AUSTRALIAN HOTELS ASSOCIATION (VICTORIA)
ABN 79 948 978 376
Australian Hotels Association (Victoria)
Response to the "Review of Gaming Machine
Entitlement Term" Issues Paper
30 June 2014
Peter M.Burnett
Brian Kearney
President
Chief Executive Officer
Australian Hotels Association (Vic)
Australian Hotels Association (Vic)
Advice • Support • Network • Influence
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LEVEL 1, 1 UTILE COLLINS STREET, MELBOURNE VICTORIA 3000 • PO BOX 18067, 111 BOURKE STREET, MELBOURNE VICTORIA 8003
TEL: (03) 9654 7100 • FACSIMILE : (03] 9654 1 724
AUSTRALIAN HOTELS ASSOCIATION (VICTORIA)
ABN 79 948 978 376
The Australian Hotels Association (Victoria) is pleased to respond to the Victorian
Government's Issues Paper- "Review of Gaming Machine Entitlement Term"- June
2014.
The overarching objective of AHA (Vic) is to effectively contribute to the
establishment and maintenance of an economic and social environment that fosters
the business success of Victorian pubs and hotels.
The on-going strategic objectives of AHA (Vic) are to:
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Protect, promote and advance the interests and rights of members;
Uphold and promote the quality, integrity and reputation of the hotel
industry;
Provide timely, effective, relevant and value adding services to
members, and
Develop and maintain value-adding partnerships with key industry
stakeholders to the benefit of members and such partners .
Within the diverse Victorian hospitality industry, AHA (Vic) membership incorporates
CBD, metropolitan, regional and rural pubs and hotels, accommodation hotels,
resorts and similar businesses .
AHA (Vic) represents the interests of hotel-based gaming venue operators, being
holders of Gaming Machine Entitlements.
Advice • Support • Network • Influence
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LEVEL 1, 1 UTILE COLLINS STR EET, MELBOURNE VICTORIA 3000 • PO BOX 18067, 111 BOURKE STRE ET. MELBOURNE VICTORIA 8003
TEL : (03) 9654 7100 • FACSIMILE: (03) 9654 1724
Contents
Page
1. Summary of AHA (Vic) Response
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2. Nature and Extent of the Issue
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3. Victorian Auditor-General's Report- Allocation of Electronic
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Gaming Machine Entitlements (June 2011)
4. Valuing an Entitlement Extension
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5. Options for Extending the Term of Entitlements
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1. Summary of AHA (Vic) Response
AHA (Vic)'s detailed response to the Issues Paper strongly contends that the best
interests of the Victorian Government, the community and gaming venue operators
will be met by:
• An extension of the term of Gaming Machine Entitlements in perpetuity;
• Only existing Gaming Machine Entitlement holders being eligible to seek to
extend entitlements that they currently hold;
• The aggregate valuation of extended-term entitlements being based on a net
present value/discounted cash flow methodology;
• Valuations applying at a gaming venue level being based on the allocation of
the aggregate valuation across the gaming venue network based on the
venue share of gaming revenue over the period 2012-14 and beyond if
available;
• The Government adopting a flexible approach to funding options to be
available to assist gaming machine entitlement holders in acquiring term­
extended entitlements including options of term payments, facilitation of
a securitisation-based funding scheme etc., and
• Gaming Machine Entitlement holders participating in the process to extend
entitlements on an opt-in basis.
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2. Nature and Extent of the Issue
Question 1:
Further evidence is sought to substantiate industry claims regarding the impact of
the 10 years entitlement term, in particular evidence to show:
• That the difficulty in obtaining finance is directly related to the current
entitlement term and extending the term would improve the confidence of
lenders; and
• How the 10 year entitlement has affected gaming machine operations,
including information such as capital costs, capital refresh and operating costs.
AHA (Vic) Response:
AHA (Vic) on behalf of hotel-based gaming venue operators, being holders of 2010·
issued gaming machine entitlements eligible to operate over the period 2012-2022,
are increasingly concerned that the diminishing operating life of the entitlements are
already impacting on the ability of gaming venue operators to raise required finance
to fund venue refurbishments, gaming-related infrastructure and new developments,
with the availability of such finance to further markedly decline as the life-span of
the existing entitlements reaches half-life and beyond.
