Gambling stocks hit jackpot, but investors should hedge their bets

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Gambling stocks hit the jackpot on Monday after the U.S. Supreme Court cleared the way for U.S. states to legalize sports betting on individual games, a move that could open up an opportunity worth US$50-billion ($64-billion) or more.

Stars Group Inc., the Toronto-based online-gambling company formerly known as Amaya, was one of the bigger winners, jumping 9.4 per cent after the U.S. court decision was announced. Stars Group, which built its business around online poker, splashed out US$4.7-billion last month to buy Sky Betting & Gaming of Britain, a move designed to bolster its presence in sports betting.

Other gambling companies also enjoyed a lift from the court’s ruling. Shares of William Hill PLC, the big British bookmaker, surged 10.7 per cent, while those of Paddy Power Betfair PLC, its Irish rival, rocketed upward by 12.2 per cent. Some U.S. casino operators such as Caesars Entertainment Corp. and Penn National Gaming Inc. bounced higher too.

The Supreme Court decision reshapes the U.S. gambling landscape, ending Las Vegas’ near-monopoly on legal sports betting and opening up new opportunities for companies that cater to people who want to get a bet down on football, hockey, basketball or any other athletic event.

Americans place US$50-billion to US$60-billion a year in illegal sports bets, according to Eilers & Krejcik Gaming LLC, a research firm. The American Gaming Association puts the number much higher, at around US$150-billion. The shift of a significant portion of those black-market wagers into the daylight could swell revenue and profits at legitimate gambling companies.

Today’s eager stock buyers may be getting ahead of themselves, though. As massive as the U.S. opportunity may be, it will take years to mature. Competition for bettors’ dollars will be fierce. And government regulation will still be a major factor in determining how profitable online sports betting in the United States will be. While investors are right to be upbeat about the potential market that is opening up, the trick will be in not overpaying for the opportunity to grab a piece of this gambling bonanza.

For all its significance, Monday’s legal earthquake is unlikely to unleash an immediate tsunami of new gambling revenue. The Supreme Court decision didn’t legalize sports betting. It only struck down a federal law that had barred states, other than Nevada, from authorizing sports betting on individual events. The judges said the federal law was an unwarranted intrusion into state policy.

In the wake of the decision, many cash-strapped states will presumably jump at the chance to grab a slice of Nevada’s gambling business. Others, though, may balk at the social costs or impose stringent conditions. Some may introduce sports-linked lotteries, while others may allow sports betting only at existing casinos and race tracks. In a recent report, Eilers & Krejcik estimated it would take until 2023 for sports betting revenue to hit US$6-billion, by which time it expects 32 states to have authorized some form of wagering on athletic contests.

A host of companies will be vying for a piece of the action. In addition to publicly traded gambling giants such as Stars Group, they will include newer entrants such as Boston-based DraftKings, a private company that until now has focused on daily sports fantasy contests. DraftKings chief executive Jason Robins said on Monday his company would enter the sports betting market and “harness our proven technology to provide our customers with innovative online sports betting products.”

Competition aside, politicians may prove to be a big impediment to lush profits for gambling companies. Legislators around the world have a love-hate relationship with betting: They crave the revenue it generates, but loath the way it preys on a small minority of the population that develops a gambling addiction. As a result, governments have a habit of opening up new opportunities for gambling operators, but then stepping in whenever they look to be getting too successful.

Shares of William Hill, the British bookmaker, plunged by 12 per cent last month after a report that the British government was going to reduce the maximum amount bettors could wager at fixed-odds betting terminals. In Australia, various states recently began to introduce taxes, ranging from 8 per cent to 15 per cent, on online gambling agencies. The tougher regulatory environment has been a major reason why both William Hill and Paddy Power have produced uninspiring results over the past two years.

The lesson here for investors? Courts can give, but governments can take away. It’s an important reality to keep in mind since none of the major gambling stocks are particularly cheap. Until the excitement dies down, investors may want to watch this game from a distance.