Billion-Dollar Horse Play The future of the sport of kings is in the hands of three very different players. Can live racing be saved?
(FORTUNE Magazine) – At times the sport of kings is still just that. On the first Saturday in May, expensively clad women in big hats and men in sharp suits flock to Churchill Downs for the Kentucky Derby, which just celebrated its 127th anniversary. The other Triple Crown races make headlines too, as do events like late autumn's Breeders Cup, the Super Bowl of horseracing. There are celebrities--Don Johnson, Reba McIntyre, George Steinbrenner--and very rich people, and other, not-so-rich people who want to own racehorses because, owners will tell you, there are few thrills in the world that compare. And the price of those horses will remind you why, as Mel Brooks has said, it's good to be a king: At the Keeneland, Ky., yearling sale this July, the top colt sold for $4 million. But you don't see much of that glamour or money at your typical track, a multilevel structure with lots of empty escalators--and even more empty space. Most days you can stroll right up to the rail and watch the horses thunder by. As top Northern California jockey Russell Baze puts it, "There are nights when you can shoot a cannon off in the grandstand." Tracks like San Francisco's Bay Meadows were built for a crowd of 25,000; these days 5,000 is a good day. "This used to be the place to be. Even on the weekdays people would line up, waiting to get in," says Bernadette McPartland, who's been waitressing at Long Island's Belmont Park for 25 years. "Things change." Indeed they do. On that first Saturday in May, the biggest crowd at the racetrack isn't at Churchill Downs. It's at Louisiana's Fair Grounds, which hosts the New Orleans Jazz and Heritage Festival that day. These are tumultuous times for the racing industry. While most tracks wage a constant battle to keep attendance from falling still further, the gambling side of the business has never been bigger. The total amount wagered on racing in the U.S. set a record in 2000--$14.6 billion. (To put it in perspective, the World Wrestling Federation, cultural phenomenon that it is, generated just $456 million in revenues last year.) That is due to the dramatic growth in off-track betting, where a stunning 80% of the money gets spent. As a result of recent regulatory changes that explicitly permit online wagering on racing, a host of players from major tracks to the Television Games Network are betting the real money will be made farther and farther from the track. At the same time, some tracks are reinventing themselves, hoping to lure customers by turning into casinos, complete with Vegas-style card rooms and slot machines. All that change is taking place in a world fraught with tension between the traditionalists who love the "game" (as true fans call horseracing), modern players who mainly want the money, and small family businesses that are fighting for survival. There are roughly 100 tracks in the U.S., running the gamut from big to small, from state-owned to shareholder-owned. But the bulk of the betting business is concentrated in the hands of a few major players. New York's city-owned off-track betting parlors and the not-for-profit New York Racing Association (NYRA), which runs Belmont, Saratoga, and Aqueduct, control some 22% of the wagering dollars. As recently as the mid-1990s no one else had more than 15%. Today two publicly traded companies--historic Churchill Downs and an upstart Canadian business called Magna Entertainment--control another 50%. For all the uncertainty, this much is clear: The fate of racing lies in the hands of these three very different entities. "These players are how the industry is going to go," says Richard Thalheimer, a Kentucky consultant. "If they fail, there are severe implications." Churchill Downs, which was founded in 1875 by Meriwether Lewis Clark--the great explorer's grandson--was first named in print in an 1883 newspaper article: "The crowd in the grandstand sent out a volume of voice, and the crowd in the field took it up and carried it from boundary to boundary of Churchill Downs." For some 100 years crowds flocked to the track, and its twin white spires became a symbol of racing. In the first half of the 20th century, Churchill was run by Matt Winn, who in the days when sports meant boxing, baseball, or racing was one of the most powerful figures in sports. In 1908, when Louisville banned bookmakers, Winn resurrected the idea of pari-mutuel wagering--meaning that customers bet against one another, not against the house, which makes its money by taking a commission. Some still argue that this