AHA (Vic) concerns are summarised as follows:
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Gaming is delivered through quality venues that require continuous
refurbishment if community expectations are to continue to be met;
however it is anticipated that further and new investment in gaming venues
will dry-up by 2016 unless the entitlement term is extended;
The diminishing value of entitlements is resulting in reducing bank
confidence in lending to the sector, with declining loan to valuation ratios
(LVRs) placing existing geared businesses at risk as well as retarding new
investment;
In respect of gaming hotels and to some extent licensed clubs, updated
property valuations in respect of lease negotiations have given rise to
substantial increases in annual rents for up to 20 to 25 years,
notwithstanding that current entitlements expire in 2022, and
Both hotels and licensed clubs have developed long-term (pre-April 2008)
business models and related financing strategies based on continuity in
gaming activity, if such activity is to cease in 2022 it is unlikely that such hotel
and licensed club businesses will be sustainable beyond that date.
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AHA (Vic) has sought advice both from the banking sector and licensed hotel valuers
and brokers regarding the continuing impact of the reducing 10 year term.
Following the volatility of the Global Financial Crisis and its impact on asset values,
there has been a marked contraction in lending to the hotel sector by major banks,
with a number of previous bank lenders withdrawing from hotel lending.
At 2014 there are only two major bank lenders to the Victorian gaming hotel market.
The additional revenue stream available to hotel-based gaming venues could be
expected to see them well-placed to attract bank and financier support; however in
circumstances where venues may already have a degree of gearing, the diminishing
life of the gaming machine entitlements is of concern as the pay-back period for
borrowing is unable to exceed 2022.
The heterogeneous nature of hotel-based gaming venue financing demands is very
much a consequence of the timing of the particular venue operators entry to the
Victorian gaming market.
Early 1992-1996 entrants operated in an uncapped less stringently regulated
environment, where gaming machine numbers, whilst subject to control by Tabcorp
and Tattersalls, were able to more easily expand in response to demand.
Entrants over the period 1997 to 2008 faced a significantly growing regulatory
regime at both a State and Local Government level, with increasingly costly
regulatory requirements and time delays to obtain necessary approvals to install
gaming machines into an existing venue, to develop a greenfield site or to top-up
existing EGM numbers.
Federal Government regulations impacting on gaming hotels also came into effect
e.g. AUSTRAC AML/CTF requirements etc.
The period saw an increasing number of on-market gaming hotel acquisitions where
required gaming-related approvals and permissions were already in place.
It was during this period that larger corporate licensed entities embarked on a
consolidation of gaming hotels through on-market acquisitions.
Such investment at market prices necessarily required relatively high levels of
financing.
Initial investments over 1992-1996 and on-market acquisitions over 1997-2007 were
erroneously based on the assumption that such gaming operations would continue in
perpetuity.
This mis-placed assumption was held by both gaming venue operators and financiers.
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The period 2007-2010 saw the onset of high levels of uncertainty, with anxiety
besetting geared hotel-based gaming operators and their financiers due to:
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The announcement in April 2008 of the shift to an owner operator model
from 2012 for a 10 year period up to 2022;
The initial and continuing impact of the Global Financial Crisis, and
The announced intentions to remove automatic teller machines from gaming
venues by 2012 and to introduce pre-commitment from 2015.
The sudden and belated appreciation by April 2008 that the initial
Tabcorp/Tattersalls gaming licence was for 20 years only, and that the announced
owner/operator model would be for 10 years only from 2012, had a seismic impact
on the sector's financiers.
With already declining asset values due to the GFC exacerbated by a new
understanding of the limited term of venue-based gaming in Victoria and
uncertainties about the proposed entitlement auction process, financiers reduced
LVRs from the then prevailing 70-75% to approximately 50%.
