MORGAN STANLEY DEAN WITTER
Industry Overview March 20, 2001 Michael Happel
Will Online Gaming be Legalized in the U.S.?
• How Big Is the Online Gaming Industry?
Online gaming revenues have grown nearly 340% since 1998 to $2.2 billion in 2000.
• Prohibition Versus Regulation
We would like to see regulation of online gaming rather than outright prohibition, but this is a topic that can generate heated debate.
• Legalization By Nevada and New Jersey?
Legislation has been introduced in Nevada and New Jersey that would allow online gaming, subject to regulation.
Gaming
This article provides a brief overview of the online gaming
industry for investors who want to understand the basics of
this rapidly developing industry. Even though U.S. residents generate about half of worldwide online gaming revenues, the traditional U.S. casino operators have essentially been “sitting on the sidelines” while foreign companies have taken the lead in the online gaming industry. To date, the traditional U.S. casino operators like Harrah’s ($30) MGM Mirage ($26), and Park Place ($10) have not been involved in online gaming primarily because such involvement could jeopardize their licenses for traditional gaming. However, legislation has recently been introduced in Nevada and New Jersey to legalize online gaming.
Although opponents of online gaming would still like to
pass laws that prohibit it, legalization by a state like Nevada or New Jersey could transform the online gaming industry. If the major U.S. casino operators do enter the online gaming industry, they could take significant market share from existing players, stimulate growth of the online
gaming industry, and enhance their own growth prospects.
How Big Is the Online Gaming Industry?
According to Christiansen Capital Advisors, worldwide online gaming revenues grew from just $650 million in 1998 to $2.2 billion in 2000 (refer to Exhibits 1 and 2).
Exhibit 1
Worldwide Online Gaming Revenues
Year
Revenues
(billions) % Growth
2001E $ 3.2 45%
2000 $ 2.2 83%
1999 $ 1.2 71%
1998 $ 0.7 NA
Source: Christiansen Capital Advisors, LLC
Exhibit 2
Components of Worldwide Online Gaming Revenues (2000)
Type of
Revenue
Amount
(billions) % of Total
Sports $ 1.0 45%
Casinos $ 0.9 40%
Lotteries $ 0.2 10%
Other $ 0.1 5%
Total $2.2 100%
Source: Christiansen Capital Advisors, LLC
Online gaming is a global business, but 40% to 60% of all
online gaming revenues are believed to come from U.S. residents. There are currently more than 1,400 online gaming sites. However, the number of online gaming operators is believed to be closer to 300 because many online gaming operators have multiple sites. Refer to www.gaming-guide.com for a list of popular online gaming sites.
The Pros and Cons of Online Gaming
Online casinos offer a number of advantages and disadvantages relative to traditional casinos. We briefly
discuss some of these advantages and disadvantages from
an operator’s perspective and from a customer’s perspective.
From an operator’s perspective, it is fairly easy to get an
online gaming license and online casinos cost substantially
less than traditional casinos. Because the costs of building a physical casino are avoided and labor costs for ongoing operations are minimal, online casinos generally have higher profit margins and a higher ROI than traditional casinos. However, there are virtually no barriers to entry in the online gaming business so competition can be intense. Online casinos can be perceived as commodities, and the marketing costs to build a brand can be substantial. In addition, online casino operators face significant uncertainty about the law as it applies to online gambling.
From a customer’s perspective, online gaming is convenient
(even though the online gaming experience can be cumbersome due to bandwidth constraints and other factors)
and online gaming is generally viewed as less intimidating
than gambling at a traditional casino. However, online gaming lacks many of the social aspects of gambling at a traditional casino (most online casinos do offer chat rooms
and other features to make online gaming more social). In
addition, concerns about integrity of the games, creditworthiness of the operator, privacy, and reliability of payment systems are all magnified for customers of an online casino.
Prohibition Versus Regulation
We can think of several reasons why governments might want to prohibit online gaming. These might include moral reasons, social reasons (e.g. concern about under-age gambling, addictive gambling, money laundering, etc.) and
economic reasons (e.g. the possibility that online gaming will erode tax revenues if it competes with traditional
gaming, but cannot be effectively taxed).
Our general view is that we would rather see regulation of online gaming rather than outright prohibition, but this is a topic that can generate heated debate. Aside from the issue of whether online gaming should be prohibited, there are questions about whether online gaming could be prohibited as a practical matter.
