The government may have finally caught up regulation-wise and is looking to crackdown on FOBTs, but they have been reaping taxes from the machines since 2013. The Machine Games Duty (MGD) takes a proportion of the machine’s net takings (i.e. revenue minus pay outs).
A brief history: the early days of FOBTs and gaming machines
It is important to understand how FOBTs came about in order to fully appreciate how important they have become to betting shops around the country. Here is a brief rundown:
- UK bookmakers were struggling in the mid-1990s and were closing stores and shedding jobs, which had led to a fall in the amount trickling into the public purse
- The government then deregulated the market in 1996, allowing bookmakers to advertise on shop fronts, offer refreshments and, most importantly, install slot and fruit machines, which had only been found in pubs beforehand
- The National Lottery inspired the first bespoke gaming machine designed for the industry and helped kick start development of gaming-related betting
- These machines initially only offered a few select high-margin games until the tax system was overhauled in 2001, taxing bookmaker’s profits rather than revenue
- This allowed bookmakers to introduce more lower-margin products, led by the industry-wide launch of roulette on the gaming machines and opening up new opportunities for software developers and manufacturers of the machines
- The government paid little attention to FOBTs in the initial years as the Association of British Bookmakers (which represents about 80% of UK bookmakers, including the biggest players) had introduced a code in 2003 to help align the rules over speed of play, stakes and prizes and limit the amount of FOBTs in each store
- These FOBTs were categorised in 2005, creating the B2 machine
How important have FOBTs become for UK bookmakers?
Practically every single FOBT in betting shops is a B2 gaming machine. Betting shops generated a gross gambling yield (GGY) of £3.4 billion in the year to the end of March 2017, of which £1.8 billion came from FOBTs.
Although the amount of machines has fallen directly in line with the decline in the amount of betting shops (as there are strict rules dictating there can only be four FOBTs in each store), the GGY has increased, and at a faster rate than the overall GGY for the betting sector. That has not helped the argument for, or the reputation of FOBTs – the more GGY betting shops generate from gaming machines, the more that is being lost by punters. This, as far as the government is concerned, twinned with the association with problem gambling (which the industry vehemently denies), the more money bookmakers make from machines, the more money the most vulnerable and addicted gamblers lose.
Betting shops attract about six million customers a year and it is clear that they are funnelling increasing amounts of money into machines rather than filling out slips and handing it to the cashier. Interestingly, estimates dating back to 2012 from a report by Landman Economics, on behalf of the Campaign for Fairer Gambling, suggested only 3% (England) to 4% (Scotland) of the UK population used FOBTs (of all types, meaning the amount of users for B2 machines would be lower). On that basis, although far from conclusive, the suggestion is about 1.6 million people in England and a couple of hundred thousand Scots are losing billions of pounds to gaming machines each year. To add some more context, the government claims around 14 out of every 100 people that use FOBTs are problem gamblers, the highest rate for any gambling activity.
UK government: the ‘weight of evidence’ justifies action on B2 gaming machines
Unfortunately, this has all led to reputational consequences, which the bookmakers have had a hard time shrugging off. There is a wide variety of accusations made against gaming terminals, linking their use to problem gambling, targeting more vulnerable people in more deprived areas and the stark and highly contested argument that players can lose tens of thousands of pounds in a single hour using them.
Industry denies these claims and says FOBTs have been unfairly targeted and used for political spin. When new technology arises it can often be controversial, and companies pioneering the latest innovation often get an opportunity to help mould the government’s decision on how to regulate a new market or product to avoid having the rules dictated and imposed on them with no say whatsoever. This time round, the industry seems to have somehow missed that opportunity.
While deciding how to lower the maximum stake on B2 machines from £100, numerous options were being considered to cut the maximum stake somewhere between £50 and £2. Despite recommendations leaning more toward the £20 to £30 mark, the government’s decision to slash the stake to just £2 was the worst possible outcome for the industry.
ABB warns the government that 4000 shops will close and 21,000 jobs will be lost
‘This is a decision that will have far-reaching implications for betting shops on the high street,’ - Association of British Bookmakers.
The ABB has slammed the government’s decision and was quick to outline the detail concerning the jobs and stores that it warned would be lost should it opt for the £2 stake limit. The warning is stark, with over 4000 stores to close and 21,000 jobs lost – equal to 47% of all the betting shops in the UK and about 40% of the 52,000 or so employees working within the betting sector.
ABB believes B2 machines have been unfairly targeted, and has argued that bookmakers should be regarded like any other supplement to the high street, like food outlets and convenience stores - not as ugly blights that target vulnerable people in deprived areas. The ABB claims the government won’t solve the issue of problem gambling by targeting B2s and believes ‘most problem gamblers’ use seven or more types of products to gamble – making B2s just one part of a much larger problem.
