items.

“If you take an industry that’s given the state billions and not help it survive, how do you solve that revenue cut down the road if it goes away?” says Sutor.

Potter is not persuaded. He supports Vegas-style gaming halls “closer to I-95, near population centers, near interstate connections where people can get right in and have a good time.”

The racinos can survive, he added, if they “change their marketing mix, beautify their locations and add some amenities. They haven’t incentivized people. Two of the three locations have done no improvements; at least give Dover Downs credit for adding a hotel. But my primary responsibility is the amount of money that comes to the state.” Potter ignores the fact that one of Maryland’s weakest performers is Hollywood Casino Perryville, smack off I-95.

Cook concedes that the current racetrack sites—chosen in keeping with the goals of the Horse Racing Redevelopment Act of 1994—are less than optimal. As for new casinos, he adds, “That opportunity has probably been missed. What you would not want to do at this point is just shift the play from a current location to another location. That doesn’t really solve the problem.”

Sutor scoffs at the notion that casino companies are lining up to invest in Delaware: “There are legislators and lobbyists who say there would be a line around the block of people wanting to come in to build a facility here in Delaware, and quite frankly we don’t believe it. I don’t know a bank out there that would finance a casino in a saturated market.”

Shortly after he made the remark, however, Pennsylvania approved a Class III license for South Philadelphia’s stadium district—just 30 minutes from Delaware Park. The casino development is a project of the Cordish Companies, the same company that built Maryland Live!

A Free Market?

In 2010, TMG Consulting of New Orleans presented a study of the Delaware casino industry that said the state could benefit from new casinos in Sussex and New Castle counties. While total gambling revenues would increase, the consultants said, the racinos would certainly feel the pinch, and earnings could fall more than 12 percent.

Wilmington attorney Darrell Baker says the study “predicted the demise” of racinos in Delaware. “We developed ostrich management, doing nothing and thinking another sunny day would come. It’s turned into a textbook failure of how a monopoly will ultimately collapse. (The Delaware racinos) are flying biplanes when Maryland Live! is launching satellites.”

Baker says he represents casino interests from California and Nevada who are eager to build in the state; he declined to name the would-be investors, but advocates a compromise in which the tax rate is lowered in exchange for an open market.

“Lower the rates and allow others in,” says Baker. “That way the people who lower the rate will have political cover to say it’s not a bailout. There will be some provisions for the horsemen, but their perpetual suckling at the state budget will be capped or finite.”

He likened it to the liquor tax in the state. “It’s quite high, a 25 percent tax, but in Delaware anybody can get a liquor license. We dole them out like Tic Tacs. If the casinos want to be treated like liquor license holders, lower the rate and you can set up shop whatever you want. You’re not going to stop the competition. And doing nothing has been a recipe for disaster.

“This drip-drip-drip of subsidy for them is not going to be able to go on.”

Do the Math

Though Delaware cashes in from sports betting?it’s one of only four states in the U.S. where sports bets are legal at the federal level—those wagers are not exclusive to the racinos, and can be placed at some 80 convenience stores, liquor stores and restaurants. Nor has online gaming provided a tourniquet. Delaware, Nevada and New Jersey launched online gaming in August 2013 expecting a windfall.

But the numbers in all three states have been underwhelming, to say the least. Last September, iGaming revenues for the state of Delaware were the lowest for all of 2014, with combined total revenue of $145,022.

The news from the racinos is also bleak. According to a November report in northern Delaware’s News Journal, in the decade between 2002 and 2012 the state’s portion of gaming taxes fell 20 percent. Casino taxes are expected to generate $180 million in the fiscal year that ended last June, down from $238 million just four years ago.

And so the debate continues. Fasy hopes for “long-term permanent changes to the business model that will allow the existing casinos to continue to employ 4,000 people, continue to market, and continue to expand and improve the product so we can compete.”

Last January, Markell seemed inclined to agree. “As a state we have come to rely on gaming revenue,” he said. “I would like to see us reduce that reliance on gaming revenue and put the casinos in a position where they can be competitive and good partners.”

As Michele Rollins, whose family trust owns millions of shares of Dover Downs stock, told the News Journal, “Where does this administration go when they want to find a business that will bring 1,500 jobs? They will go to China, they’ll go to the end of the earth. But I hope they’ll take a serious look at what they have under their nose and help us.”