makes racing a cleaner form of gambling than casino gaming, where the house profits from customers' losses. Churchill Downs barely survived racing's long, slow decline, which started well before the kudzu-like spread of casinos. Racing still isn't sure exactly what went wrong, but a few obvious factors get most of the blame. In the 1960s the sport decided to avoid TV coverage for fear that fans would stay home. Racing thus missed out on the greatest sports-marketing tool ever, and its heroes--names like Secretariat--gave way to telegenic jocks like Magic Johnson. The advent of state lotteries was another blow. "Our regulator became our competitor" is an oft-heard industry lament. Churchill hit its nadir in 1983. After a few years of operating losses, little remained of its former glory but the Derby. When Tom Meeker became Churchill's president in 1984, he began spending some $50 million on much-needed renovations. He fixed the crumbling paddocks and barns, cleaned up the clubhouse, and helped open the Kentucky Derby Museum. In the late 1990s, in search of growth, Meeker launched an aggressive plan to consolidate what wasn't so much an industry as a disparate group of hobbyists and state-run entities. Since 1998, Churchill has spent more than $300 million on acquisitions, and it now owns six tracks, ranging from Miami's Calder Race Course to L.A.'s Hollywood Park. Revenues--about 70% of which come from gambling--have more than tripled in the past four years, to $362 million. Churchill's headquarters outside Louisville are a mixture of racing's past and its increasingly businesslike present. In the corporate offices, which overlook the track, walls are covered with pictures of Derby winners dating back to the 1800s. Just a short walk from where Meeker and other executives talk to Wall Street is the utterly different world of the "backstretch." Even during the off-season, some 1,000 horses board and train here, creating a micro-economy of trainers, vets, exercise riders, hot walkers, blacksmiths, and of course the racehorses at the center of it all. The track kitchen serves breakfast at 5 A.M. and lunch at 10 A.M., and little seems to have changed in the past century. The word that comes up most frequently to describe Meeker, 58, is "tough." He has cropped white hair and carries himself like the ex-Marine he is. He likes impromptu quizzes, like "How many horses have won the Derby?" (The answer is zero, because technically a horse is a "colt" or a "filly" until its fourth birthday.) And he's quick to toss out statistics to bolster his chief contention: that racing is not just healthy but growing. In 2000 gross revenues from thoroughbred sales topped $1 billion, a record; purses crossed that mark for the first time too. The stud of the moment, Storm Cat, gets $500,000 a pop. This year's Derby, one of the few races that fill the grandstand, drew its second-highest turnout ever--154,000--behind only the turnout for the 100th anniversary. Meeker says that consolidation has resulted in some economies of scale, such as in food and beverage purchasing. But as any entertainment company would tell you, the far greater benefit comes from controlling content. Although Churchill by law can host its "meets" only in the spring and autumn months, it can offer its fans races from Churchill-owned tracks nine months of the year. That is due to a phenomenon known as interstate simulcasting, which exploded in the 1990s. Today tracks sell their "signals" around the country--allowing fans at other tracks and off-track betting parlors to watch those races on TVs and bet. Many second-tier tracks make most of their money buying signals from other tracks, especially for big races like the Derby. Simulcasting is the reason that off-track betting (which includes money bet at one track on another track's race) has soared. Of Churchill's $3.2 billion "handle"--the amount bet at company-owned tracks and off-track sites--only about one-third was bet at the track. If someone somewhere wants to bet on racing, Churchill wants to have a race to offer. Churchill's desire to control content also makes sense because interstate simulcasting has changed horseracing's economics. Tracks make most of their money on the "takeout"--the roughly 20% of the handle that they collect as commission. (The remaining 80% goes back to the bettors.) About 10% of the handle, or half the takeout, goes to the horsemen in the form of purses. Another 2% to 3% of the handle goes to the state. All that leaves the track with 7% to 8% of the handle on a live race. (Thus, tracks pay taxes equivalent to about 30% of their betting revenues, plus the standard tax