Inside Asian Gaming

9 8 in China will be slower than previously as- sumed. CLS itself has revised its roll-out tar- gets downwards – predicting 20,000 VLTs and 10,000 Keno machines by end-2006. As of end-June, however, Citigroup estimates only 8,000 VLTs and 400 Keno machines (the latter in a test phase) were operating across the country, making even the more modest targets appear hard to achieve. Furthermore, Tabcorp, the majority JV-partner in the Keno project, only forecasts for “a couple of thou- sand” Keno machines by end-2006. CLS informed Inside Asian Gaming that it is currently ironing out some technical problems relating to the Keno terminals, and expects the massive roll-out originally sched- uled for July to be delayed to the third quarter. CLS claims that once the technical problems are resolved,the massive roll-out can be done “very quickly.” Furthermore, CLS predicts rev- enue generated by VLTs for full-year 2006 will be five times greater than in 2005. Citigroup also suggests that the exten- sion of CLS’ exclusive 10-year Keno and VLT contracts are uncertain, though CLS counters that “in practical and operational aspects, as we will have invested hundreds of thousands of terminals in the market in 10 years time – we think it will be very difficult for other companies to replace us at that time.” Thus, despite missing its short-term roll-out tar- gets, CLS remains confident about its long- termprospects,especially given China’s huge market potential. Other Players Hong Kong-daily The Standard ran a feature on companies involved in the China lottery market entitled “A Sure Bet” in October, at which time the stocks were undergoing a rapid ascent. The article compared the rise of such stocks to the earlier fad for Macau gaming-related plays, and pointed out how several “unprofitable penny stocks are hitch- ing themselves to the China lottery boom through vague announcements of potential deals, touching off huge share price jumps.” The article noted that such companies have hardly prospered. Among companies that made such announcements and either failed Keno involves players choosing two to eight numbers from 1 to 80. A central computer system randomly selects 20 numbers out of the total 80, and players receive payouts depending on how many of the numbers they picked fall within the selected numbers. Perhaps it is fitting that according to ancient records,Keno is said to have originated in China almost 3,000 years ago to fund military provisions, and was even said to have helped pay for construction of the Great Wall. It was brought to America in the nineteenth century by Chinese immigrants, and it was in the US – which accounts for over 70% of Keno sales worldwide – that the game really took off. Keno draws take place once every 3 to 5 minutes. Nationwide, each keno terminal averages about Rmb10,000 (US$1,250) in rev- enue per day (and Rmb5,000 in Beijing), and each terminal costs about Rmb12,500 to install. Keno terminals are now available in a wide range of locations, including restaurants, karaoke lounges, coffee shops and other food and beverage outlets. All that is needed at the point of sales is a ticket issuing machine and monitor for displaying results, with both linked to the centralized operating system. Although only Keno itself is available through this network in China, the system can generally support four to eight different games. In Australia, virtual horse and car racing are also offered through the Keno network, and the government is expected to ap- prove more games in the near future. High-Frequency Options Two types of high-frequency lottery games are available in China Video Lottery draws are instantaneous, taking place at the touch of a button. Video Lottery Terminals (VLTs) are virtually indis- tinguishable from slot machines, and any game that can be played on a slot machine – including poker, baccarat, roulette, mahjong and dice games – can be played on a VLT. Six games are now avail- able on VLTs in China, with more expected to be introduced in the near future. The difference between slots and VLTs is that slots determine draws by means of an internal random number generator, whereas VLTs are linked to a centralized operating system,which determines the results. The system allows lottery officials to keep close tabs on money wagered and prize money paid and to add new games with- out changing equipment. Nationwide, each VLT generates an average of about Rmb5,000 in revenue per day, and costs Rmb25,000 to install. Video Lottery Terminals are currently restricted to parlours op- erated by Beijing Lottery Online Technology (CLO), and through the centralized system, offer a single mega jackpot. The CLO halls are financed, built and operated by provincial and municipal wel- fare lottery centres. All CLO parlours will feature a standardized layout of 200-300 sq. metres in size, with 20-40 VLTs and one Keno monitor. The first CLO parlour was opened at the end of 2004, and by June 2006 there were 267 across China featuring about 8,000 VLTs. assembly, but is considering setting up its own production line in Dongguan. Meanwhile, CLS also plans to upgrade Tianyi’s technology through its acquisition of 90% of Octavian International, a Britain- based gaming systems company. CLS plans to then market Tianyi’s VLTs to Octavian cus- tomers in Europe, South America and India. Off and On Target Shares of CLS have recently been sold down hard after peaking at HK$4.2 on January 19. On August 11, the company announced first half 2006 losses of HK$9.03million,compared to a loss of HK$10.8 in the year-ago period, and its stock ended