Most discussions about how to prohibit online gaming have focused on (i) operators of online gaming sites, (ii) individual consumers (iii) Internet Service Providers (“ISPs”), (iv) search engines/portals, and (v) credit card companies. Legislation aimed at prohibition would probably need to be directed at some or all of these industry “participants.”
Targeting online operators, by itself, is unlikely to result in effective prohibition of online gaming. The Internet is borderless so offshore companies can offer online gaming to U.S. residents. In many cases, it may be impossible for U.S. law enforcement officials to even determine the identity and location of the company offering online gaming. Even if the identity and location of the online company can be determined, U.S. courts may not have legal jurisdiction over the online operators.
Targeting home users also provides challenges. First, it may not be politically feasible to pass legislation aimed at punishing citizens that gamble online from the privacy of their own homes. Second, even if such a law was enacted, the enforcement issues could be significant (wiretaps and raids of personal residences would presumably be key parts of an enforcement strategy). At the end of the day, punishing citizens for casual betting is probably not going to be a high priority for law enforcement officers.
Targeting ISPs, the gateways to the Internet, is another way to pursue prohibition of online gaming. Some of the major ISPs include UNNET, G-Home, T-Online, and AT&T. In
general, enforcing prohibition would involve limiting access to the ISPs or trying to control the content offered by ISPs. Although some countries limit access to ISPs (i.e. they limit access to the Internet), this is probably not a realistic option in the U.S. It is more likely that laws aimed at prohibiting online gaming would focus on restricting content on the Internet. However, this raises practical issues (could the content successfully be blocked) and freedom of speech issues that could be significant. Similar issues arise with regard to regulation of online service providers (“OSPs”)
and “backbone providers.” OSPs differ from ISPs because
they offer both access to the Internet and a private network. Some of the major OSPs include (America Online,
CompuServe, and Prodigy).
Regulators could also choose to focus on search engines/portals such as Yahoo, Alta Vista, Excite, and
Infoseek. Different search engines work in different ways,
but they all help Internet users find out what sites are
available and they provide the URL address of sites. Search
engines/portals also typically make a majority of their
revenues from advertising. Targeting search engines as a
way to implement prohibition could be based on the idea of
restricting advertising about online gaming or on the idea of blocking searches related to online gaming.
Credit cards have sometimes been referred to as the “life
blood of the online gaming industry.” Most transactions on
the Internet involve a credit card, but other alternatives (e.g. debit cards, electronic checking, or digital cash) may become more prevalent over time. Some credit card
companies already try to prohibit the use of their cards for gambling. This is partly because there is a risk that credit card obligations related to gambling could be viewed as “unenforceable gambling debts.” The issue of whether a credit card bill for a customer that used his credit card to gamble constitutes an unenforceable gambling debt is being considered in the courts.
The Legal Framework in the U.S. Online gaming, like other online activity, doesn’t fit neatly within geographic boundaries. As a result, online gaming raises some difficult jurisdictional issues for lawmakers and
law enforcement officials. For example, where does an
online gaming transaction take place? Which courts have
jurisdiction over the parties to an online gaming
transaction? Which governmental entities have the right to
tax an online gaming transaction? Can online gaming be
effectively prohibited? Can online gaming be effectively
regulated?
For the most part, existing federal and state laws in the U.S. do not specifically address online gaming. As a result, courts have had to evaluate online gaming issues in the context of existing laws while legislators have debated about whether online gaming should be prohibited or
regulated.
At the state level, a few states have passed laws specifically prohibiting online gaming (e.g. Louisiana, Illinois, Michigan, South Dakota, and Nevada), but there have not been any states that have passed laws specifically legalizing online gaming. As we discuss below, legislation has recently been proposed in New Jersey and Nevada that would legalize online gaming.
At the federal level, opponents of online gaming have taken
the view that existing federal laws (e.g. the Wire Act)
prohibit online gaming in the U.S. At least one federal court has ruled that the Wire Act does prohibit online sports wagering. However, many experts believe the Wire Act
does not apply to other forms of online gambling (e.g.
online casinos). There are other Federal laws that could
apply to online gaming in certain circumstances (e.g. the
Professional and Amateur Sports Protection Act, the Federal
Antigambling Statute, the Travel Act, RICO, or the
Wagering Paraphernalia Act).
Opponents of online gaming have also tried to enact federal
legislation that specifically prohibits online gaming in the U.S. (e.g. the Kyle Bill in the Senate, the Goodlatte Bill in the House, and Leahy Bill in the House). To date, these proposals to prohibit online gaming at the federal level have not been successful.
