M&As – Why So Many, Why Now?

written by I. Nelson Rose

© Copyright 2010, all rights reserved worldwide. Gambling and the Law® is a registered trademark of Professor I Nelson Rose, www.GamblingAndTheLaw.com

It seems that every day brings news of more mergers and acquisitions (M&As) in the online gaming world.

[NOTE FOR EDITOR – If you want to list some of the most notable here, feel free. You may not need to. Read the whole piece first.]

There have always been licensing and other partnership agreements in the world of legal gambling. But such arrangements boomed for land-based gaming within the last 20 years, with the realization that branding works for casinos just as it works for breakfast cereals.

Probably the two most significant developments for land-based casinos in this area were:

1) The hiring of Gary Loveman, former Harvard Business School professor, as Chief Operating Officer, now Chief Executive Officer and President, of Harrah’s Entertainment, Inc., in 1998; and
2) The licensing of “Wheel of Fortune” by Merv Griffin to IGT in 1996.

The first led to Harrah’s passing Caesars Palace as the best known gambling brand name in the world, in part from Loveman’s genius at creating player loyalty programs.

The second resulted in the most successful slot machine ever invented, and the drive to find other brands, both nostalgic and invented, to copy that success.

Internet gambling has its own versions of these stories. There is nothing inherent in the words “party” and “poker” that would guarantee that putting them together would end up capturing as much as 40% of the world market. Non-U.S. online betting operators, free from the prohibitions on anything connected with wagers imposed by American sports leagues, have sponsorship tie-ins with teams throughout Europe.

But the most amazing story has to be the initial success of 888, which before passage of the Unlawful Internet Gambling Enforcement Act, claimed that it was the largest poker operator in the world: A claim that was mostly correct, except that it was actually only a marketing company, which did not actually operate a poker room.

So, part of the consolidation that we see has always been there. The easiest way for an operator, like PartyGaming or Harrah’s, to acquire the enormous marketing power of an established brand name, like the World Poker Tour or the World Series of Poker, is to buy it. This sometimes means licensing, as with Wheel of Fortune. But it sometimes requires buying the entire company.

But M&As have continued beyond the requirements of branding. And it is especially noteworthy that the corporate action grew in the online world while its land-based counterparts came to a screeching stop.

Part of the reason is that the two branches of the legal gambling industry are at completely different stages of development.

All companies start with small, breakthrough operators. These are entrepreneurs and mom and pop shops that latch on to an invention or social development with little funding, but lots of guts. Few succeed, but those who do so, do so with fantastic, newsworthy flashes of money and brilliance. People hear about the billionaires created by MicroSoft, Apple Computer, or BoDog, and figure they can do the same. Of course, most fail.

The successful small businesses buy up the less successful ones, in part, simply to drive out the competition. The consolidation follows the same general pattern, whether it is automobiles in the early 1900s, or computers 80 years later.

The land-based gaming companies have already gone through much of this consolidation. Three multi-national corporations control 60% of the casino market on the Las Vegas Strip.

It is now the turn of Internet gaming.

The money has dried up for land-based gambling. If the Great Recession had not hit, there would be even fewer publicly traded and independent operators. Private equity funds, which used to demand 20 per cent-a-year return on their investments, were buying up casinos, because nothing matches the cash flow generated by a casino.

Unless it is an Internet gambling site.

While the giants of land-based gaming were fighting to stave off bankruptcy, online operators continued to grow. Yes, the downturn in the economy hurt. But the result was, at worst, a leveling off, not a falling off a cliff.

Internet sites were mostly saved from making the mistakes of their Nevada and Macau counterparts, because they simply could not invest billions of dollars in overpriced real estate and unnecessary buildings. So, online operators still have cash, and sometimes even stock at respectable prices, to buy up competitors.

One reason consolidation seems to take place so quickly among Internet operators is that it truly can be accomplished quickly, especially when compared with land-based companies.

The attempt by private the equity firms, Fortress Investment Group and Centerbridge Partners, to buy the publicly traded Penn National Gaming for about $6 billion, is a case in point. The offer, made in June 2007, would have given the buyers not only the assets, but also the expertise of one of the best-run gaming companies; the current owners and managers would have retained control and still have some equity, as well as instant profits.

But the market crashed, and the banks financing the deal panicked. Penn Gaming refused to renegotiate, and its lawyers had written non-breakable agreements, including a $200 million kill fee and the express right to go to court to require the banks to fund the buyout. By the end of 2008, the banks were willing to give Penn Gaming $700 million in cash and another $775 million in what effectively is an interest free loan – $1,475,000,000 to NOT buy the company.

I asked Thomas N. Auriemma, Penn Gaming’s Vice President and Chief Compliance Officer, about those agreements. He told me everyone thought the buyout would go through. But he knew it would take much longer than a year to get all the government approvals required for the merger. And during that time, Penn Gaming could not even look at other suitors.

For a land-based gaming operator with licenses in many states, tribes and countries, a corporate merger or acquisition can take up to two full years to get all the government approvals. Delay makes M&As costly. Thinking about restructuring interferes with the day to day operation of a business. Plus, who knows what stock prices or interest rates will be in two years?

By contrast, even the largest pure-Internet gaming operations can, and do, clear all regulatory barriers in far less than a year.

M&As will continue throughout the online gaming world, because the time is ripe for consolidation. A successful, established company that wants, say, to get into the bingo business knows that it is better to buy the expertise and customers of an existing site than to try to start one from scratch.

Some of the most interesting developments will come in the next few months and years, especially once the states of the U.S. start legalizing intra-state poker. Because the easiest way to get in, or back in, to the American market is to team up with an already licensed U.S. operator.

© Copyright 2010, all rights reserved worldwide. Gambling and the Law® is a registered trademark of Professor I. Nelson Rose. Harvard Law School educated, Prof. Rose is recognized as one of the world’s leading experts on gambling law. He is an internationally known public speaker and a consultant and expert witness for governments and industry. His latest books, Internet Gaming Law (1st & 2nd editions), Blackjack and the Law and Gaming Law: Cases and Materials, are available through his website, www.GamblingAndTheLaw.com.

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