on profits.) When interstate simulcasting began, tracks treated the additional revenues as free money and agreed to sell their signals for around 3% of the handle. As a result, brokerage firm CIBC estimates that tracks collect about 1.5% of the total dollars wagered on their races at other outlets. By aggregating content, Churchill can bundle its products--for instance, by forcing a place that wants the Derby to also take a less desirable signal--and maybe eventually gain some pricing power. Churchill has made a bold gamble--and now it's proving time. Stagnant results can no longer be papered over with acquisitions, for the simple reason that there isn't much left to buy. CIBC analyst Adam Steinberg says that only a handful of independent top-tier U.S. tracks are left. Simulcasting, which spurred growth over the past decade, will probably moderate now that it's no longer new. Growth becomes even more challenging in a tough economy. Wall Street isn't sure. The market values Churchill at about $370 million; Churchill's stock, which traded over $40 in mid-1998, amid early excitement about expansion plans, now sells for around $28. The reason there aren't many tracks left to buy is that someone else has bought most of them--Magna. In 1998, in a move that shocked horse people, the Canadian auto-parts empire snapped up California's Santa Anita, one of the country's premier tracks. In the past few years Magna has spent $500 million acquiring and improving nine tracks reaching across the U.S. to Florida's Gulfstream Park in Hallandale Beach. Today Magna generates more revenues--$414 million a year--and has a bigger share of the gambling pie than does Churchill. Frank Stronach, the chairman of Magna, inspires more admiration, fear, even antipathy in the racing industry than does Churchill's CEO. Stronach, 69, is both interloper and insider. He's been a thoroughbred owner and breeder for four decades, with farms in Canada, Kentucky, and Florida. He's won the Eclipse award--the Oscars of racing--as the top owner for the past three years. Stronach's vision reaches beyond racing to an electronic empire in which people can bet on any kind of sport from anywhere--a "soft casino in every living room," as he puts it. "His supporters think he's a visionary, while people who don't like him think he's a radical nut case," says Tim Rice, a Magna shareholder and self-described "totally addicted horseman" who is the managing partner of research firm Rice Voelker. Once a penniless Austrian immigrant who bought his first horse in 1961 for $700 because "it was something totally away from work," Stronach has built the company he founded in 1957, Magna International, into a top supplier to the auto industry, with 2000 sales of $10.5 billion. In the early 1990s, Magna had a brush with bankruptcy following Stronach's forays into restaurants, glossy magazines, and politics. Despite the firm's stunning recovery, when Stronach began buying racetracks, wary investors pushed him to spin Magna Entertainment off into a separate company--and to promise that he would allocate no more than $550 million in automotive cash to horseracing over the next seven years. Wall Street, which values Magna Entertainment at roughly $500 million, doesn't yet know what to make of the company. Both the racing and the auto businesses are headquartered outside Ontario in an elaborate Viennese-style castle, complete with a circular drive and a pond. Stronach, an avid athlete who is perfectly attired in his trademark navy silk suit, ends many of his comments with the word "right," which isn't meant as a question. Speaking with an accent that observers compare with Schwarzenegger's, he predicts that Magna Entertainment will eventually be larger than Magna itself, with 300 million to 500 million customers around the globe in ten years. If that sounds insane, note that worldwide, people wager more than $100 billion on racing. And Stronach, who believes that betting on all sports should be legal, does not plan to stop with racing. "What we're building will be practically impossible to duplicate," he claims. "Right." Stronach has his gripes about racing, such as the heavy regulation--to limit competition, there are laws about both the time of year and time of day that tracks can run. "That's why there's so much mediocrity," says Stronach, who likens such rules to permitting a restaurant to open only three months of the year. He also talks of turning tracks into entertainment centers, complete with shopping and other diversions. And he believes tracks need to be more fan-friendly. "Screw the customer" is how a fan at New Jersey's Meadowlands describes the usual