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The Independent UK
The Independent UK
National
Via AP news wire

State lotteries increasingly cede control to huge firms

Copyright 2022 The Associated Press. All rights reserved.

The companies that run state-backed lotteries already have a heavy hand in how the games are operated. But in the years ahead, their control over lotteries is expected to expand significantly while state officials take a step back.

Analysts who track the industry say the largest companies are trying to forge what one calls “enhanced partnerships” with the states, and what others refer to as “privatization” programs that will transfer most of the day-to-day management and strategic decision-making from states to private companies.

The lottery industry in the U.S. is dominated by two giants, International Game Technology PLC and Scientific Games Holdings LP, and a handful of smaller companies including Intralot SA and Pollard Banknote Ltd. These companies are likely to continue to dominate this market, which boasted $82 billion in ticket sales in the 2020 fiscal year, because states are reluctant to risk hiring an upstart to run such a high-profile business.

Lottery systems nationwide are evolving into quasi-privatized operations, with state governments assuming an oversight role while private companies reap millions running this sophisticated form of gambling.

These companies provide the software and computer systems that help run games such as Pick 4 in Kentucky and Maryland, Cash Pop in Florida and Lotto in Colorado. Some of the companies also print instant scratch-off tickets, process winning tickets and manufacture terminals — including video lottery terminals — used at retail locations.

They also power the massive multistate lotteries such as Mega Millions and the enormously popular Powerball, which made history in 2016 with a jackpot that hit $1.6 billion.

While these companies play a vital role in all of the 45 states that operate lotteries, plus Washington, D.C., the industry is transitioning, according to analysts, in a way that will give them nearly total control as private managers of state lotteries.

“The transition that is taking place will let the companies effectively provide more service and manage almost everything end to end,” said Adam McLaren, a vice president and senior analyst at Moody’s Investors Service in New York.

As lottery jackpots grow, involving multiple states, and as lotteries introduce new products such as sports betting apps, the technology needed to drive these changes and upgrades becomes more complex.

McLaren said states don’t have the capital or expertise to manage these systems, monitor and secure user data, and process winning tickets, all while designing new games.

So far, only three states — Illinois, Indiana and New Jersey — have gone so far as to “privatize” their lottery operations. Illinois was the first to do so in 2011 when it hired Northstar Lottery Group LLC, a consortium owned by International Game Technology and Scientific Games. Indiana picked a company a year later that in 2014 bought International Game Technology and assumed its name. New Jersey struck a deal in 2013 with Northstar.

In these transactions, the private manager generally takes over lottery sales, marketing and management functions in exchange for an upfront payment and a promise to generate a minimum net income for the state.

These arrangements aren’t always smooth at the start. Illinois canceled its contract with Northstar after a few years because revenue came in lower than expected. It then hired Camelot Group, a company in England that operates the U.K. National Lottery.

Under New Jersey’s 2013 agreement with Northstar, the state received $120 million upfront and a commitment from the company to generate at least $1.42 billion of additional net income for the state over the life of the contract. In a press release issued at the time, the state said the deal would bring in more revenue than it could have expected had lottery operations remained unchanged.

“By combining the Lottery’s and Northstar NJ’s expertise and resources, we will be able to expand the Lottery’s presence in the marketplace, offer exciting new games to our customers and new services to our retailers,” said Carole Hedinger, who was executive director of the New Jersey Lottery at the time. But Northstar wasn’t able to meet its targets and the deal was renegotiated in 2019.

In February, the Washington, D.C., lottery lost revenue and had its image tarnished when its sports betting app went offline during the Super Bowl, one of the biggest days of the year for sports betting. The DC Lottery blamed a software glitch at Intralot SA, which signed a five-year contract in 2019 to run sports wagers and other lottery services. In April, the DC Lottery said it received $500,000 in compensation from Intralot for the Super Bowl fiasco.

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Is it really privatization?

There are limits to how much control states can pass along. Federal law generally prohibits private companies from operating lotteries, fearing their presence could lead to corruption.