The period 2010 to the present has generally seen increasing confidence return to
the sector as the complex 2010 gaming machine entitlement auction process was
resolved, the owner/operator scheme was implemented, albeit with transition to the
new monitor presenting challenges, and with the post-2012 gaming taxation rates,
although recently increased, having reasonable regard to the increased venue costs
and risks incurred through the owner operator/model.
Such growing confidence is now being weighed down by the increasing uncertainty in
response to the limited 10 year term of the entitlements.
Banks and financiers remain wary, with LVRs remaining at the 50%-60% level.
Gaming-related capital funding has a reducing payback period, now just 8 years,
which is also deterring financing and consequential investment.
The impact of the 10 year and reducing term is not only evident through reduced
financing availability but is also impacting on gaming venue leasehold rental
payments where 20 to 25 year leases for gaming venues are being executed
notwithstanding that gaming revenues are only secured to 2022.
AHA (Vic) has sought expert advice in respect of market rentals pertaining to gaming
hotels and specifically the effect on such rentals ofthe new Victorian gaming
regulations from 16 August 2012 to 2022.
The gaming segment of a gaming-hotel business is not valued separately to the
entire hotel business. Rather the valuation addresses all segments of the business as
a single integrated entity.
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Historically, rentals for hotel-based gaming venues have been determined within the
range of 35% to 45% of EBITDA (Earnings before Interest, Taxation, Depreciation and
Amortisation), and 15% to 20% of gross revenue (the latter generally utilised as a
check method).
It is agreed by market participants that ratios will not markedly alter from the historic
levels under the post-2012 regime.
Rental ratios reflect a range of considerations including:
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The lease terms and conditions including the rent review provisions and
obligations of both parties to the leasing arrangements, and
Considerations in respect of location, the extent, condition, design of
improvements, the style & mix of trade and an analysis of the business
operation.
Valuers advise that in the post-2012 environment in Victoria regard must also be had
to:
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The adverse impact upon gaming expenditure as a consequence ofthe
removal of ATMs from all gaming venues is still to be fully determined;
Further changes to gaming regulations including voluntary pre-commitment
and changes to gaming taxation rates;
Uncertainty regarding the operation of gaming beyond 2022, and
The impact of online gaming alternatives upon the Victorian gaming industry.
To measure the impact on rentals of the post-2012 regime, five (5) finalised rent
reviews under the post-2012 regime were analysed per Table 1.
TABLE 1: Increases in hotel-based gaming rentals post August 2012
Hotel
Inner Metropolitan Hotel100 EGMs
North Suburban Hotel100 Entitlements I 90 EGMs
Eastern Suburban Hotel75 Entitlements I 65 EGMs
Northern Western Suburban
Hotel- 42 EGMs
Southern Suburban Hotel65 EGMs
Increase in EBITDA
$1,250,000 p.a.
($12,500 p.m. I 100 EGMs)
$1,500,000 p.a.
($16,666 p.m. I 90 EGMs)
$1,275,000 p.a.
($19,615 p.m. I 65 EGMs)
$825,000 p.a.
($19,643 p.m. I 42 EGMs)
$1,060,000 p.a.
($16,308 p.m. I 65 EGMs
Increase in assessed rent
over previous market rent
$385,000 p.a.
31% of EBITDA increase
$383,000 p.a.
25.5% of EBITDA increase
$457,000 p.a.
35.9% of EBITDA increase
$305,000 p.a.
37% of EBITDA increase
$385,000 p.a.
36% of EBITDA increase
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In the above sample, rental increases in dollar terms range from $305,000 to
$457,000 p.a. (excluding GST), representing 25.5% to 37% EBITDA-based increases.
The Lessee is now providing the gaming operation at a significant capital cost and is
taking on additional risk whilst the freehold owner is generally benefiting from a
"windfall" through providing the same premises as prior to August 2012.
It is anticipated that rental increases in the range of 25% to 37% of the increase in
EBITDA will be normal in rental outcomes for gaming hotels going forward.
The increased rent being faced by gaming hotel leaseholders is but one element of a
"financial trap" that is confronting Victoria's gaming hotel sector i.e.
