Casting on the Net

Online gambling businesses are extremely profitable," says Bear Stearns & Co. analyst Jason Ader. "Those operators who submit financial reports show net income margins of 65 percent …."

A report from Christiansen Capital Advisors finds cash-flow margins of 80 percent at some online casino companies, with net-income margins running to 60 percent. "No land-based gambling business we have seen can come close to that," the report adds.

Are these online operators U.S. companies? Some are, the ones that have engineered ways to get into the new field without violating present or pending U.S. laws being used to stymie online gaming. That often means going offshore to join or base operations in foreign countries. The companies' names aren't necessarily household words, but they are gaining "respectability" through association with recognized public and business figures, whether it's performer Kenny Rogers or MGM Grand chairman Terrence Lanni, who was elected a director of the Youbet.com horse-betting firm last month.

In fact, some 250 companies now run at least 650 Internet gambling Web sites around the world, according to Bear Stearns' January report, "E-Gaming-Endangered Species or Rising Star?" While the number of sites seems to grow daily, "the industry is still in its infancy, and there is ample room for growth."

"Internationally, we're seeing tremendous growth in the online gaming industry, and the biggest winners so far are the brick-and-mortars," or established land-based casinos that open online operations, says Richard Iamunno, CEO of Online Entertainment Systems, speaking at last month's American Gaming, Lodging and Leisure Summit in Las Vegas. "We see that in Australia, South Africa and Europe."

To Ader, "It is clear that the dynamics are there for this industry to succeed. People are spending more time on line, they are becoming more comfortable with e-commerce and they love games of chance. Just look at the recent success of TV shows like 'Who Wants to be a Millionaire' and 'Greed.' It is clear games of chance with the potential for big payoffs attract a huge audience."

Among other conclusions reached by Ader and his colleagues, based on his firm's research of online gaming operations and the business, legal and social conditions surrounding them:

• U.S. Sen. Jon Kyl's Internet Gambling Prohibition Act can do little to prevent online gaming because it exempts many forms. "We believe it will not be passed into law."
• Opening an online casino is, as proponents were predicting a couple of years ago, relatively inexpensive.
• Bingo is the logical, cheap and easy place to start offering online wagering.
• Marketing, including buying "shelf space" on such portals as Yahoo!, will continue to be an increasing cost. Joint efforts with recognized names are likely to pay off, though.
• New payment systems under development can make online gambling safer and more secure, a feature bound to attract more players.

'Explosive'

Those are among the reasons Ader and his colleagues "believe that any future industry that is comprised of both the Internet and gambling is going to be explosive."

From 1998 through 1999, Internet wagering increased 80 percent, to an estimated $1.2 billion, Bear Stearns says. "At the current growth rate of the online gambling industry, we estimate that total wagers could exceed $3 billion by 2002."

The report from Christiansen Capital, a New York business research firm specializing in entertainment and gaming, says "Internet gambling sites are blooming like flowers in the spring and, although the earth that supports these sites is not very firm, seeds are being planted in more stable (and fertile) places like Australia."

The $2,495 report, "E-Gambling: Wagering on the Internet," was prepared in concert with The River City Group (www.rivercitygroup.com). It listed 47 nations that in some way sanctioned online gambling when the report was completed last September. By January, the number had climbed to 55, says River City president Sue Schneider.

In general, however, gaining paying players can be a tough act for virtual casinos, just like other Internet businesses. One recent study points out that the "free" nature of the Internet lingers on among many experienced users. The Internet originated as a means of transferring military defense information in emergencies, then evolved for information exchange among scientists and academics. There was no charge; the Internet was not created for marketing, sales and other business.

In that atmosphere, most virtual casino visitors play only the free, "play money" games available, the report says. A large percentage of those who do play bet only a few dollars at a time.

One likely factor in their decisions: While they are comfortable with using computers, spending big money is still an unknown, and they have yet to develop trust with an online casino. There is no Caesars Palace or other major "brand name" out there yet. "Lack of trust and security issues will continue to be the leading inhibitors of online gambling," the Christiansen report says.

Gaining early players' trust and getting more of them to gamble and make larger bets--as well as attracting more players in the first place--will be a matter of marketing for firms that go into the business.

