Acquiring: Doubling Down on Gambling And Payments

Kevin Woodward

Online gambling, now legal in only three states, could produce a big payoff for payments companies.

Payment companies hoping to hit the jackpot by providing services for online gambling in the United States will want some patience, education, and a bit of luck.

Just three states—Delaware, New Jersey, and Nevada—currently allow legal online gambling, with a host of payment companies providing various services such as transaction processing and online wallets. California, New York, and Pennsylvania are considering allowing online gambling, says Optimal Payments Plc, a Montreal-based payment processor that provides services to online operators in New Jersey, Delaware, and Nevada.

Online gambling in the U.S. is not new, having been available until passage of the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA), which restricted payments for Internet wagers. Since then a different interpretation of that law has emerged, one that has resurrected online gambling at a time when state coffers are tapped out.

A major turning point came in December 2011, when the U.S. Department of Justice released a memo in which the department interpreted the 1961 Wire Act to apply only to online sports betting. This interpretation, which came in response to states looking to sell lottery tickets online, appeared to clear the way for online poker and other games, as well.

Incidentally, sports betting accounts for 53% of global online gambling winnings, with casino games at 25.5%, poker, 14.2%, and bingo trailing at 7.4%, according to a 2013 report from Gibraltar-based online game developer Odobo and United Kingdom-based H2 Gambling Capital, a research firm.

Special Legislation

The attraction, of course, is money. Some estimates suggest the current U.S. spend is about $2.6 billion via internationally regulated operators, says Bill Beatty, editor-in-chief of CalvinAyre.com, a gambling news site.

“Over the next 10 years, some suggest estimates as high as $23 billion a year by 2023 from the bullish and as low as only $2 billion by the more bearish anti-gambling folks,” Beatty says.

Another estimate, from Odobo and H2 Gambling Capital, forecasts $7.7 billion in U.S. online gambling winnings by 2017. That forecast envisions some type of online gambling in 17 states by then.

In New Jersey alone, online gambling operator revenues have increased 234% since January, when the six licensed casino-affiliated sites took in $9.5 million compared with $31.7 million in March. In the first quarter, the sites had a combined $60.9 million in revenue, according to data from the New Jersey Division of Gaming Enforcement.

“There’s no doubt it’s going to be spreading across the nation, and much faster than the state lotteries,” says I. Nelson Rose, a professor of law at Whittier Law School, Costa Mesa, Calif., and a nationally recognized expert on online-gambling law. But, it’s not going to happen in 2014, he says.

Legal online gambling in New Jersey started with a soft launch in November and encourages residents and visitors within the state to use the Web sites of New Jersey casino operators. People outside the state can’t simply log in to one of those sites and start playing. Meanwhile, newspapers and other media in New Jersey are reporting that revenues at brick-and-mortar casinos in Atlantic City continue to fall and that the new online revenues aren’t fully offsetting the decline.

Much of the initial online gambling efforts in other states are likely to involve state lotteries—Illinois, Georgia, and Minnesota currently permit such sales—because some states do not need legislation to offer online lottery purchases, Rose tells Digital Transactions. But other states do require special legislation, and that may impede their adoption of online lottery sales, he says.

‘Pipe Dream’

Get beyond state-sanctioned lotteries, however, and politics can come into any discussion about expanding online gambling. At least one casino executive—billionaire Sheldon Adelson, chairman of the Las Vegas Sands Corp., which operates The Venetian and The Palazzo in Las Vegas, among others—opposes online gambling. He supports the Coalition to Stop Internet Gambling, which posits that online gambling targets the young, the poor, and the elderly. It wants Congress to ban online gambling.

But politics will have a diminished role in the adoption of online gambling by states, Rose says. “This is purely to raise tax revenue,” he says. “Almost every state has been struggling since the Great Recession.”

Where politics may be a factor is in how online licenses may be structured, he says. States like California that have Native American gambling and other gambling operators may have to fashion legislation that enables investment from outside of the state while keeping the local operators appeased, Rose says.

Officialdom, however, generally will want to enable online gambling, according to Beatty.

“What we’re seeing now is that various levels of government in the United States are finally recognizing that regulating online gambling will increase tax revenues, create jobs, and give their citizens more choice over how they spend their discretionary income,” Beatty says. “Without regulation, international companies and governments rather than U.S. governments at the state and federal level realize the benefits that come from regulated online gambling.”

But Beatty doubts any sort of federal regulation is coming, given the fractious nature of Congressional politics.