It thinks people will simply shift to other forms of gambling, particularly online ‘where there is less chance of human interaction and its impact on problem gambling levels is far from certain’.
New rules will change how gambling industry advertises and protects customers
The government is also asking more from industry when it comes to advertising responsible gambling. A ‘major multi-million pound’ ad campaign will be launched later this year ‘supported by industry’, and the Industry Group for Responsible Gambling (IGRG), which represents the trade associations of the sector such as ABB, has edited its code that will see a message promoting responsible gambling permanently on-show for the duration of all TV adverts.
Rules on age verification will also be tightened and protections for online players improved. ‘Proposals’ have also been put forward to impose a limit on the amount someone can spend before affordability checks have been carried out.
The government says any stake above £2 would still allow the most vulnerable gamblers to suffer severe losses and has made the decision based on the ‘weight of evidence’ that has built up over recent years.
Having said that, the Parliamentary briefing paper published in May conceded that ‘academic research suggests that the causes of problem gambling are complex and not well understood’, adding the Responsible Gambling Strategy Board recognises the ‘regulatory dilemma’ of balancing the level of enjoyment and protection.
‘When faced with the choice of halfway measures or doing everything we can to protect vulnerable people, we have chosen to take a stand. These machines are a social blight and prey on some of the most vulnerable in society, and we are determined to put a stop to it and build a fairer society for all’, Secretary of State for the Department of Communities, Media and Sport Matt Hancock said when unveiling the new measures.
Crackdown on FOBTs will spur on consolidation among bookmakers
This will all feed into the existing consolidation that has been occurring among bookmakers with firms aiming to battle against tougher conditions, expand abroad or beef up their offerings as online gambling, which accounts for around a third of total GGY in the gambling industry, continues to become more prominent.
Paddy Power and Betfair completed a £5 billion merger in 2015 and GVC Holdings, which bought bwin.party in 2011 after fending off competition from 888 Holdings, is now the UK’s biggest high street bookmaker after snapping up Ladbrokes Coral Group in March, which itself was formed by the £2.3 billion merger between Ladbrokes and Gala Coral in 2016. Last year, William Hill sold off its Australian online sports betting arm to The Stars Group, owner of PokerStars, after the pair previously failed to merge together.
Read more on the top M&A contenders for 2018.
It is highly anticipated that consolidation in the market will only be fuelled by the government’s decision and supported by the swathe of stores and jobs that will be lost. This includes those more focused online like Jackpotjoy, 888 Holdings and Rank Group.
Cut to maximum stakes on FOBTs prompts mixed response from industry
With the impact of the decision to be concentrated on the high street, the two listed companies that own the bulk of the bookmakers, William Hill and GVC, will be dealt the biggest blow to the benefit of the online competition. Investors will also be reanalysing the rationale and value of GVC’s recent purchase. GVC is currently the sixth-most shorted UK-listed stock according to data from Bloomberg, while none of its peers feature in the top 20.
GVC Holdings: ‘disappointed’
‘Although we are ultimately disappointed with the outcome of the Triennial Review, it is a decision we accept. The uncertainty has weighed heavy on the industry and the many thousands of people who work within it,’ – GVC Chief Executive Kenneth Alexander.
GVC has said it doesn’t intend to appeal the decision of the review so it can ‘achieve a positive and constructive working relationship’ with regulators and the government, but has called for an implementation period so the sector can adequately prepare for what will be an overhaul of the country’s betting shops, which the government has promised.
GVC is a specialist in online gaming and sports betting but now has over 3500 stores after buying Ladbrokes Coral, and the bookmaker is more UK-focused compared to a more internationally-focused GVC. There is justification for the deal as GVC lowers its exposure to unregulated markets, Ladbrokes Coral is in a better position to absorb the ongoing struggle on the high street and over £100 million of synergies can be delivered.
GVC did take the review of FOBT stakes into account. It acquired Ladbrokes Coral in cash and shares worth 160.9p per share, equal to £3.1 billion, and it said it would pay up to a further 42.8p (to take the total value of the deal to £3.9 billion) depending on the outcome of the review of B2 machines. However, the cut to a stake of £2 means Ladbrokes Coral will not receive any of that extra payment. Still, GVC says earnings per share (EPS) will see double-digit growth in the first full year after completion even with maximum stakes limited at £2.
The company is confident it can reshape itself in response to the decision in just two years, expecting to suffer heavy losses in the first year before recovering in the second. It has said earnings before interest, tax, depreciation and amortisation (EBITDA) would be hit by £160 million in the first year, but it will recoup some of those losses to end the second year with a total EBITDA hit of £120 million. GVC believes its betting shops can remain profitable and highly cash generative while continuing to expand its online offer.