The techniques are nothing very new to traditional casinos. If any of those does go into Internet gaming, Christiansen points out, it will arrive under the favorable aspect of its established name: "Internet gamblers will gravitate to recognized and trusted brand names. Traditional gambling or nongambling businesses with an established brand have a key advantage when they go on line."

From there, ways of reaching and keeping players include using customer databases, cross-marketing the bricks-and-mortar casino with the electronic version, providing "second-to-none" service, and providing the mix of "product" information Amazon.com uses to provoke sales of more books and related items on line. Efforts might even include mailing out software CDs to potential players, the approach that put America Online on its way to gaining 22 million customers.

Even so, Christiansen recommends using traditional media at least as much as the Internet to advertise a gaming site. Consumers still trust printed matter they can hold in their hands and refer to suggest a company's substance. And for "newbies"--beginning Internet users--traditional ads are often the starting point for learning about the Web sites most U.S. companies now keep. "Savvy e-gambling operators will work at becoming a starting point for the novice gambler and capitalize on this opportunity for capturing consumer loyalty."

No Warehouses Needed

Online casino operators will need marketing to differentiate themselves, too, since most online casinos offer the same kinds of games that run on the same basic software. And, while software makers do have to deal with manufacturing factors such as production, warehousing and shipping, virtual casinos have few such impediments to the profitability analysts enthuse about: There is no product to acquire or manufacture, store, inventory and ship.

Some companies Bear Stearns lists as companies to watch now that they are entrenched in the "second-generation" online gaming business run online casinos. Some make online gambling software. One, Youbet.com. is a horse-betting service.

The others in Bear Stearns' report: Total Entertainment Inc. in Quebec; GIC Global Intertainment Corp.; American Wagering Inc. in Las Vegas; Venture Catalyst Inc. (formerly Inland Entertainment Corp.); Boss Media of Sweden; eLottery in Connecticut; Cryptologic Inc. in Canada; Starnet Communications International Inc. in Vancouver; Tab Limited and Access Systems Pty. Ltd. in Australia; MicroGaming Systems; Online Gaming Systems Ltd. in Boca Raton; and UWin! Corp., a U.S. subsidiary of GTECH Corp.

Those are only companies to watch at this point, in Bear Stearns' view. The brokerage firm does not recommend purchasing their stock in its report. Ader had to reiterate that point, "almost angrily," according to one publication, after some of the watch-worthy companies issued press releases that many thought at least implied Bear Stearns had recommended them.

Why does Bear Stearns urge paying attention to these companies? Their track records show they have the experience, know-how or resources to make their operations bring in money.

Cyberbetz, for example, "has one of the better hit:bet ratios on the Internet," says Bear Stearns-up to 15 percent of 200,000 hits or visits per day. A subsidiary of Global Intertainment Corp., Cyberbetz draws players to its Dominica site with numerous incentives, ranging from bonus virtual chips for minimum cash deposits in their wagering accounts to monthly drawings for free cruises.

As a sizable publicly traded company, Bear Stearns points out, Global Intertainment has the resources to advertise the Cyberbetz site, which offers sports betting as well as 25 casino games, with software users can download directly into their home computers. No waiting for a CD to arrive in the mail, no delay while the Web site loads on each individual visit. Players can play any time they want.

'Creatures of Our Regulators'

Whether U.S. residents are violating the law by betting at foreign virtual casinos is a point legal experts don't yet agree on.

Bear Stearns observes that "casino Web sites are the only form of gaming that the Kyl bill does not make exception for in the proposed 'ban' on Internet gambling."

That's because the established gaming industry backs the Kyl bill and other potential bans of Internet gaming. Regulations are the often-cited reason, but few casino companies were interested when Net betting first appeared; it looked to them like a small-potatoes diversion for geeks, the folks who don't spend money in casinos when they visit computer trade shows in Las Vegas.

Besides, the first signs of a going business showed up just when many casino companies were building costly new resorts. Putting more money into an unfamiliar venture made little sense to many, but fending off what in the late 1990s was starting to look like possible competition for their new operations did. A fundamental business move: build a barrier to competition. Or let Jon Kyl do it.

"They decided they preferred to protect their core business," says Las Vegas gaming attorney Anthony Cabot, quoted in Interactive Week. "If you don't support online gaming, you're leaving the industry to non-U.S. participants."