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Diminishing value of the gaming asset due to the 10 year term of the
entitlements;
Increasing reluctance of banks to lend due to the diminishing value and
related uncertainty;
Reducing LVRs increasingly placing existing leveraged businesses at risk and
retarding new investment, and
Increasing long-term rents locked in for up to 20 years based on short term
EBITDA increases driven by gaming-related revenues up to 2022.
Timely action to extend gaming machine entitlements beyond 2022 in perpetuity
will:
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Redress the declining value of the gaming asset;
Increase certainty and confidence regarding future cash flows from gaming;
Stabilise LVRs in respect of gaming venue financing, and
Better align leasehold rental terms with gaming-related revenue earning
capabilities.
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Question 2:
It will be helpful to better understand venue operators existing bank finance
arrangements at the high level, in particular:
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What are the different classes of assets that venue operators use to obtain
bank finance?
What are the respective proportions for each asset class in obtaining the
venue operators total lending requirements, including gaming machine
entitlements?
How reliant are venue operators on gaming machine entitlements with
respect to overall lending requirements?
AHA (Vic) Response:
The ability of a gaming hotel operator to leverage the value of a hotel is dependent
upon the equity held within the asset.
Entities with sufficient equity within their hotels will generally not be required to
provide additional supporting assets to assist them with the financing of their venue.
Those who are more highly geared or do not reach the minimum equity standards
prescribed by a financier will be required to top up their security position through
either security over additional business assets or security over available personal
assets.
Such borrowers are exposed to changes in economic conditions, in financiers
appetite for gaming-related investments and to changes in gaming taxation and the
gaming regulatory regime.
The basic asset classes related to gaming hotel venues can be categorised as:
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Going-concern operations
Leasehold operations
Gaming machine hardware and software upgrades
A Going-Concern Operation entails both the hotel freehold and the hotel business
owned and operated by the same and/or related entities.
This is the preferred asset class for the majority of financiers. Such assets are more
often owned by generational operators, with the assets being highly-priced and
closely held.
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A small gaming freehold going-concern hotel within suburban Melbourne would be
valued in excess of $10 million dollars, with the largest hotels in this asset class being
valued at in excess of $60 million dollars.
In respect of going concern assets, financiers are generally willing to lend up to
60/65% LVR of the going-concern valuation of the hotel, with the valuation based on
a multiple of current hotel core EBITDA earnings.
The current multiple of EBITDA of a going concern gaming hotel within suburban
Melbourne for acquisition purposes is generally between 10 and 11times EBITDA.
A Leasehold Operation entails the freehold being owned by a non-related party with
a commercial lease entered into with a hotel operator to conduct business from the
leased premises.
The term of such a lease is typically 20 to 25 years, with regular rent reviews.
Financiers may be less attracted to this class of asset due to the reduced security
should the business become financially stressed and/or fail. Financiers may be
attracted into lending into this class where the operator is of considerable
experience and/or the leased business forms part of a larger diversified portfolio.
Leaseholders operating gaming venues are not permitted to utilise Gaming Machine
Entitlements as security for borrowings.
In respect of a Leasehold Operation, financiers will typically lend up to a maximum of
50% of the EBITDA-based valuation of the leased hotel.
The current multiple of EBITDA of a leasehold gaming hotel within suburban
Melbourne for lease acquisition purposes is between 5 and 7 times EBITDA.
Gaming Machine Hardware and Software Upgrades
The funding of the gaming machine hardware and software upgrades is a
significant financial demand on gaming venue operators.
With a gaming venue's core financier often already holding a specific charge over the
entity which maintains the venue operator licence (VOL), the venue operator is very
much dependent upon the appetite of alternate financiers to further extend their
borrowings for this class of asset.
Venue operators increasingly rely on the finance provided by entities recorded on
the Manufacturers and Supplier Roll, in particular Gaming Management Service
Providers and electronic gaming machine manufacturers.
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Gaming Management Service Providers may provide for regular gaming machine
updates and replacement through their negotiated service offer at an agreed per
machine per day cost to the venue operator.
