G2E: The State of Online Gaming, 2013

"We're moving on, with or without you."
-- A.G. Burnett, Chairman, Nevada Gaming Control Board

Last week, the gaming industry convened at the annual Global Gaming Expo, or G2E, in Las Vegas. While the gaming industry as a whole remains strongly in favor of having some set of regulations regarding online poker at the federal level, the reality has sunk in that nothing is likely to happen on the federal level any time in the foreseeable future -- if ever.

Every year since the passing of the Unlawful Internet Gaming Enforcement Act of 2006, or UIGEA, the online gaming discussion at G2E had always begun with a discussion of various bills. This year was different, with virtually zero discussion of prospective federal legislation. The general sentiment is that online gaming is a backburner issue in Congress (government shutdown aside), while the only relevant bills at the moment -- an online poker-only bill sponsored by Rep. Peter King (D-N.Y.), and another by Sen. Joe Barton (R-Texas) -- are not viewed as being realistic.

Moreover, in a conference session entitled "Momentum: Is It Building for State-by-State Regulation in the U.S.?", James Kilsby of Gambling Compliance Ltd. described any conversations taking place in Washington as having a "prohibitionist tone."

Nevertheless, legal, licensed, and regulated online gaming in the U.S. is now a reality, and moving forward rapidly on a state-by-state basis. In the past year, Nevada, New Jersey, and Delaware have all passed legislation legalizing online gaming, and are either live or close to it.

State-by-state momentum: Nevada, Delaware, New Jersey, and beyond
On April 30, Station Casinoslaunched Ultimate Poker in Nevada, becoming the first legal, real-money online poker room in America. On Sept. 19, Caesars Entertainment became Nevada's second online poker room operator with the launch of WSOP.com, using software supplied by 888 Holdings.Three more competitors are slated to come online in Nevada at some point later this year: Wynn Resorts and Treasure Island -- which will both be skins on the All American Poker Network, or AAPN, a joint venture between 888 Holdings and Avenue Capital Group -- as well as South Point Gaming's Real Gaming site.

In August, Delaware's three casinos began offering a full suite of play-money casino games, including blackjack, roulette, slots, and poker. The three casinos -- whose online sites serve as skins for the Delaware Lottery -- are expected to begin taking real wagers in late October, with a joint partnership of 888 and Scientific Games providing the technology.

New Jersey is on track to have full-scale online casinos up and running by Nov. 26. Meanwhile, several other states -- including California, Illinois, and Massachusetts -- are in various stages in the consideration of online gaming legislation as well.

Patchwork: The passing window for federal legislation
As the first states come online, the challenges to any federal legislation are already apparent. Right from the get-go, we already have three states with three different sets of regulations.

In Nevada, only poker is legal online, whereas New Jersey and Delaware will have full-scale online casinos. In Nevada and New Jersey, an online operator must have a brick-and-mortar presence, while in Delaware the three casinos' online sites are merely skins for the state-owned lottery. And apparently even the brick-and-mortar rules aren't cut-and-dried: In New Jersey, Wynn Resorts -- which doesn't even own a casino in New Jersey -- will be able to satisfy the requirement simply by keeping hardware in a Caesars Entertainment-owned casino.

Meanwhile, whereas PokerStars (and other companies who stayed in the U.S. market following UIGEA) is being excluded from operating in Nevada due to a "bad actor" clause, no such clause exists in New Jersey, where the company has secured a potential entry point as a supplier to Resorts Casino Hotel's online gaming operation. The company also plans to build a $10 million poker room at Resorts as part of the partnership, and is offering to set up its North American headquarters in New Jersey if its licensure is approved.

Moving forward, it doesn't get any less complicated, as different states bring different sets of challenges. In California, for example, any online gaming legislation must contend with the presence of existing tribal compacts. In Maryland, the Maryland Lottery must convince over 4,400 lottery retailers in the state that selling lottery tickets online won't hurt their businesses, which is an argument that can't be made. And states like Hawaii, Texas, and Georgia have neither legal casinos nor legal card rooms.