Besides fretting over competition, the gaming companies believe their hands are tied. "We're the creatures of our regulatory bodies," primarily in Nevada and New Jersey, American Gaming Association president Frank Fahrenkopf recently told Interactive Week. "Before any of our major companies can get involved in cyberspace, regulatory authorities have to agree to it."

No less a regulatory authority than Steve DuCharme, chairman of the Nevada Gaming Control Board, recently told Casino Journal that his agency's experts have not yet seen a way to regulate online gaming and enforce rules tightly.

At the American Gaming Summit, Christiansen Capital vice president Sebastian Sinclair remarked, "I often hear people say Internet gaming is unregulatable. That's the stupidest thing I've ever heard. The industry is immanently regulated. There are detailed records for everyone of the games …."

Regulation is under way to varying degrees in several Australian states. "The states believe you can't effectively prohibit Internet gaming," says David Ohlson, executive manager of Lasseters Online, the Net gaming arm of Lasseters Casino in Alice Springs. It got its online license from the Northern Territory state government last year.

Much of the two years Lasseters took to set up was occupied by the Northern Territory's examination of the company's software and background checks of its 250 employees. "It was a very tough process," Ohlson says.

Jupiter's Ltd., which opened Australia's first land-based casino, announced in mid-February that it plans to open an online casino before the end of this year, depending on which state it seeks its license from. Las Vegas-based Park Place Entertainment, the world's largest casino company, holds a 19.9 percent interest in Jupiter's. The Australian company is seeking Queensland approval for a "cyberkeno" game it has developed, and will initially offer roulette and blackjack through software developed by a Canadian firm, Cryptologic.

Like Lasseters, Jupiters is targeting overseas customers with its online offerings--presumably including any Americans who may care to take the "risk" of playing. (The latest version of the Kyl bill does not target individual bettors.)

The tendrils of blooming global Internet gaming, then, are creeping toward the United States from Australia, Caribbean nations, Sweden and other European countries where operating online casinos is legal. Federal and state authorities in the United States have tried to build a legalistic wall against it, but it's only paper in an electronic world. Even the Kyl bill's provisions against using the Internet to transmit wagers across state lines would be nearly impossible to enforce broadly, many experts agree.

Cabot, who works with the law firm of Lionel Sawyer & Collins, disagrees with Bear Stearns' prediction that the Kyl bill will fail. With the companion "Goodlatte bill" in the U.S. House, Cabot figures federal lawmakers will get the two very similar measures resolved during the current session for presentation to President Clinton before he leaves office.

Whether Clinton will sign the law is still open to question, but Cabot tells the lasvegas.com Gaming Wire many gamers would look forward to that: "It will significantly clear the arena and also open up a significant market, both in the U.S. and other countries, for interactive gambling."

Prime beneficiaries would be exempted operations, of course, such as lotteries and race tracks. How Indian casinos might be treated was still being debated among congressmen at press time. And, with the green light for many forms of Net betting, suppliers previously worried about their own gaming licenses would see markets open for equipment and services such as advertising or Web site design.

Yanking the Chain

Still, the uncertainty of federal law--not to mention the conservative "can't regulate it" position of the Nevada Gaming Commission--prevents the likes of Terrence Lanni from carrying his interest in and knowledge of Internet business over to gaming.

"You can build a reputation in 20 or 30 years, but you can destroy it in five minutes," the chairman of MGM Grand Inc. tells Interactive Gaming News. "I wouldn't do anything to hurt my standing in Nevada."

Lanni was the only member of the National Gambling Impact Study Commission to vote against the panel's recommendation to ban Internet gambling. Prohibition won't work, he believes: "Don't pass a 'feel-good' resolution if you don't have a practical way to enforce it."

Lanni was talking about his new association with Youbet.com several weeks after stepping down from day-to-day duties at the Las Vegas casino company (he remains a member of its board of directors). Youbet.com is a thoroughbred betting firm in Los Angeles (Lanni owns racing thoroughbreds), and it hired Lanni because it wants to go global, befitting the nature of the Internet.

"I definitely believe the Internet will be the equivalent of the Industrial Revolution," Lanni has said. Naming Lanni a director is one way that YouBet.com is fortifying its image after the Los Angeles district attorney had police raid its offices last summer. The D.A. was looking for evidence of Californians' bets being placed in violation of state law, although Youbet.com says it only transmits wagering instructions to Hilton PLC's Ladbroke facility in Pennsylvania for actual placement at individual tracks.

