Why an Upcoming SCOTUS Decision is Possibly Game Changing for William Hill and GVC PLC

During the last decade two US states, Delaware and New Jersey, have been fighting the losing battle to overturn the Professional and Amateur Sports Protection Act of 1992 (“PASPA”), which prevents US states from regulating and offering sports betting. Another federal law, called the Interstate Wire Act of 1961 (“Wire Act”), prevents interstate wagering; however, PASPA is the main roadblock to intrastate gambling within the US.

US federal law is complex. Federal laws usually overrules state law and sometimes Congress passes a federal law that may appear to be in conflict with another federal law. For example, the Unlawful Internet Gambling Enforcement Act of 2006 (“UIGEA”) “prohibits gambling businesses from knowingly accepting payments in connection with the participation of another person in a bet or wager that involves the use of the Internet and that is unlawful under any federal or state law.”[1] UIGEA has a specific carve-out for fantasy sports (under certain conditions) “but does not expressly mention state lotteries, nor does it clarify whether inter-state wagering on horse racing is legal.”[2] Complicating matters more, the Wire Act says:

“Whoever being engaged in the business of betting or wagering knowingly uses a wire communication facility for the transmission in interstate or foreign commerce of bets or wagers or information assisting in the placing of bets or wagers on any sporting event or contest, or for the transmission of a wire communication which entitles the recipient to receive money or credit as a result of bets or wagers, or for information assisting in the placing of bets or wagers, shall be fined under this title or imprisoned not more than two years, or both.”

“However, the U.S. Fifth Circuit Court of Appeals has ruled that the Wire Act prohibition on the transmission of wagers applies only to sports betting and not other types of online gambling.”[3]

The battle over PASPA has been unsuccessfully wagered by the States of Delaware (2009) and twice by New Jersey in 2009 (Christie I) and 2012 (Christie II). Delaware and Christie I were both appealed to the Supreme Court of the United States (“SCOTUS”) but when SCOTUS didn’t accept their appeal, the cases died.

The essence of the arguments for the repeal of PASPA stem from the 10th amendment, which says:
“The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”[4]

Essentially the argument is that the federal government cannot make laws reserved for the US states. Gaming likely falls within this field; moreover, PASPA benefits some states over others, a major flaw in the law.
The sports leagues and the federal appellate courts see it differently and their view is complex:
“The state did not dispute that the 2012 law conflicted with PASPA. Instead, it countered that PASPA violates the 10th Amendment, which the Supreme Court has interpreted to prohibit the federal government from “commandeering” the states to enforce federal law. But the lower courts rejected that argument, with the U.S. Court of Appeals for the 3rd Circuit ruling that the “anti-commandeering doctrine” did not apply because PASPA does not require the states to do anything; it simply bars them from allowing sports betting. The Supreme Court denied review of that decision.

In 2014, the New Jersey legislature returned to the drawing board. It passed a new law that did not affirmatively legalize sports betting, but instead repealed existing prohibitions on sports betting, at least as they applied to New Jersey casinos and racetracks. The NCAA and professional sports leagues again went to federal court (Christie II), where the lower courts once again ruled for the leagues. This time, the full 3rd Circuit ruled that, even though New Jersey had “artfully couched” the 2014 law as simply a “repealer,” the statute nonetheless authorized sports betting at casinos and racetracks in the state. This time the Supreme Court agreed to weigh in, granting two petitions for review by New Jersey Governor Chris Christie and the New Jersey Thoroughbred Horsemen’s Association, a group of horse-owners and trainers that also owns a racetrack in New Jersey, which the group believes can only be saved from financial ruin by money from sports betting.”[5]

As Christie II was being pushed through the system, there were other related, but significant developments in the US. The first was the advent of daily fantasy sports (“DFS”) which itself faced legal and regulatory challenges despite the “apparent carve out” that DFS obstinately relied on. DFS resulted in nationwide discussions about sports betting since DFS was a clear perversion of the fantasy sports the UIGEA probably envisioned. Secondly, instead of the federal government suing New Jersey and Delaware, it was the major sports leagues who sued, but who also happened to control significant investment stakes in the two major sports fantasy operators which legalized sports betting would compete with and that have now been deemed to be gambling enterprises by several US regulators — this entire situation corrupts their position since Christie I.