And that's before we even get to issues such as how tax revenues would be distributed among states. Do you tax deposits (no)? Do you attribute revenue at the point of supply (where the supplier is located, which is less likely), or at the point of consumption (where the player who contributed the revenue is located, which is more likely)? And if you attribute revenue at the point of consumption, which method do you use (for any given hand of online poker, there are no less than three different methods of attributing rake to the various players at the table, which would yield three different results for attributing revenue by player location)?

In addition, California's live poker rooms take a flat rake from each pot (rather than taking a percentage of the pot as rake with a cap, as is mostly standard practice), and as such rake differently than anywhere else in the known universe. If you're Nevada and you desperately want to do business with California, are you going to tell California that they're doing it wrong?

That said, we are at a point where the technical issues regarding even potential interstate compacts are becoming more complex, while the probability of federal legislation is rapidly approaching zero.

On the latter subject, MGM Resorts International spokesman Alan Feldman labeled the closing window for federal legislation a "tragic, wasted opportunity."

The better question: Why is federal legislation even important? And to whom?
The fact of the matter is that from 2007 to 2012, the reason the AGA pushed specifically for poker-only legislation at the federal level was because poker as a skill game presented the most realistic opportunity at a one-shot job of passing online gaming legislation in the U.S. among the states that wanted it, eventually making online casino games a formality. But as it stands in 2013, online gaming is now legal in three states, and two out of the first three states to pass online gaming legislation have bypassed the poker-only foreplay and gone straight to full-scale online casino gaming.

And so the better question at this point is why federal legislation is even important, and to whom it is important.

In a Sept.19 special to the Las Vegas Review-Journal entitled "Policymakers Must Get On Board With Online Gambling," new American Gaming Association (AGA) president and CEO Geoff Freeman first noted that -- according to H2 Gambling Capital -- Americans spent $2.6 billion gambling on unregulated sites online in 2012, representing "nearly 10 percent" of the $33 billion global online gaming industry (my calculator says under 8 percent). Freeman then cited the three main reasons the AGA "has long encouraged Congress to pass legislation":

  1. "To establish federal minimum standards that address consumer protection; prevent underage gambling; promote responsible gaming; and provide help for those with gambling problems."

  2. To provide a framework to allow Native American casino operators -- "who will never agree to be regulated by the states" -- to get involved, and

  3. To "clarify and restore federal law" in order to give federal law enforcement agencies the tools to keep illegal gambling operators out of the U.S. market.

For those who have read the article or have been following the AGA over the past month or two, we'll ignore for the moment the part where the AGA is using the new movie Runner, Runner starring Ben Affleck and Justin Timberlake as a cautionary tale, as using a universally panned, overdramatized fiction is clearly overselling the point. But the thing you'll notice about these points is that they are merely arguments for, and are not the "why" the AGA has pushed for federal legislation.

The first point -- or rather, set of points -- addressing consumer protection, age verification, and problem gambling is the biggest point; but it is also a moot point as individual states come online and address these issues themselves. As it is, every state with casino gaming is already set up to address these issues from a brick-and-mortar standpoint, and will be set up to do so when they go online as well.

On the second point, the AGA doesn't actually care whether Native American tribes have a framework to get involved, because the AGA doesn't represent the Native American tribes -- the AGA represents the interests of the commercial gaming industry, including casino operators such as Caesars Entertainment, MGM Resorts International, and Las Vegas Sands, as well as virtually every other casino operator and gaming equipment manufacturer in America other than Wynn Resorts.

And while strengthening the ability of law enforcement agencies to keep unlicensed operators out of the U.S. markets is a legitimate issue, it's also a secondary concern to, you know, getting online gaming legalized to begin with.

It's interesting to note that nowhere in Freeman's piece does he argue for the rights of Americans to gamble online. Because at this stage, regulated online gaming in America is both (a) happening now in Nevada, Delaware, and New Jersey and (b) virtually a foregone conclusion at least in principal in states that already have casino gambling.

