Weakly Interactive

8 April 2002

Forrester Research recently estimated that about 15 percent of the 105 million U.S. television households will have some kind of interactive television service by year end--almost double the percentage last year (The New York Times, April 4, 2002). Forrester's estimate is small comfort to shareholders of Gemstar-TV Guide International, which traded above $90 in the first quarter of 2000 and saw its stock collapse this week, closing at $9.01 on April 2, 2002, down 37 percent on the day. According to The Wall Street Journal (April 3, 2002), analysts downgraded Gemstar because its interactive television program guide "wasn't developing as previously expected"; concerns arising from an SEC filing in which the company disclosed that it hadn't actually received $108 million in revenue from licensing its program guide to Scientific-Atlanta it had booked over the past 29 months and a $210.2 million net loss for the quarter ended Dec. 31, 2001 didn't help. For Gemstar and the universe of companies large and small with stakes in domestic interactive television, however, Forrester's somewhat surprising projection is good news.

Gemstar-TV Guide has a direct interest in domestic interactive television through its ownership of Television Games Network (TVG), an interactive television horse race betting service. TVG launched in 1999 and hasn't exactly set the world on fire. TVG's programming--races, racing information and commentary--was available in more than 8 million by the end of 2001 through distribution agreements with EchoStar's Dish Network, C-band satellite services (Turnervision and Netlink), and cable systems in Maryland (Comcast) and Kentucky (Insight Communications Lexington and Louisville). More about Insight in a moment.

TVG's cable rollout has been slow. Only on June 29, 2001 did a cable company outside Kentucky add the service (when TVG became available to 40,000 Comcast subscribers in the Baltimore area). The lack of cable interest is a function of the miniscule size of U.S. horse racing's consumer base: if, as Rupert Murdoch once remarked, the three most important words in programming are sports, war and movies horse racing is way, way down the list. How far down? Well, the National Opinion Research Center (N.O.R.C.), in a survey of American gambling behavior for the recent Federal National Gambling Impact Study Commission (NGISC), determined that just 7 percent of U.S. adults cared enough about horse racing to have made even one (1) bet on it in 1998--and the number of regular bettors, the consumers who support the domestic pari-mutuel economy, is very much smaller.

Things may be looking up. In January 2002 TVG became available on Adelphia Communications's southern California cable systems, just in time for the start of horse race account wagering (which includes Internet and interactive television platforms) in California. (Adelphia, controlled by the Rigas family, has 5.8 million subs and troubles of its own arising from $15 billion in debt; the troubles worsened last week with the disclosure that Adelphia was co-borrower on as much as $2.7 billion in loans that weren't included on Adelphia's balance sheet. Like Kirch Media, Adelphia is said to be looking at "asset sales"--meaning, probably, the sale of the company.)

Carriage of TVG's programming by cable operators will make new horse racing fans. The question for Gemstar is, how quickly will this happen?

The exhibit below presents the results of the first 52 days of account wagering in California.

California Account Wagering >January 25 - March 17, 2002
Xpress Bet (Magna) $9,258,037 - 70.6%
TVG (Gemstar) $3,309,015 - 25.2%
YouBet! $529,827 - 4.04%
Total $13,096,879

*Source: California Horse Racing Board; grossannualwager.com

For these 52 days the three licensed account service providers handled $13.1 million, or about 3.4 percent of the aggregate California horse race handle of $376 million during this period. (Readers used to reading about casinos should bear in mind that this $13 million is gross wagering, not win.) Xpress Bet, the interactive service owned by Magna Entertainment (which owns California's Santa Anita Park), is the clear winner, handling nearly 71 percent of the account wagering total. TVG was a distant second, handling 25 percent. YouBet, a publicly traded Internet horserace betting service, handled 4 percent.

Magna, having established market leadership, can take satisfaction at its dominant market share but the market's size is, at least initially, proving to be much smaller than expectations. Annualized at current rates California account wagering would total $91 million in its first year. We expect the actual figure to be higher than this, partly because Adelphia's carriage of TVG programming should interest new consumers. Still, the California account wagering market is evidently not (again at least initially) the $300 million-plus bonanza many people expected it would be.

Why? For two reasons. One, it is extremely difficult, and intrinsically time-consuming, to make new horse players. Handicapping horse races has perhaps the longest learning curve of any product in the leisure economy. This learning curve takes a lifetime to surmount and it is initially steep.

The second reason will come as no surprise to readers of this newsletter. The California horse race betting market, as far as existing serious handicappers are concerned, already fully supplied by Internet betting service providers. True, these service providers aren't licensed by the State of California, but to many California horse players that is an advantage: not being licensed these Internet betting service providers may not, and many do not, have the same tax-and-purse-contribution revenue distribution obligations the three licensed betting service providers have, and they can (and many do) pass the lower cost along to consumers. In other words, if you are a horseplayer, in California or anywhere else, it may pay to bet offshore.

Where does all this leave Gemstar and the universe of companies interested in U.S. interactive television?

Not as far behind the curve as you might suppose. Forrester Research is projecting that U.S. household penetration for interactive TV will double in 2002 because interactive television is, finally, taking off in this country--or, more accurately, creeping into American homes in places far removed from the media centers of New York and L.A. that get all the media attention.

That brings us to Insight Communications. Insight Communications cable serves places like Kentucky, Indiana, Ohio and Illinois--the Heartland, not the Coasts. Insight isn't AOLTimeWarner or Comcast: it is the nation's ninth largest cable company, with about 1.4 million subs. And the interactive services it provides are essentially one-way, weakly interactive: viewers can choose from about 200 on-demand movies, check the local weather report, browse show times at the local multiplex--that sort of thing.

It is not the apocalyptic vision TimeWarner had in Orlando--the Full Service Network of $7,000 (that's not a misprint) set-top boxes that TimeWarner launched there in the mid 1990s, at undisclosed but certainly enormous cost, that, if one believed the TimeWarner publicity so many Wall Street analysts believed, would make it possible for viewers to do everything except beget children through the living room TV.

Insight's vision is more modest and it is local. What is the weather like, when does the movie start at the mall multiplex, what is the traffic like between there and my home? Compared to the full-blown, strongly interactive services British households are learning they can't do without this weak interactivity is unexciting stuff.

But there is a difference between the U.S. and Britain--between the U.S. and most of the world outside Finland, for that matter. The difference is that 60 percent of U.S. households have PCs. An awful lot of those PCs are wired to the Internet, and as of September 2001 more than half of them had broadband connections. Those online PCs do bring all the exciting stuff Bits are getting though their TV sets into American homes--including gambling. Californians who want to bet on horses at home don't have to wait for their local cable company to carry TVG; they can log on to a reliable, brand name Internet betting service provider anywhere in California they happen to be. And real soon they will be able to do this through wireless.

In this light the broad range of weakly interactive television services Insight cable provides its subscribers looks cutting edge to us. From the 55th floor in Manhattan these weakly interactive services may not seem like much. It's not the greatest thing since sex and it won't drive $7,000 set-top boxes into the home. Most Wall Street analysts don't seem to get the picture. But Insight's viewers do.

Christiansen Capital Advisors, LLC is a gambling and entertainment industry research and consulting firm. The company's Web site, www.cca-i.com, offers a large selection of research items on an array of gambling industry topics, including Internet gambling, riverboat gambling and fantasy sports, as well as charts and tables from the report "The Gross Annual Wager of The United States," a comprehensive account of all forms of wagering in the United States that has been published annually since 1982. To subscribe to CCA News, their free daily e-mail newsletter, send a blank email to subscribe@grossannualwager.com.