Gaming machine manufacturers may offer leasing options to gaming venue
operators.
Major financiers have been seemingly reluctant to seek approval to join this Roll due
to potential reputational risk, the protracted procedure required to participate and
their inability to take a security charge over the gaming machine entitlements that
underpin the utilisation of gaming machine hardware.
Question 3:
In section 2.3, the nature of the problem claimed by the industry was identified. Are
there any other problems (e.g. market failures), that arise for the current term of
entitlements? If so, please explain and provide supporting evidence.
AHA (Vic) Response:
There are a range of Government-mandated restrictions on the availability and
operation of gaming machines in Victoria that fundamentally distort the market,
including:
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Local Government Area caps;
Maximum 13750 gaming machines in pubs and licensed clubs respectively;
80/20 geographic allocation of EGMs between Metropolitan and Regional
areas, and
50/50 allocation of EGMs between pubs and licensed clubs etc.
The Government has stated through the Issues Paper that these restrictions are not
on the table for further consideration as to their efficacy during the Review ofthe
Gaming Machine Entitlement Term.
A significant and presumably unintended consequence of these restrictions is the
very limited capacity of developers, investors and venue operators to establish new
hotel-based fully diversified hospitality venues, including gaming, in the substantial
emerging residential communities on Melbourne's perimeter.
Whilst a relatively small number of new such gaming hotel-based developments have
been successfully undertaken at Craigieburn, Point Cook, Mernda etc. since 2012, the
investments have typically drawn on the utilisation of Gaming Machine Entitlements
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acquired at the 2010 auction rather than through the Gaming Machine Entitlement
Pool or relocation of previously allocated entitlements.
With such capital investments typically ranging between $10-$30 million per venue,
new proposals are now being severely retarded by both:
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The lack of available gaming machine entitlements to underpin the revenue
requirements of such a new business, and
The limited term over which the current gaming machine entitlements may
operate to repay borrowings.
Question 4:
Given the problem articulated by the industry, are there any other options that
would address this problem apart from extending the term of entitlements?
AHA (Vic) Response:
Within the limitations imposed by the Government in terms of responses to the
Issues Paper e.g. no changes to Ministerial Directions re: caps, number of EGMs etc.,
AHA (Vic) does not identify any options other than a meaningful extension of term of
post-2012 Gaming Machine Entitlements in order to address the range of issues
detailed in responses to Questions 1to 4 of the Issues Paper.
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3. Victorian Auditor-General's Report- Allocation of Electronic Gaming Machine
Entitlements
The Issues Paper canvasses the perceived deficiencies in the 2010 Gaming Machine
Entitlement auction as reported by the Victorian Auditor-General's Office (VAGO).
Such deficiencies were in no way a consequence of the auction participants seeking
to compromise, distort, disrupt or manipulate the auction process.
Rather, auction participants were required to engage in an auction process totally
and solely designed, controlled and implemented by the then Victorian Government.
To the extent that VAGO has identified deficiencies, they were due to the policy and
practice of the Victorian Government of the day.
The then Government opted for a "competitive" auction-based model that delivered
an outcome consistent with prevailing market forces operating within the strictures
of the auction model and its processes.
That the then Government may have over-estimated the competitive tension,
particularly in light of the impact of the pre-auction club offer, the large group cap
etc., was a risk amongst many inherent in the adoption of such a market-driven
auction process.
To second-guess in hindsight and criticise the "competitive" market-driven auction
outcome through the utilisation of an alternative non-market driven "administrative"
valuation approach, as adopted by VAGO, may be informative for comparison
purposes, however in no way does it render the former nugatory.
Whilst it is appropriate and reasonable for the Government to be "significantly
informed" by VAGO's findings related to the process of the 2010 Gaming Machine
Entitlement auction in determining a process for consideration of the extension of
the entitlements beyond 2022, AHA (Vic) rejects the proposition that the VAGO
estimate of value for the period 2010-2022 based on 2011 inputs, and not informed
by current and forecast gaming venue Profit and Loss Statements, is the benchmark
against which the value for an increase in the gaming machine entitlement term
beyond 2022 should be measured.