GVC Holdings share price
William Hill: ‘catastrophic’
‘The government has handed us a tough challenge today and it will take some time for the full impact to be understood, for our business, the wider high street and key partners like horseracing. We will continue to evolve our retail business in order to adapt to this change and we will support our colleagues as best we can,’ – William Hill Chief Executive, Philip Bowcock.
William Hill had the biggest presence on the high street before GVC’s purchase of Ladbrokes Coral, with 2340 betting shops employing 16,000 people. The bookmaker and its CEO have been the most critical of the government’s decision to cut the maximum stake on B2s to £2, with Bowcock describing it as ‘catastrophic’. Amid the ongoing consolidation in the sector, he said he would not want the decision to play a ‘factor in the name of William Hill being added to the list of companies now in foreign ownership’.
It seems the initial shock will hit William Hill the hardest and it has warned that the longer-term impact of the ‘unprecedented’ move won’t be fully understood for years. Still, it has provided preliminary guidance that paints a devastating picture for the bookmaker. It estimates around 900 of its betting shops (38% of its total) will become loss-making and that some would have to close soon after the new stake limit is implemented, with the future of the rest uncertain until it understands the effect on its business over both the medium and long term.
Just 30% of its net gaming revenue in the first four months of this year was generated by players betting stakes of below £2, with the rest coming from higher stakes. William Hill has warned its overall net gaming revenue will plummet by 35% to 45%, and that’s after recouping some of the losses by introducing substitute products to its gaming machines and poaching those customers left astray as rival bookmakers shut-up shop.
This will lead to annual adjusted operating profit being hit by £70 million to £100 million, but the bookmaker is looking for other ways to help mitigate the challenge ahead and it has committed to continue paying out 50% of its underlying earnings in the form of dividends, which will still suffer as a result of the changes.
William Hill share price
Paddy Power Betfair: ‘positive development’
‘We have previously highlighted our concern that the wider gambling industry has suffered reputational damage as a result of the widespread unease over stake limits on gaming machines. We welcome, therefore, the significant intervention by the Government today, and believe this is a positive development for the long-term sustainability of the industry,’ – Paddy Power Betfair Chief Executive Peter Jackson.
Paddy Power Betfair has online operations and is also present in the US and Australia. In the UK and Ireland it has 620 Paddy Power betting shops employing over 3000 people. However, the company focuses on its sports proposition and the changes to maximum stakes won’t have any significant impact on the company.
The firm estimates revenue from gaming machines will drop 33% to 43%, equal to around £35 million to £46 million. But that represented just 2% to 2.6% of its overall revenue last year.
Paddy Power has conceded that ‘market consolidation’ could be an option it considers to mitigate the wider challenges in the industry, in addition to introducing new replacement products.
Paddy Power Betfair share price
The crackdown doesn’t stop there…
‘I want to be very clear that a stake reduction on B2 gaming machines should not be a signal to the wider industry to take its foot off the pedal on this issue. We want to use this opportunity to see the industry redouble its efforts to promote responsible gambling and to deliver on the actions set out in the National Responsible Gambling Strategy,’ – Minister for Sport and Civil Society Tracey Crouch.
The government may have started to make some firm decisions but much more is yet to come and future intervention is likely to spread further afield than bookmakers, to the online operators, casinos, arcades and bingo operators. High street bookmakers have a difficult journey ahead, but one that the wider sector will probably have to take in the not so distant future.
Further research is looking at other possible measures that could be introduced, like capping the amount one person can lose in a single session by tracking their activity on not just B2 machines, but B1 and B3 machines too. While the government is maintaining the status quo for all other machines for the meanwhile it has said it will persist in monitoring activity and willing to take action if necessary. Even the outlier of gaming machines, Category Ds that represent penny arcade machines and games that offer prizes found in all good seaside resorts, are being reviewed.
The reduction in revenue earned by bookmakers through B2 machines will leave a sizeable hole in the public purse and the government expects the online gambling sector to fill it. Currently, the system taxes FOBTs through the Machine Games Duty, which taxes 25% of the B2’s net takings with other machines offering maximum stakes below £5 mostly falling under a rate of 20%.
The government has said it will increase the Remote Gaming Duty at the next ‘relevant budget’, likely to be in autumn, to offset the loss of income from gaming machines. This duty largely applies to online operators offering remote gaming services over the Internet. They already pay 15% of their profits under the existing duty and that will now rise and impact the online player’s margins that have so far proven robust compared to those burdened by the cost of their high street estate.
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