In settling the civil case "until California law is clarified," Youbet agreed to provide its California subscribers only with information and no longer transmit their betting instructions. The company says it also "agreed to move from California certain equipment which might be considered to be record wagering information."

And--a point that start-up online casinos might want to consider when establishing a contingency fund--Youbet.com wound up paying $1.3 million in its settlement. Besides costs and civil payments, $300,000 was contributed to the Los Angeles County Education Foundation in support of computer education, while $200,000 went to the California Council on Problem Gambling.

"When the legal environment is clarified in California and nationally," says Youbet.com chairman Robert Fell, "it is [our] intention to resume activities in California."

Bear Stearns' report notes that "if the Kyl bill passes, YouBet will have the largest share of the online thoroughbred and sports-wagering market." The company is one of the most successful online gaming companies formed so far, according to Bear Stearns. Its third-quarter revenues in 1999 reached $1.1 million, up from $76,000 a year earlier. (Heavy marketing led to the firm to register a loss of $7.2 million, however.)

As Youbet.com's experience shows, success has not necessarily been any armor for online casinos. In fact, it can make a company a target for authorities worried that online gaming is getting out of hand.

In December, the Nevada Gaming Control Board charged American Wagering's Australian subsidiary, Mega$ports, with accepting wagers from a Nevada resident. He turned out to be a control board agent who alleges he placed twelve $10 bets with Mega$ports. The complaint was still pending at press time. Facing fines and action against its license, American Wagering plans to challenge the complaint.

Authorities are lodging criminal charges against online casinos, too. Recent action by the U.S. Attorney in St. Louis led to the two officers of Hoss Ltd. and its Paradise Casino pleading guilty in January to violating the federal Wire Act for taking Internet wagers at their virtual casino in Antigua. Hoss Ltd., a Nevada corporation, pled guilty to money-laundering charges.

Marc Meghrouni and Scott D. Shaver, who also admitted impairing the Internal Revenue Service, face five years in prison and $500,000 fines when they are sentenced in June, and their company could be fined $3.5 million. The company will pay $11.4 million in back taxes, interest and penalties, while the two operators are forfeiting a rare car, a condominium and an office building.

'Net Age requires Net reality'

In prosecuting online casino operators, many sources say, authorities and lawmakers are failing to recognize that the Internet has changed the world in its social outlook, including the ways it does business and regards business. If someone can watch or buy a movie on her computer, or can order groceries, why not drop some discretionary dollars at the casino-in-the-computer?

A simple example: Can sales taxes be imposed on Internet transactions? What city or state gets the tax? Some sources say that concept is dead-again basing their outlook partly on the concept of the "free" Internet.

The notion leaves some government revenue-hunters wringing their hands; they do understand that Internet commerce is beginning to displace notable percentages of sales in real stores, even though traditionalists argue--often convincingly--that nothing will replace the joys of journeying to the mall. In the speeded-up world the Internet has helped inspire, though, many consumers have better ways to use their time than trekking across town for underwear.

To be sure, the major changes inspired by the Internet are occurring largely in the United States. It has more personal computers than any other nation.

And there are legitimate concerns among many citizens and their representatives. The Internet is, for example, a prime source of pornography for those who want to pull it up. (Those who don't can instead download a complete electronic version of the Bible.)

When one MD-80 crashes, potential passengers grow reluctant to fly with any airline using those planes. One online scandal, many say, will tar the online gambling industry as well as land-based operations, which is a significant worry for responsible regulators. They are public servants, after all, charged with protecting citizens against fraud or worse.

Casino operators genuinely do have to worry about how regulators will treat them if they even dabble with online gaming today.

If now is the time to enter the virtual gambling business, policy makers have to hunker down with gaming companies and regulators to see what the approach will be. And the traditional way might have to be radically changed.

As Youbet.com's Fell said at the Las Vegas gaming summit, "We're in the Internet Age and the Internet Age requires Internet reality, and we need to recognize that. The legislators have to look at the Internet and understand the Internet, and see it for what can and can't be regulated. They need to see it from a global perspective."

With money starting to pile up across the ponds, U.S. gaming companies and their regulators have been put on notice.