If you happened to step into gaming stocks like Zynga (ZNGA), Caesars Entertainment (CZR) or Boyd Gaming (BYD) in 2013 after a handful of states finally legalized online poker — a couple of years after the U.S. government finally lifted its ban on Internet-based poker (played for real money) — the past year or so has been surprisingly disappointing.
Although a small number of states — three so far, to be precise — have legalized online gambling via sites like PokerStars or Full Tilt, the online poker industry has fallen alarmingly short of initial revenue expectations.
Indeed, the tepid response to online gambling thus far is leaving some investors to wonder when, or even if, gaming stocks will ever benefit from digital betting.
If you’re one of those investors, you might not want to hold your breath.
State of the Online Gambling Market
While online gambling may be legal in Nevada, Delaware and New Jersey, that doesn’t mean it’s popular. Nevada’s Internet poker tables aren’t even driving $1 million in monthly revenue yet. Delaware has yet to see a six-figure revenue total in any month since launching online poker in November, although other online gambling options for Delaware have pushed the state’s Internet casino revenue up to near the quarter-million dollar mark as of April. New Jersey has found the most success so far, but even its success has been muted at about $10 million per month in online gambling revenue, as of March.
It’s not the billions that onlookers were expecting for their gaming stocks before online poker became legal. But there is a game-changer on the horizon.
Last week, Canadian gaming equipment maker Amaya Gaming (AMYGF) agreed to buy PokerStars Inc. and its Full Tilt division to the tune of $4.9 billion. The union of Amaya and PokerStars doesn’t create anything magical, but it removes the reason PokerStars has thus far been unable to break into the U.S. online gambling market: owner Isai Scheinberg.
In 2006, the U.S. government finally took a definitive stance against online gambling by enacting the Unlawful Internet Gambling Enforcement Act. By that time, PokerStars had already developed some serious U.S. market share, and even after it became technically illegal, PokerStars continued to operate in the U.S. Although the Department of Justice has since undone the ban, the company still had to settle on money-laundering charges under Scheinberg, and the owner still is the subject of semi-related indictments, and PokerStars won’t likely be granted a gaming license as long as it’s linked to Scheinberg.
With Scheinberg out of the picture, some say PokerStars will be able to leverage its good global name and quickly develop the U.S. market.
Don’t Hold Your Breath, Though
While the introduction of PokerStars and Full Tilt could arguably accelerate the entire online gambling movement in the United States, owners of gaming stocks with a chip in the game might want to prepare for a long wait to see a payday.
The impasse is a lack of scale — neither Nevada nor Delaware have enough players at any given time to make for an attractive, cash-liquid game; New Jersey’s pools aren’t exactly ideal, either. It’s admittedly a catch-22, but players don’t care. Until enough games are big enough to make them worth playing, would-be bettors are steering clear.
Nevada and Delaware partially solved the problem in February by starting to share player pools, but it remains to be seen if there’s going to be any noticeable improvement in revenue; doubters remain plentiful. And even if Delaware and Nevada jointly make a dent in their online gambling struggles, most states will need to legalize Internet poker — and develop pool-sharing partnerships — for the industry in the U.S. to ever reach the $3.5 billion in revenue that Morgan Stanley now projects by 2017.
As for why more states aren’t getting behind the idea — only 10 more are seriously considering it — the related tax revenue to date for Nevada, New Jersey and Delaware has hardly been worth it. New Jersey taxes online gambling revenue at 15%, yet has only collected a few million dollars in tax revenue year-to-date. Higher tax rates would seemingly drive more tax revenue, but rates like the 20% tax that Pennsylvania is mulling for online poker also might prevent a casino from setting up shop there in the first place.
A “too much headache for not enough revenue” mentality is starting to get traction.
Never even mind the fact that most state legislatures remain altogether disinterested.
A Potential Catalyst for Gaming Stocks
With all of that being said, if there’s one state that could prove online gambling is worth the trouble and simultaneously provide a boost for gaming stocks like Caesars Entertainment or technology providers like Zynga, it’s California.
The state’s populace of 38 million might well be big enough to create betting pools big enough to draw a crowd, and the state’s government is close to legalizing Internet poker. Some solid tax revenue there could motivate other states to not only allow it, but actually support it as a way of beefing up state coffers.
Throw in the fact that PokerStars and/or Full Tilt will also finally be unchained and allowed to develop the market here the way they have overseas (PokerStars controls more than half of the global online poker market), and there might be enough revenue potential on the table to make it a bet worth lawmakers making.
Even so, with the political will and social support of online gambling varying widely from state to state — and laws sometimes taking years to enact — owners of gaming stocks hoping for a payoff anytime soon might want to rethink just how long they’re willing to wait.
It’s likely going to take years before the industry to start taking a meaningful rake.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.