Legalization By Nevada and New Jersey?
Legislation has been introduced in Nevada and New Jersey
that would allow online gaming, subject to regulation. At the moment, we think the Nevada legislation has a fairly good chance of becoming law in 2001, but we don’t think the New Jersey legislation is likely to become law anytime soon. If either state legalizes online gaming, we think it would be a major event in the online gaming industry.
Nevada: Assemblywoman Merle Berman has introduced a
bill (Bill 296) in the State Assembly that could legalize
online gaming. If the bill becomes law, it would authorize
the Nevada Gaming Commission to adopt regulations for
licensing online gaming companies. The bill specifically
says online gaming licenses could only be granted to a
resort hotel in Nevada that holds a nonrestricted license (i.e. a traditional gaming license) and that online gaming
revenues would be taxed in the same way as all other
gaming revenues. The bill also says operators would be
allowed to offer online gambling to people who are
communicating from jurisdictions that allows online
gambling. Initially, this would mean a licensed operator
could offer online gaming on an intrastate basis plus it could be offered to foreign jurisdictions that allow online
gambling. If more states legalize online gaming over time,
online gaming could be offered to people communicating
from those states.
It’s hard to predict whether the bill will pass this year, but it does seem to have significant support. Thirty-three members of the 42-member assembly have co-sponsored
the bill and five members of the 21-member senate have
signed on. In addition, the Nevada Resort Association
supports the bill. A hearing date has been set for March 30th in the Judiciary Committee. From there, the bill would go to the full Assembly for a vote. If the bill passed in the Assembly, it would go to the Judiciary Committee in the Senate and then to the full Senate for a vote. If it passed the Senate, it would then go to the Governor for his signature.
Supporters hope the bill is successful this year because the Nevada legislature only meets biannually.
Even if the bill does become law, it could take some time
for the Nevada Gaming Commission to actually enact
regulations authorizing online gaming. The Nevada Gaming
Commission will have to be satisfied that it can successfully regulate online gaming.
New Jersey: Assemblyman Tony Impreveduto has
introduced a bill (Bill A-3150) authorizing the Casino
Control Commission to permit Atlantic City casinos to offer
gambling over the Internet. To date, this bill has not made
much progress and we doubt it will become law anytime
soon. Assemblyman Joseph Azzolina, Chairman of the
Commerce, Tourism, Gaming and Military and Veteran
Affairs Committee, may be working on an alternative bill to
legalize online gaming.
The Legal Framework Outside the U.S.
A comprehensive discussion of online gaming laws
worldwide is beyond the scope of this report. However, as
Exhibit 3 indicates, there are currently 54 jurisdictions that allow some form of online gaming.
Exhibit 3
Online Gaming Jurisdictions
Africa (4) Caribbean (10) Europe (19)
Anjouan Antigua and Barbuda Aland
Liberia Dominica Alderney, UK
Mauritius Dominican Republic Austria
Swaziland Grenada Belgium
Jamaica Finland
Australasia (14) Netherland Antilles Faroe Island, Denmark
St. Kitts and Nevis France
Australian Capital Territory St. Vincent Germany
Cook Islands Trinidad Gibraltar, UK
New South Wales, Australia Great Britain, UK
New Zealand North America (1) Iceland
Norfolk Island, Australia Ireland
Northern Territory, Australia Mohawk - Kahnawake Isle of Man, UK
The Philippines Liechtenstein
Queensland, Australia South America (3) Malta
Solomon Islands Norway
Tasmania, Australia Chaco, Argentina Scotland
Vanuatu Formosa, Argentina Spain
Victoria, Australia Venezuela Sweden
Vietnam
Western Australia Russia (1)
Central America (2) Kalmykia, Russia
Belize
Costa Rica
Source: igamingnews.com
Australia has attracted a lot of attention in the online
gaming world because Australia could become the first
large industrialized country to enact comprehensive
legislation that permits online gaming. However, online
gaming has become an intensely debated political topic in
Australia. Things looked good in May 1997 when the Draft
National Model For The Regulation of Internet Gaming was
released. Unfortunately the draft was never adopted.
Instead, several states and territories enacted their own laws allowing or prohibiting online gaming. The national
government then became involved when Parliament passed
a moratorium on new online casino licenses with the
support of Prime Minister John Howard. The one-year
moratorium lasts until May 12, 2001. Prime Minister John
Howard supports prohibition of online gaming and the issue
is being studied during the moratorium period.