Christie II also brought interesting drama to the scene. Despite losing its initial appeal with the 3rd Circuit Court, it appealed to the entire panel, a highly unusual move which was accepted and later defeated by a 10–2 margin. After that defeat, New Jersey appealed to SCOTUS again and it was widely believed SCOTUS would deny certiorari as it had done in Christie I . But, SCOTUS asked the solicitor general to weigh in on behalf of the Government; and, as expected, the solicitor general wrote a brief asking SCOTUS to deny certiorari. Despite all these events, SCOTUS accepted Christie II (granted certiorari). Oral arguments will be heard in the coming months and a final decision will arrive in the summer or fall of 2018.

Statistically speaking, SCOTUS overturns at least 66–70% of the time, but this case is exceptional in other ways. Several justices over the years have referenced PASPA unfavorably (despite it not being previously accepted for repeal), 14 states have passed legislation legalizing sports betting should PASPA be found unconstitutional, and finally the sport leagues, who are the plaintiffs against New Jersey, are now heavily invested in sports gaming (“DFS”) enterprises.

Anyway you cut it, the result will be a political decision. Amicus curiae briefs have been filed in wholesale supporting a repeal of PASPA, despite the lower court opinions. Thus SCOTUS can find reasons for either side to prevail.
But the backdrop is worth understanding here. Had SCOTUS not accepted Christie II, sports betting in the US would have faced a long uphill battle that could have lasted at least another 5 years (but more likely the next decade). There are no other PASPA cases in the system that could presently be appealed to SCOTUS and the likelihood of a repeal in the current Congress is very low. So if SCOTUS had not taken this case, then sports betting would have been dead for years (if not the next decade) and the same goes for SCOTUS affirming the lower court decisions, which would permanently seal the litigation route and leave only an act of Congress; So if SCOTUS had seen no hope for repeal, then simply shelving (denying certiorari) would have been enough to kill sports betting hopes for years, if not decades; these factors are well known to the Court.

The backdrop has been set for a significant upheaval in sports wagering in the US, which some estimate is a market as large as $400B.

We think the table has been set for repeal. We base this on the combination of facts and inferences previously mentioned. The plaintiffs are corrupted (they own gaming businesses) and states are lining up to legalize, which has included several public state referendums, meaning that there is public support for legalized sports betting. And, since 1992, terrestrial gaming has proliferated throughout the United States and is widely regulated and accepted (PASPA was created against an entirely different regulatory outlook where gambling was not yet widespread). SCOTUS accepted Christie II knowing the stakes. If there was a need for PASPA its time has long past. To differentiate sports betting from traditional casino wagering is absurd, since both are internationally regulated in most jurisdictions under the same umbrellas.

SCOTUS is going to repeal.

IMPLICATIONS FOR EUROPEAN ONLINE GAMING COMPANIES

We see two major investment paths for investors in European online gaming companies and argue that the time to begin acquiring these businesses is now in anticipation of a PASPA repeal.

US B2B Operations

Their first business development path will be in providing existing US Stakeholders with B2B betting platforms. Current legislation throughout the US envisions that existing US stakeholders (state gambling licenses) will be granted extension licenses to operate sports books under their current gambling licenses. This means that most European operators will mainly be shut out of B2C operations since they have long focused on international expansion outside the US and US stakeholders will primarily be current terrestrial gambling establishments. However, while European players are mostly not stakeholders, they will be able to provide B2B services to US stakeholders that don’t currently have, or are financially unwilling to build a sports book, which include smaller tribal casinos, card rooms in California, and race tracks (we expect major Indian Casinos like Foxwoods to operate their own sports books, but they may enter into short-term arrangements before leaping to their own operations). Once PASPA is legalized, the competition will be fierce to acquire partnerships within the US among operators. Moreover, while we believe that Internet will be an option, we anticipate that walkup betting, with in-person sign-ups will be the initial path most, if not all, states will legislate. We base this on how telephone betting was previously handled at racetracks, all of which required in-person walk-ups. Moreover, the states will need to guarantee that betters are not betting from out of state (since this would be a violation of the Wire Act), so in person sign-ups will create a necessary KYC process to ensure that betters where at least resident or located in state at signup and are the authorized account holders. Once registered, IP blocking and other technologies can be utilized to ensure in-state compliance.