Rather, drawing on the learnings from the 2010 auction experience, AHA (Vic)
proposes the adoption of an objective and independently determined valuation
model based upon net present value/discounted cash flow methodology in valuing
an extension of the term of Gaming Machine Entitlements beyond 2022 utilising up­
to-date data to inform the input metrics.
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AHA (Vic) supports the intention of the Government as detailed in the Issues Paper
to engage an independent consultant to provide advice on the value of the extension
based on such a valuation methodology.
Rigorous assessment of gaming venue revenues and costs over the relevant period,
the application of an appropriate discount rate, all in the context of the required
internal rate of return for the venue, will result in the application of a valuation
methodology consistent with the methodology utilised by VAGO in their 2011
review.
Whilst each gaming venue has differing metrics for the revenue and cost variables
impacting on its unique business, the adoption of agreed averages for the various
inputs will allow the determination of an aggregate valuation for the extension of the
term of Gaming Machine Entitlements for the negotiated term.
Both the Government and the venue-based gaming industry are now much better
placed in 2014 than was VAGO in 2011 to identify accurate values for the input
variables following two years of post-2012 gaming trading, the impact of the total
removal of ATMs from gaming venues, softening gaming revenues and increased
gaming taxation from 1May 2014, the continuing shift of consumers to on-line
gaming (over 1.8 million Australians gambled on-line in 2012/13) etc.
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4. Valuing an Entitlement Extension
As detailed at Section 3, AHA (Vic) proposes the adoption of an objective and
independently determined net present value/discounted cash flow methodology for
the valuation of an extension of the term of Gaming Machine Entitlements beyond
2022 utilising up-to-date revenue and cost data.
Question 5:
What kind of capital, operating and other business costs are faced by venue
operators and what proportion of player loss do they generally constitute?
AHA (Vic) Response:
In modelling a relevant Net Present Value/Discounted Cash Flow table AHA (Vic) has
identified capital, operating and other business costs, measures and variables
including:
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Valuation date
Forecast period
Weighted average cost of capital
Venue type
Average number of EGMs
Forecast inflation rate
Net expenditure per EGM and forecast growth
EGM maintenance and marketing
Wages- managerial, admin, operational etc.
Regulatory costs (monitoring, pre-commitment, VCGLR regulatory fee etc.)
EGM software upgrades
EGM hardware acquisition and replacement
Venue refurbishment
State gaming tax
Commonwealth GST
Depreciation on refurbishment and EGMs
Commonwealth company tax and other relevant taxes based on entity
structures
Cost of gaming machine entitlement acquisition
Federal Government regulatory costs e.g. AUSTRAC etc.
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The metrics for these variables as identified and applied by AHA (Vic) in its modelling
will be provided to the Victorian Government for independent assessment during the
process of the review.
Question 6:
What are the costs of capital considerations faced by venues seeking access to
finance? What is the appropriate discount rate which should be applied in this
instance, including an appropriate risk premium?
AHA (Vic) Response:
As detailed in responses to Questions 1to 4, the cost to venues of acquiring capital
varies in response to the unique business case.
In its analysis in identifying the appropriate discount rate, AHA (Vic) has had regard
to:
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•
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The current yield on a 10 year Australian Government bond combined with
the forecast 10 year government bond yield in the future;
An equity risk premium;
A small stock premium, and
A premium for risks and uncertainties.
Based on the above and as detailed at Table 2, AHA (Vic) estimates the cost of capital
for the purposes of valuing an extension of Gaming Machine Entitlements beyond
2022 at 17%.
TABLE 2: Estimated cost of equity- see table on page 18.
Question 7:
Is the valuation method reasonable in reflecting venues' cost structures? Are there
any other variables that the Review should consider?
AHA (Vic) Response:
AHA (Vic) proposes a net present value/discounted cash flow methodology for
valuing gaming machine entitlements post-2022.
At QS the relevant input variables are identified.