the day at HK$1.1. Eq- uity analysts have also dramatically reversed their views on CLS’ stock price. In January, Citigroup issued a HK$4.3 price target on the stock, but by July, had cut its target to HK$1.1 – right on the money, but not for those who acted on the January target. The main reason for Citigroup’s new- found bearishness on CLS is the view that the roll-out of both Keno and VLT machines 2005 – accounting for 4.7% of the estimated US$184 billion global lottery market. Still more needs to be done to bring gam- bling in China back under the government’s control. The China Centre for Lottery Studies at Peking University estimates the nation’s il- legal gambling activities – including online betting and illegal lotteries – last year were worth US$87 billion; ten times more than le- gal lottery takings. Moreover, mainland Chi- nese are estimated to have spent over US$75 billion annually on gambling overseas in re- cent years. Apart from its ongoing crackdown on illegal gambling, the Chinese government has a three-pronged strategy to increase the appeal of its legal gambling options. First, it aims to offer a better deal. According to a recent Deutsche Bank report, prior to March 2005, Chinese lotteries returned only 50% of sales to winning players, compared to in- ternational lottery standards of 60-75% and black market gambling payouts of 80-90%.In March, the government announced it would gradually raise returns on selected lottery games to international standards. The por- tion of sales revenue going into the Social Fund will correspondingly drop from 25% to 10-20%, but Deutsche Bank points out that a rise in payout of this magnitude could poten- tially double legal lottery sales. Secondly, the Chinese government has sought to expand the range of legal gam- bling options in the country. Prior to 2003, the CWLC only offered two games, lotto and instant scratch cards. Proving the choice-cre- ates-desire thesis, following the launch of a simple new game, 3D – in which players pick a 3-digit number from 000 to 999 – lottery revenue soared 80% year-on-year in 2005. The Deutsche Bank report points out that when Keno was introduced in California in 1993, lottery sales jumped 30%, and similar growth was observed when it was brought to the state of Georgia. In order to offer even greater gambling choice, the Chinese government introduced high-frequency lottery games in mid-2005. Unlike traditional lotteries, where drawings are typically made once or twice a week, new technology allows drawings to take place ei- ther every 3 to 5 minutes, as with the Keno network, or even instantaneously through Video Lottery Terminals (VLTs). Thirdly, the government is seeking to widen the geographical distribution of legal gambling options in order to compete with ubiquitous illegal gambling. Traditional lot- tery tickets are sold in over 60,000 dedicated lottery booths or shops throughout China. While VLTs will be restricted to parlours op- erated by Beijing Lottery Online Technology (CLO) – the mainland’s sole operator of elec- tronic lottery ticketing systems, operating under license of CWLC – keno terminals can be located in almost any retail outlet with space for a ticket machine and keno moni- tor, including food and beverage outlets, convenience stores, bars, youth centres and hotel lobbies. There are currently about 400 keno machines operating in a testing phase in separate locations in 23 provinces across China. CLO aims to expand its keno network to 60,000 machines by 2008, at which time it also wants 150,000 VLTs operating across China, from 8,000 in June 2006. Until recently, CSLC outgrossed CWLC, but the latter took the lead in 2004 after the widely publicised “BMW scandal,” in which a Shaanxi Provincial Sports Lottery Center con- tractor was found to have been setting aside grand-prize winning tickets for his friends. One of these tickets had mistakenly gone to a 17-year-old migrant worker, and when he went to claim his prize of a BMW and Rmb120,000, the lottery center insisted his ticket was fake, prompting the young man to protest atop a city billboard. The scandal dealt a big blow to CSLC’s sales, and CWLC’s lead is likely to widen given its control of high-frequency games, demand for which is predicted to explode. One of the companies that stands to gain most from the huge expansion of keno and VLTs is Hong Kong-listed China Lotsynergy (CLS). CLS was formerly called WorldMetals Holdings and provided online metal trading platforms, but changed its name in October 2005 and switched its focus to the China lot- tery business. On August 1 2005, CLS formed a joint venture with Australian gaming com- pany Tabcorp. One-third of CLS-Tabcorp is held by CLS and the remainder by Tabcorp, and the JV was awarded an exclusive 10-year contract with CLO to assist in the roll-out of China’s first nationwide keno system, provid- ing CLO with softare, central systems, termi- nals and other technical support. CLS-Tab- corp began testing its Keno network at the start of this year, and has ambitious roll-out targets. In January, CLS paid HK$980 million for a 50%stake inCorich International,whichowns Tianyi Electronics, a mainland company with a 10-year exclusive agreement to supply VLTs to CLO. While CLS-Tabcorp receives 0.92% of keno revenues, Tianyi is entitled to 1.6% of VLT takings. Tianyi currently outsources VLT Unlike traditional lotteries, where drawings are typi- cally made once or twice a week, new technology allows drawings to take place either every 3 to 5 minutes, as with the Keno network, or even instan- taneously through Video Lottery Terminals (VLTs)