While many of the major European online gaming companies have some exposure to the US, only William Hill PLC (“William Hill”) is an existing US Stakeholder with its Nevada operations controlling over 60% of that market. In fact, it was William Hill that won the contract to operate Mammoth Park had/when New Jersey won/wins its case. While Paddy Power Betfair PLC (“Paddy”) and GVC PLC (“GVC/BWIN”) have operations in the US, their exposure to sports betting is legally non-existent within the US market (they have however other gaming interests mostly in New Jersey). Paddy also owns the TVG network (horse racing), which is currently the only interstate online gambling operation legally allowed due to horse racings carve out from the Wire Act; but it seems unlikely TVG will benefit directly from the legalization of sports betting since it’s not a stakeholder. Within the US, while some major US casinos operate their own sports books, none of them currently offer B2B services, leaving this market wide open to European operators.

William Hill currently earns only about +£14M from its US operations, and without a doubt, this company is poised to see significant revenue growth from the US, which could surpass its revenue from all other sources over the next 5 years past a PASPA repeal. Perhaps this is the reason that Parvus William Hill’s largest owner, has killed two deals to sell the company which clearly didn't meet expectations of value. We have run the numbers and to get “value” out of William Hill that we believe Parvus expects, you have to set a high multiple for the US business. We now generally agree with such an assessment; William Hill is a strong buy (although that doesn't make it a good merger partner for GVC), despite other UK centric issues discussed further in this paper which are really distractions to the bigger potential William Hill is exposed to in the US. Ladbrokes PLC (“Ladbrokes”) and Paddy should also benefit, because they have strong brands combined with existing POS systems in place to service the US market; they will likely pick up business that is in direct competition to William Hill. GVC/BWIN is a wild card, as it has no current experience operating POS systems, but we feel that this should not be an obstacle because its internet BWIN based B2B operations are industry leaders. Developing a modern POS system add-on might ultimately give GVC/BWIN an advantage over both Paddy and Ladbrokes should it aggressively target the US market and not get distracted by other acquisitions in Europe which could delay its US entry. As a result, all the major public European operators should be able to take a piece of the US market, depending on how each approach the problem strategically; however, William Hill is significantly better positioned than the rest of the field.

Acquisition Targets

US terrestrial gaming operators are specialized real estate operators. Notwithstanding, they are all seeking growth opportunities and the advent of legalized US sports will result in a significant opportunity. Terrestrial operators have long shied away from their European Internet brethren for several reasons, including the fact that they view some of these operators as risks to their current gaming licenses in Nevada, the rest of the US, and Asia. However, legalization will require Ladbrokes, GVC/BWIN, and Paddy to gain nationwide licenses thus legitimizing their businesses among the major regulators. Even the largest European operator by market capitalization, Paddy Power is only a $7.5B US company; whereas MGM currently stands at nearly $20B. Other possible targets from US operators include 888 PLC (less likely due to grey market exposure and regulatory issues) and Sportradar AG (privately held data feed and B2B provider). The list of interested parties is significant and could range from a small operator like Penn National (which itself could become a target of European operators) to IGT, or even Las Vegas Sands Corp (valued at over $50B) despite how unlikely that may seem now. We think a repeal of PASPA will lead to a new wave of merger and acquisition activity involving the major European players and US terrestrial casinos or slot machine makers; some from US interests looking for new footholds and others from European interests looking for a way out of their current position and into ready-made operations based in the US. Licensing concerns were always one of the issues that forestalled these investments, but once this group gets licensed within the US, that should clear the path.