attitude. At the track you pay for everything, from admission to beer. At the casino, it's all free. While some tracks do give rebates to big bettors, observers like Thalheimer say that to compete with casinos, tracks need to reduce their takeout. Slot machines, he notes, pay roughly 93% back to the customers, while tracks pay just 80%. And illegal offshore gaming outlets are luring customers away from tracks by offering a higher payout. Of course, Stronach's main reason for being in this business is the same as Churchill's: controlling the content that generates those gambling dollars. Both believe racing's future lies in online wagering via computers or interactive TV. "If racing is going to flourish again, it will be by bringing races to people, not bringing people to the races," says Jack Liebau, who manages Magna's California operations. The hope is that account wagering--in which remote bettors set up accounts with specified minimums--will spur interest in the sport, creating new fans who will then venture to the tracks. In California, which is regarded as a premier racing state and represents some 13% of wagering, the future will arrive on Jan. 1, 2002, when account wagering becomes legal. That will affect both Magna, which owns three tracks in the state, and Churchill, which owns one. In late 2000 the federal government clarified that online and telephone betting on racing is legal across state lines, as long as the individual states agree; on Aug. 13, 2001, Governor Gray Davis legalized account wagering in California. It will be a big test. For all the hope that this is racing's future, it's quite possible that those who would have ventured to the track will now bet in their bathrobes from their living rooms, and that those who wouldn't have gone to the track still won't. "It's unclear that it will spur growth," says Steven Crist, publisher of the Daily Racing Form. "There's no example of that anywhere." In fact, in 1995, when NYRA allowed in-home betting on New York races over phone lines, the tracks suffered a combined decline of 25% in their handle and attendance over the next 18 months. Sure, tracks could still make money from gambling dollars, but if fans stopped coming to the track, would racing still be a sport? Companies other than Churchill and Magna want their share of electronic wagering too. In 1999, Television Games Network (TVG) started a cable channel dedicated to live racing, hoping that customers would eventually set up wagering accounts through it. TVG has spent some $100 million so far; this summer it struck a partnership with Youbet.com, which in turn has invested $80 million in an online-betting platform it launched in 1998. "Horseracing is at the crossroads," says Youbet.com CEO Robert Fell. "The way to make it viable 20 years from now is the Internet." But both TVG and Youbet.com are still losing money, and it's not clear how any profits would be divvied up. Churchill, for instance, has a partnership with TVG, in which TVG shows Churchill races and collects 5.5% of money bet on them. But Magna, at least to date, is going it alone. It's difficult to characterize the country's remaining independent tracks because ownership structures vary so much. Some, like New Jersey's Meadowlands, are state-owned. There also are family-owned businesses like Minneapolis' Canterbury Park and New Orleans' Fair Grounds. Most independents are pleased that Magna and Churchill are investing in the industry--but they're also scared. Take Canterbury Park, which was built in the mid-1980s and was a runaway success until the advent of casinos and state lotteries in the late 1980s. The track then stayed vacant until Randy Sampson's family took it over in 1994. Thanks to a petting zoo, pony rides, and perhaps the flower beds painstakingly planted by Sampson's 67-year-old mother, average attendance has doubled from the lows, to around 4,000--despite the dramatic expansion of Mystic Lake Casino nearby. But as with many tracks, most of Canterbury's gaming profits come from the handle on races it simulcasts, not its own racing. "Will they ratchet the price up and squeeze our margins to the point where we can't afford the signals?" asks Sampson. Others worry that tracks under corporate ownership will focus on profits at the expense of customers and the sport. "I hate to see racing turned into a corporate sport," says Bryan Krantz, who runs the Fair Grounds and is president of the Thoroughbred Racing Association. "It's a sport of emotion." That concern is echoed by NYRA Chairman Barry Schwartz, who says about Meeker in particular, "What he cares about is the bottom line." Schwartz, a longtime fan