Who’s Who In the Online Gaming Industry
The vast majority of companies in the online gaming
industry are private and incorporated outside of the U.S.
Exhibit 4 describes fifteen public companies that generate a significant part of their revenues from the online gaming
industry. This is not a comprehensive list of all the public companies in the online gaming industry. These fifteen companies make up the “RivTrend Global I-Gaming Stock Index” as defined by the River City Group and Investrend Research. In broad terms, the industry can be divided into gaming software providers, financial transaction software providers, online gaming operators, and others.
Exhibit 4
Online Gaming Leaders
Company
Market
Capitalization
(U.S.$) Description
North America
AutoTote 84 Autotote (AMEX: TTE) is dedicated to providing software and technical support to the lottery, racing, and telecommunications industries. Autotote acquired Scientific Games in September 2000 for
$308 million.
Chartwell Technology 10 Chartwell (Canadian Venture Exchange: CWH) specializes in the development and maintenance of entertainment software for Internet and Intranet deployment.
CryptoLogic 140 CryptoLogic (NASDAQ: CRYP, Toronto Stock Exchange: CRY) specializes in the development and maintenance of entertainment software for Internet and Intranet deployment. It focuses on the online gaming industry and is one of the "big three" software suppliers for the industry.
eLOT 15 eLOT (NASDAQ: ELOT) and its subsidiary, eLottery, Inc., are leading providers of web-based retailing and Internet marketing services to governmental lotteries.
dot com Entertainment 12 dot com Entertainment (NASD OTCBB: DCEG, Frankfurt Exchange: DOZ.FRA) is a leading provider of interactive, multi-player, low denomination casino and lottery games and provides a suite of online casino games for the Internet.
Starnet Communications 33 Starnet (NASD OTCBB: SNMM) specializes in the development and maintenance of entertainment software for Internet and Intranet deployment. It focuses on the online gaming industry and is one of the "big three" software suppliers for the industry.
Virtgame.com 4 Virtgame.com (NASD OTCBB: VGTI) is an application service provider for the gaming and lottery industries, specializing in technology that limits e-commerce to one jurisdiction or restricts access of users from a specific jurisdiction. In addition, Virtgame has built customizable Internet lottery, casino and sports wagering software and applications.
YouBet.com 9 Youbet.com (NASDAQ: UBET) provides U.S. and Canadian members the ability to watch and wager on a wide selection of live horse racing events.
Sources: igamingnews.com and Company web sites
EuroAustralia
Boss Media 148 Boss Media (Stockholm Stock Exchange: SEK0.02) specializes in the development and maintenance of entertainment software for Internet and Intranet deployment. It focuses on the online gaming industry and is
one of the "big three" software suppliers for the industry.
Ebet 7 eBet (Australian Stock Exchange and New Zealand Stock Exhange: EBT) develops and markets networked solutions for gaming machines. It also develops, markets and operates online gaming technologies.
ENIC 109 ENIC (London Stock Exchange: ENI.L) is an international sports and entertainment groupspecializing in the creation, development and management of brands and related services.
Gocorp NA
Gocorp holds online casino licenses in Queensland, Australia, but has been forced to suspend its activities under the moratorium on interactive gaming imposed by the Australian government. The company plans to merge with fellow Australian gaming operator, Lasseters Online.
Lasseters has been able to continue online gaming because its business was in operation prior to the May 1999 moratorium deadline. Gocorp shares have not traded since December 2000.
Hilton Group 4,943 Hilton Group (London Stock Exchange: HG) is a major international company focused on the worldwide hospitality and regulated gaming industries with leading brand names such as Hilton and Ladbroke. The
Ladbroke Betting and Gaming division is one of the world's largest commercial off-track betting and gaming organizations.
Sportingbet.com 174 Sportingbet.com (Alternative Investment Market - London StockExchange: SBT) is a global on-line and telephone sports betting business with operations in Alderney (in the Channel Islands) and in
Costa Rica. In addition, Sportingbet offers an online casino to its North American sports betting customers.
Stanley Leisure 386
Stanley Leisure (London Stock Exchage: SLY) is the second largest casino operator and the fourth largest betting shop in the U.K. In addition, the company has launched and acquired Internet casino sites.
Sources: igamingnews.com and Company web sites
+1 (1)212 761 4648
Michael.Happel@msdw.com
Angi Kwok, CFA
+1 (1)212 761 6334
Angi.Kwok@msdw.com
Rachael Rothman-Ould
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