“The national casinos have been pushing hard for a federal regulatory solution for online gambling as it’s likely to give them an advantage over their competitors, but with far more important business failing to see any movement in a divided Washington, the idea of federal regulation for online gambling is a pipe dream,” he says.

‘Hills to Climb’

However the states work it out, the potential for payment processors serving the industry is enormous. Rose says U.S. gamblers wager more than $1 trillion annually, which is a mix of electronic and cash payments.

What does all this mean for payments companies, ones that could provide online transaction processing and digital wallets?

“We are at the very start of the U.S. online gambling industry,” says Ben Dalfen, executive vice president at Optimal Payments. “The market has been open for less than one year and less than 5% of the U.S. population is legally able to gamble online.”

Optimal provides payment services to licensed online operators in Nevada, New Jersey, and Delaware, including customer account funding via credit and debit cards and electronic checks. Optimal plans to offer electronic-wallet and prepaid funding methods in the future, Dalfen says.

Payment providers have to submit to a rigorous vetting process and have to maintain performance standards to continue providing services. One challenge for payment companies in the niche is that each state has its own regulations and requirements, Dalfen says, “and it is very expensive to become certified and licensed in each state.”

A state, for example, may require the provider to set up a data center to serve just that state. “From a software standpoint, it is very challenging and expensive to meet the demands of each state regulator,” he says.

Delaware, Nevada, and New Jersey restrict online gambling to those players located in the respective states, using geolocation technologies to determine the location of the computer they use.

“Companies setting up in the regulated online gambling market will be looking at various hurdles and hills to climb,” says CalvinAyre.com’s Beatty, including the initial cost of licensing, infrastructure setup, marketing, and educating potential players about their brands, all of which come with steep costs.

Finding Customers

Even in the gambling mecca of Nevada, Dalfen says some of the largest casino operators hesitate to enter the online market because of the required investment for operations and compliance, along with ongoing marketing costs.

The Nevada Gaming Control Board’s Regulation 5 outlines the rules for operating gambling establishments and governs the licensing of payment-processing service providers. The regulation defines an online payment service provider as “a person who directly facilitates the depositing of funds into or withdrawing of funds from interactive gaming accounts for a licensed operator of interactive gaming or licensed interactive gaming service provider.”

A handful of exclusions from Regulation 5 apply, says Jim Barbee, chief the Nevada Gaming Control Board’s Technology Division, such as a licensed gambling operator directly providing payments services for its patrons without employing a third-party payment company.

Payment companies in Nevada may provide funding mechanisms, transaction processing, and risk-management services, provided they comply with anti-money laundering, Bank Secrecy Act, and FinCen requirements. FinCen is the U.S. Treasury Department’s Financial Crimes Enforcement Network.

Consumers can fund their online wagering accounts with checks, credit and debit cards, and automated clearing house transfers, Barbee says. Not all banks, however, authorize their cards for use with online gambling. Those issuers are afraid of chargebacks and the question of legality, according to Rose. There are ways around that, as some consumers use the cash-advance feature of their credit cards to fund their online gambling accounts.

Once the regulatory requirements are met and online gambling sites are operational, the sponsors and payment companies will face the task of finding and keeping customers. The ability for players to quickly move from one game to another will be an important consideration in consumer decision-making about playing on which sites, according to Neil Steinhardt, chief executive of Skrill USA, the New York-based unit of Skrill Holdings Ltd., a London-based online payment processor. Skrill provides a digital-wallet service that enables consumers to fund accounts that they then can use to move money into and out of online gambling accounts.

‘Incredibly Expensive’

That ability to move from one game to another, called liquidity, is necessary to create an environment where operators can generate positive returns, Steinhardt says. “In order to create the ecosystem, they need players, and the cost of acquiring these players will be incredibly expensive in the beginning,” Steinhardt says. Skrill has more than 36 million account holders and serves 150,000 merchants.

Figures from another online gambling operation indeed show that finding customers can be expensive. Gibraltar-based 888 Holdings Plc’s average new-customer acquisition cost was $58.29 in 2013 compared with $52.48 in 2012. Digital Transactions calculated these costs by dividing 888’s annual marketing expenses by the number of new account holders registered each year.

“The goals of our industry-leading analytics is simple: to maximize customer recruitment, increase customer lifetime value, and minimize the cost per acquisition,” notes 888 in its 2013 annual report.

Even with regulatory and marketing hurdles, online gambling seems assured to grow from where it is today, and that holds potential for payment companies.

“Outside of the U.S., online gambling is one of the largest and most regulated industries worldwide,” says Skrill’s Steinhardt. “Customer demand will always be there. It’s just a matter of the U.S. making it ‘legal.’”