and horse owner, is also CEO of Calvin Klein--the chairmanship of NYRA has always been more of a honorary role than a business position. Indeed, NYRA itself is seen as a bastion of racing's old world, run more for wealthy horsemen than for ordinary customers. Schwartz's office is filled with racing photos, including a recent shot of him with Hillary Clinton presenting the Belmont Stakes trophy. "My goals are very different from Frank Stronach's or Tom Meeker's," says Schwartz. "My only interest is the well-being of racing and breeding in New York." He and others say that so far, Stronach's talk of revitalizing tracks is mostly just talk--perhaps, he speculates, because of a lack of funds. (Magna just filed that it may raise up to $500 million by selling both equity and debt.) NYRA is changing too. Last summer, in an effort to be fan-friendly, Schwartz lowered the takeout at New York tracks. "He gets it because he's a horse player," says Jerry Brown, owner of Thoro-graph, a handicapping and advising service. Indeed, even NYRA can't ignore the new world of racing--as was all too apparent last summer, when it seemed as if Mayor Rudolph Giuliani would succeed in his plan to sell the city's Off Track Betting parlors, the major off-track outlet for NYRA's racing. In 1993, Giuliani promised to privatize the OTB, famously ridiculing it as the only money-losing bookie in town. Says Ray Paulick, editor of The Blood-Horse magazine: "The New York OTB has turned off one or two generations from going to the track." Yet the OTB controls a huge amount of money, with over $1 billion wagered there in 2000. When Giuliani put it up for sale, Magna, Churchill Downs, and NYRA--which doesn't want to see its chief off-track outlet in the hands of a competitor--all wanted it. In early August 2001, after a lengthy, politically charged process, Giuliani announced that the OTB would be sold to a group led by Stronach for up to $389 million. The outcry, especially from NYRA, was fierce. Schwartz called the decision "ridiculous" and vowed to marshal all the political forces he could to fight the sale. (Stronach didn't make Schwartz any happier by announcing that he'd also like to buy NYRA's franchise when that expired in 2007.) The sale required the approval of the New York State legislature, with most in the industry saying privately that Stronach didn't stand a chance. After the Sept. 11 terrorist attack, the question of the OTB's fate is likely to be shelved for quite some time. No matter what, racing still needs to figure out how to respond to its biggest threat--casino gaming. The tracks that have coped best so far are those that have embraced such gaming themselves. Despite Canterbury's success in increasing attendance, half of its profits now come from a small card club, authorized by Minnesota in 2000. In states like Delaware, which allow tracks to have slot machines, the slots have saved the tracks. Churchill is lobbying aggressively to get video lottery terminals at some of its tracks. Supporters argue that slots allow tracks to have bigger purses, attracting better competition and more people--even purists say the tracks may have little choice. "I loathe the idea of slots," says Rice. "Yet from a realistic standpoint, they're an absolute miracle worker." But no one is sure that those who come for the slots will ever become racing fans. Slot machines are all about quick, mindless thrills and constant jangling. Racing is trifectas and quinellas and handicaps and bloodlines, long pauses between short bursts of action, and perhaps the slow amble to the paddock to view your pick before you place the bet. One is instant gratification; the other is an intellectual pursuit. If live racing is to recover any of its past glory, it still has to do what it has needed (and failed) to do for the past 20 years: attract new people who come because they love the game, as Nascar addicts do, as WWF fans do. Magna especially seems aware of that. "If you haven't got live racing, you've got nothing," says Stronach. "Imagine watching a football game where the stadium has no spectators." In the fall, some of the best racing in the country takes place at NYRA's Belmont Park, with its ivy-covered walls, its statue of Secretariat, and the black-and-white photos of old-time celebrities like Fred Astaire and Bing Crosby that decorate its hallways. On a sunny September Saturday, a young couple--a rare phenomenon at the track--give their prescription for racing's future. "They should emphasize horses, not gambling. There are too many other places to gamble." FEEDBACK: bmclean@fortunemail.com |
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