And though Freeman does mention poker specifically, nowhere does Freeman mention the terms "pooled" or "shared liquidity."

Online poker and pooled liquidity
Though the April 30 launch of Ultimate Poker in Nevada was a landmark event for online poker in the U.S., the bigger deal for most poker players was supposed to be the Sept. 19 launch of Caesars' WSOP.com, a site which would offer better game selection (WSOP.com offered various forms of Omaha and stud poker games at launch, while Ultimate Poker launched only with hold'em, with many of the no-limit cash games having only 50BB-max buy-ins) and better software. But as it turned out, the launch of WSOP.com was such a big deal that many Las Vegas-based pros of various levels weren't even in Nevada for the launch week -- or the week after that, either.

Instead, many Las Vegas-based pros were down in Mexico playing poker -- online -- and participating in PokerStars' World Championship of Online Poker, or WCOOP, a series of 66 tournaments with buy-ins ranging from $109 to $10,300 that ran from Sept. 8 through Sept. 29. The number of entrants for these events ranged from 61 for a $10,300 buy-in NLHE (no-limit hold'em) heads-up tournament to a whopping 11,381 for a $215 buy-in NLHE event, and 1st place in the $5,200 NLHE Main Event paid $1.5 million to a German guy named PlayinWasted.

There is very little risk of anything on that scale happening in Nevada any time soon.

As everybody knows by now, the challenge for a less populous state like Nevada is simply getting enough people to play even just to get various games to run at various stakes. The more players any given site has, the wider the range of games and stakes the site can offer, and the more attractive the site will be. The problem is that the player pool in Nevada is thin by default, and will only be stretched thinner as more competitors enter the market.

That said, as we discussed this time last year, the attraction of federal legislation with regard to online poker specifically is the concept of pooled liquidity -- that is, combining player pools across states in order to create larger player pools, leading to bigger tournaments and better cash game selection, making online poker in general far more attractive to the consumer.

And there are really two main groups of constituents who stand to gain the most from pooled liquidity:

  1. Poker players, for reasons just explained, and

  2. Casino operators with large, national brick-and-mortar networks, namely Caesars Entertainment and the MGM Resorts/Boyd Gaming /bwin.party online joint venture.

Now nobody really knows at this point what the rules for online poker room operators would be either under federal legislation or various interstate compacts. For example, would an operator have to have a brick-and-mortar casino property in every state it wants to operate online in? Or would PokerStars be allowed to operate in markets outside of New Jersey (assuming it's allowed into New Jersey to begin with)?

Regardless, the operators with the biggest advantages will likely be the ones with the best brands and the biggest reach, which would be Caesars with its WSOP brand and the largest, most geographically diverse network of casinos in the U.S.; and MGM/Boyd/bwin.party, which has a collection of strong brands at its disposal (including the World Poker Tour, which bwin.party owns) and a similar combined reach as Caesars.

Consequently, Caesars and MGM/Boyd/bwin.party would be the two most likely companies to generate network effects and ultimately achieve PokerStars-like or Full Tilt-like (pre-July 2011) market shares, while leaving everybody else in the dust. You might recall this chart from bwin.party's 2012 First Half Results investor presentation:

I wouldn't rule out other major competitors emerging, especially since other viable partnerships may have yet to form. As more states come online, 888 Holdings' All American Poker Network in particular looks to be a serious challenger, and could be an attractive fit for dominant regional casino operators such as Pinnacle Entertainment -- which recently doubled in size with the acquisition of Ameristar Casinos -- and/or Penn National Gaming, neither of which companies has yet stated intentions regarding online gaming.

But there are really two points to be made here:

  1. Liquidity is the critical issue impacting the viability of online poker. And for poker players and online poker room operators, liquidity is both the main potential benefit of federal legislation for online poker and the biggest risk of the current path of state-by-state legalization.

  2. A few big players stand to gain much more from federal legislation and the resulting pooled liquidity than everybody else.

