A Breath of Fresh Air for the Gaming Space

 | Mar 22, 2013 | 2:50 PM EDT
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Amid the NCAA college basketball tournament, and the "March Madness" bracket contests, it seems a worthy moment for an online-gaming update.

Congress banned the practice in 2006, using the 1961 Federal Wire Act to block related financial transactions via banks and other intermediaries. This has allowed for inter-office or even nationwide March Madness wagers, so long as no money officially changes hands. So far, the law's authors feel it has worked well, and an intense twirl of political and business interests -- including casinos, Native American tribes and religious conservatives -- will block any effort to repeal the ban anytime soon.

Nevertheless, odds are pretty good for more modest legislation to come through within the next six months to a year. That's because of a landmark 2011 Justice Department ruling -- which held the Wire Act was only meant to apply to sports betting -- as many believe it is about to break open the floodgates regarding Internet gambling. So far, it has cleared the way for Delaware, New Jersey and Nevada to pass laws allowing Internet casino-like gaming, largely as a means of raising revenue. Meanwhile, an even more explosive buy-in could involve online state-lottery sales.

The responsive legislation would formally legalize online poker, though it would include new bans on intrastate sports gambling, games of chance and even lotteries. This clarifying result has at least some potential as a net positive catalyst, although it may ultimately prove a mixed bag: Both onliners and casino companies may have to give up some of the gains expected from this Wild West environment that's recently emerged.

Meanwhile, the situation in Congress remains complex, given more or less bipartisan support for the online-gambling ban. A bill to blanket-legalize online gambling, for instance, failed to move in 2010. The casino interests, for their part, support legalization only of limited online gaming as they continue to view the state lotteries warily. Another element here: Online poker advocates have somehow achieved a perceived separate status and tolerance, perhaps due to the broad popularity of the game and aggressive lobbying by its supporters.

As a result, instead of a potential repeal of the ban, the discussion is moving toward a bill that would legalize intrastate online poker while specifically reinforcing an online betting ban for sports and games of chance. The fate of online state lotteries would remain up in the air. This was at the heart of the bill from Harry Reid (D-Nev.) and Jon Kyl (R-Ariz.) in the last Congress, although that legislation was never finalized.

Investment Implications

An obvious question is: Why would online-gaming companies benefit from a bill that prescribes but constricts legal online gambling opportunities in the U.S.? The answer is that these companies would still face possible legal exposure that the Obama Administration or a successor could begin to enforce almost at whim. A Ried-Kyl-type bill could help to remove that. Passage of such a clean-up bill would at least clarify where the companies could legally profit (i.e., online poker) while guarding against strategic breakout from competitors. Same goes for the casinos, as they could also forge strategic relationships in individual states.

So what are the potential investment plays? Per savvy Wall Street analysts, among the major casino operators it's Caesars (CZR) and MGM (MGM). Not only could their shrinking dependence on Asian earnings make online gaming a more differentiated driver, but both firms have significant market share in New Jersey --  one of the three states that have passed legislation allowing casinos to run gaming websites with blackjack, slots and poker, among others.

If Washington doesn't hinder the rush to online gambling after all, that could give a leg up to Caesars and MGM, among other early industry winners there. Of course, it could also mean that analysts might have to work back their positive assumptions regarding the meaning of the New Jersey legislation, should a re-regulation bill pass.

Meanwhile, I'm told that -- due to the hurdles for success in the business -- partnerships are evolving wherein the European operators bring technology and expertise, and local/U.S. operators provide license, capital and brand. This may position already-formed partnerships involving Boyd Gaming (BYD), MGM, and United Auburn (called bwin.party) and Caesars, Williams Industries (WMS) and Avenue Capital (collectively, 888). Others potentially include William Hill, Paddy Power and Betfair.

Finally, among cash processers and lottery/machine suppliers, Global Cash Access (GCA), International Game Technology (IGT), Gtech, Scientific Games (SGMS) and Bally (BYI) all deserve a look.

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