UK Specific Issues Impacting UK based Operators Share Prices

Despite our bullishness, the share prices of Ladbrokes and William Hill have suffered in 2017. The reason for this partially relates to a pending review of a specific type of gaming machines found in their betting shops which industry groups claim result in significant problem gambling. Currently, these machines allow betters to lose some £100 every 20 seconds, but industry groups are proposing cutting it to £2, which would have a rather dramatic impact on the revenue of the major UK operators (Ladbrokes, William Hill, and Paddy Power Betfair). The consensus is that a cut will occur, but it will be reduced to around £50; the earning impacts will be significant, but manageable. We think that the current market prices reflect the risk of something less than £50, perhaps something closer to £40, but we believe that even £30 wouldn't cause too much damage to current share prices. A decision is expected before the end of the year.

If it were not for this issue, then the positive news from the US would certainly be adding value to their shares now, especially in the case of William Hill.

Ladbrokes has other issues that are a distraction, including a desire to sell itself. It was once a major racetrack owner in the US, only to sell out before the gaming boom arrived; management has failed over a decade (despite different CEOs and two mergers) to reinvigorate the business. While its merger with Coral appears to be going smoothly, Ladbrokes faces a decade where the total number of betting shops in the UK will diminish, with uncertainty in its ability to re-capture all of those offline players back onto its growing internet platform (not growing fast enough to replace lost future retail players). Nor is the debt load it inherited from the Gala acquisition helpful something unusual among the public gaming enterprises (Amaya is the only other operator with this much financial leverage which will eventually need repayment). No wonder they want to sell. As a result, despite its brand and size, we are somewhat skeptical the current Ladbrokes will be able to compete as effectively in the US market as William Hill, Paddy or potentially GVC/BWIN (via BWIN). Especially if it manages to effectuate a merger in 2017/2018 with another European operator which would certainly result in a major distraction at a key moment in history.

Summary

Several European gaming operators offer a unique event opportunity that has a catalyst arriving in the next 12 months. We think that the timing is perfect to be investing in William Hill and GVC/BWIN (who has no exposure to the betting machine controversy). We like 888 PLC, too, but we think it's less likely to be a US target so the bull case for 888 PLC is for another discussion. The issue with Ladbrokes is that while their brand would likely be well received in the US and they have existing retail experience, they are also the most exposed to the betting machine issue and have a distracted management looking for a buyout partner, lots of debt and many other internal challenges; hence we think Ladbrokes is not as well positioned as other competitors. We think Paddy is also a good buy and will do well in the US market.

William Hill is the most leveraged to the US, while GVC/BWIN represents the best acquisition target for a US operator, with Paddy right behind William Hill for its access potential. Additionally, GVC/BWIN’s lack of a retail experience could end up being a positive, allowing them the opportunity to “reinvent” the POS system with something new. Either way, GVC/BWIN is a wild card that has several possible positive outcomes should it gain even a small foothold in the US or be acquired by a US operator. Although our assumptions for GVC/BWIN are somewhat based on the guess that BWIN will pursue a business development strategy in the US, given it could itself become an acquisition target that may not be necessary for a buyer to extract value 12–18 months out.

We think the event mechanics will begin impacting these equities as soon as SCOTUS oral arguments begin in the coming months; and, as speculation builds into the spring (2018). At that point, William Hill, then past the betting machine controversy, will be gradually climbing higher in anticipation of a PASPA repeal. Whether GVC/BWIN is impacted will depend on perceptions in the market, but we think other analysts will publicly come to the same conclusions we have, that a PASPA repeal will at the very least make GVC/BWIN an acquisition target unless itself expands into the US through business development.
William Hill and GVC are strong buys with Paddy Power a Buy. We rate Ladbrokes a hold and do not expect them to be a major winner in the US market even if they may pick up some business over time.
Notes: the author has equity positions in William Hill and GVC

Footnotes:
https://en.wikipedia.org/wiki/Unlawful_Internet_Gambling_Enforcement_Act_of_2006 [Accessed 9 Sep. 2017].
https://en.wikipedia.org/wiki/Unlawful_Internet_Gambling_Enforcement_Act_of_2006 [Accessed 9 Sep. 2017].
https://en.wikipedia.org/wiki/Federal_Wire_Act [Accessed 9 Sep. 2017].
https://en.wikipedia.org/wiki/Tenth_Amendment_to_the_United_States_Constitution [Accessed 9 Sep. 2017]
http://www.scotusblog.com/2017/08/10th-amendment-anti-commandeering-sports-betting-plain-english/