It's important first to note that the concept of pooled liquidity is a poker-only thing, and does not apply to casino games, because you don't need other players to play blackjack or craps against the casino.

That said, if you are an independent casino like South Point with a poker-only site based in Nevada, you are going to be at a major disadvantage in a federally regulated environment where your competitors have the benefit of reach into other markets. As such, you really don't care if poker gets legalized and regulated at the federal level -- in fact, you'd probably rather that didn't happen.

Alternatively, if you are the Tropicana Atlantic City (with technology supplied by Gamesys) or Landry'sGolden Nugget Atlantic City with technology supplied by Bally Technologies, you know you are probably not going to be competitive in the online poker space anyway. On the other hand, you are probably satisfied that you have online casino gaming to offer, and so you are pretty much indifferent to the prospect of federal online poker legislation as well.

Ultimately, whether federal legislation occurs or not is almost inconsequential to the smaller players, as the online poker operations of many of the smaller operators are bound to wind up either being consolidated into larger poker networks, such as 888's All American Poker Network, or otherwise being folded altogether almost regardless.

A game of many interests
As the AGA says, online gaming is here, and it's happening. The downside is that the issues surrounding it are becoming more complex by the state.

This is a game of many interests. These interests are often in conflict, as when states such as California must deal with the Native American casino operators, or when states such as Maryland must deal with lottery retailers. In many cases there is aligned conflict, such as when casino operators are aligned in that they want to get gaming legalized in a new jurisdiction, but then must compete for a limited number of licenses once legislation is passed; or when both PokerStars and the AGA both want online gaming legalized, but the AGA does not want PokerStars to be in the U.S. at all.

But even interests that are aligned may not be squarely aligned, such as when a few operators -- namely Caesars Entertainment and the MGM/Boyd Gaming/bwin.party partnership, as well as possibly 888 Holding's AAPN with Wynn, Treasure Island, and other potential partners -- stand to gain far more from federal legislation of online poker than anyone else.

While nobody in the industry seems to really be against the idea of federal online poker legislation, the forces for it also seem to be getting weaker by the state. Obviously, a big part of that is the current political climate in Washington, which makes any hope for it futile at the moment. But the other big part of it is that as more states come online, the interests of the various parties are becoming less and less aligned squarely on federal online poker legislation.

Professional poker players are often called upon to represent the interests of poker players in various panel discussions, but the truth is that nobody outside of poker -- not even the casino operators -- actually care what professional poker players want.

The reality is that in the online gaming legislation game, the professional poker player is an externality, and not a protected species. While the gaming industry and much of the rest of America seem to accept the fact that professional poker players exist, there aren't many people outside of poker who see it as a job that needs to be protected.

As I said earlier, from 2007 to 2012, the AGA (representing, for the most part, the whole commercial gaming industry) strongly supported at least the idea of online poker-only federal legislation. During this period, the interests of the gaming industry were squarely aligned with the interests of poker players, and that of Caesars and MGM/Boyd/bwin.party, etc. But this had nothing to do with the right of Americans to play poker online (or make a living at it), and everything to do with the presumption that poker presented the most realistic chance at one-shot federal legislation.

Now in 2013, Nevada, Delaware, and New Jersey have all moved ahead on their own. While Nevada is poker-only at the moment, Delaware and New Jersey both have bypassed the poker-only stage and moved directly to full-scale online casino gaming, and in essence have what they want. So while the AGA still supports the concept of federal poker-only legislation in theory, it is a concept that is quickly becoming obsolete as more states skip directly to full-scale online casino gaming, and instead pursue interstate compacts to solve any liquidity issues.

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The article G2E: The State of Online Gaming, 2013 originally appeared on Fool.com.

Fool contributor Jeff Hwang is a gaming industry consultant and the best-selling author of Pot-Limit Omaha Poker: The Big Play Strategy and the three-volume Advanced Pot-Limit Omaha series. Jeff owns shares of Wynn Resorts, MGM Resorts International, and Las Vegas Sands. You can follow Jeff on Twitter @RivalSchoolX.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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