In 2008, the Department of Justice issued an advisory noting that states can hire private companies to operate certain aspects of lotteries, but the advisory also said federal law requires that states maintain control over “all significant business decisions” and that the private companies may not receive more than a “de minimis” interest in the profits.

The advisory means that states, not the private companies, must make major decisions, such as whether to join multistate games, allow online sales or create a sports betting app.

“What the ‘de minimis share of profits/losses’ phrase means is that DOJ effectively signaled that what would be disallowed would be a long-term lease where you’d fully monetize the lottery for some long period,” said Leonard Gilroy, vice president of government reform at the Reason Foundation, a libertarian organization that believes most business functions of government should be privatized.

Gilroy said the DOJ decision means lotteries can’t be fully privatized. “That is not going to happen. Federal law won’t allow it,” he said, adding that what most people call privatization plans are actually public-private partnerships.

Whether they are called privatization plans or partnerships, analysts agree that more will be crafted in the future.

In a recent report about Scientific Games, Zacks Investment Research Inc. in Chicago said the lottery industry’s transition toward more private management has already begun and is “evident from the increasing involvement of private vendors in state lottery management, higher prize payouts and introduction of tiered pricing for national jackpot games.”

David Gale, executive director of the North American Association of State and Provincial Lotteries, said there is a practical reason why lottery companies will be playing a larger role. He said they are needed to print out the dizzying array of instant tickets, design and build new terminals, and create the systems to transition lotteries to the internet.

“States can’t do that on their own, they are not manufacturers,” Gale said. The association represents 53 lottery organizations.

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A recession-proof industry

The lottery business is one of the few sectors of the gaming industry that appears recession-proof.

Early in the pandemic, for example, casinos were hurt badly when they shut down as COVID-19 was spreading and stay-at-home ordinances were put in place. But lottery operations weren’t affected as much by the pandemic as gaming overall and revenues at some companies actually grew.

During the first year of the pandemic in 2020, Scientific Games posted a total revenue of $2.7 billion, 20% less than the $3.4 billion reported in 2019, according to its 2020 annual report. But revenue from the company’s gaming operations plummeted 47% to $926 million during that period. Meanwhile, revenue from the lottery business edged up slightly to $918 million in 2020 from $911 million in 2019.

IGT’s results were also buoyed by its lottery operations. IGT reported its 2020 revenue from gaming operations plummeted 45% from the previous year to $953 million while revenue from the lottery business declined just 5.6% to $2.2 billion. Both segments bounced back in 2021. IGT declined to comment, but in its 2021 annual report, the company said, “The global lottery industry has demonstrated remarkable resilience during the COVID-19 pandemic.”

Meanwhile, growing jackpots can result in higher revenue. In 2016, when the Powerball jackpot hit $1.6 billion, IGT’s revenue hit $5 billion that year, a record high. The company wouldn’t confirm the impact of the Powerball jackpot on its growth.

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Consolidation and lack of competition

While lottery revenues are growing, the number of companies that provide lottery services has declined. That’s partly due to a series of mergers and acquisitions over the past few decades that have consolidated the sector and centered the industry operations in Canada and Europe, even though the U.S. is the largest market for most companies.

The last remaining U.S.-based lottery giant, Scientific Games, sold its lottery business in April to Toronto-based private equity firm Brookfield Business Partners LP for nearly $6 billion. The remaining part of Scientific Games, mainly slot machines and online games or iGames, was renamed Light & Wonder Inc. and is based in Las Vegas. Brookfield retained the Scientific Games name and will operate the unit in suburban Atlanta.

That transaction leaves two Canadian firms, Brookfield and Pollard; two British companies, IGT and Camelot; and one Greek firm, Intralot, at the forefront of the industry.

“Years ago there were three times as many lottery companies. Through attrition, buyouts and mergers, the number of companies has been reduced,” Gale said. “There aren’t any new companies.”

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University of Maryland Lecturer Constance Mitchell Ford contributed to this report.

The Howard Center at the University of Maryland is funded by a grant from the Scripps Howard Foundation in honor of newspaper pioneer Roy W. Howard.

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