17
• We have utilised in our indicative valuation analysis a cost of equity (which was based on the Capital Asset Pricing Model) of approximately 17%
Ke= Rf·+ ( B *ERP) +Ssp+ u
17%
•
= 4.4% + (0.85·* .6o/o ) + 4.5o/o + 3o/o
• We have adopted the current yield on a 10 year Australian Government bond combined with the foreca st 10 year government bond yield in the future, which
resulted in an adopted 'risk free rate' of approximately 4.4 percent
• We estimated the beta( ) to be in a range of 0.8 to 0.9 based upon our comparable company analysis
• The equity risk premium typically used in Austra lia to va lue investments is 6 percent
• The discount rate of small compa nies are typically higher than large capitalisation companies. We have assumed a small stock premium (Ssp) in the range of 4
to 5 percent
• We included an alpha factor (a) in the discount rate. This adjustment accounts for risks and uncertainties that have not been reflected in the cashflow
forecasts. Whilst we adjusted the cashflows for
best estimate of the impact of pre-commitment the regulatory reform is still developing and
consequently the assumptions are very subjective. Additionally the venue operating model is a new concept f or many Victorian gaming machine entitlement
holders and therefore elements of the assumed costs are as yet unknown
• Based on this we assumed. in our estimate of a cost of equity, an alpha factor of 3 percent
Note: each venue operator will have their own cost of equity and should consider the above analysis as an indicative calculation
_,
cP
5. Options for Extending the Term of Entitlements
From the Coalition Government's public response to the financial outcome of the
2010 auction, informed by the VAGO report, it is clearly the Government's view that
the 2010 auction of Gaming Machine Entitlements did not achieve maximum value
for the State.
In light of the Government's view, the Issues Paper details the specific objectives of
the 2014 review, being to:
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Ensure a rigorous assessment of the industry position seeking an extension
of the entitlement term and designing an efficient and targeted policy
response;
Maximise value for money for the Victorian community;
Ensure priority considerations are strictly observed, and to
Deliver on the Government's on-going commitment to policies relating to
problem gambling.
In respect of achieving value for money, the Issues Paper also identifies the necessity
of ensuring the continued competitiveness of Victoria's pub and club-based gaming
industry.
Based on learnings from the 2010 Gaming Machine Entitlement Auction and the
earlier Pre-auction Club Offer, AHA (Vic) is of the view that a model to extend the
term beyond 2022 should be based on:
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A clear understanding of the objectives of the review from both a
Government and a gaming venue operator perspective;
The utilisation of a simple, sound and transparent process devoid of the
complexity, mystery and secrecy (paranoia) of the 2010 process;
The settlement of a term of the proposed extension that reasonably balances
the respective interests of the community and gaming venue operators;
The application of an extended -term entitlement allocation process that
soundly reflects value from both the Government and the gaming venue
operator perspective;
Implementation of payment options that deliver a timely return to
Government within the financing capabilities of gaming venue operators.
The Issues Paper seeks responses to key matters relevant to consideration of
extension of the term of gaming machine entitlements:
• Who should be eligible to apply for an extension of the term and for what
entitlements?
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• What are the options for the length of the term extension and should it be
fixed or variable?
• How should payments be made for the term of the extension?
• Should an "administrative" or "competitive" model be applied to allocate
term-extended entitlements?
Gaming Machine Entitlements for the period 2012-2022 are licensed to:
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Entities who successfully bid for them at the May 2010 auction and/or who
acquired them through the Pre-auction club offer, with the overwhelming
majority of entitlements now deployed at approved gaming venues;
Entities who have acquired entitlements through the purchase of gaming
hotel leaseholds or freehold/leasehold, and
Entities who have acquired entitlements through the Entitlement Transfer
Pool to be deployed in approved gaming venues.
The acquisition and deployment of entitlements is subject to the Gambling
Regulation Act and Regulations and an extensive range of Ministerial Directions.
The Issues Paper in contemplating options for who may be eligible to apply for a
term-extended entitlement identifies:
a) Venue operators who currently hold 2012-2022 entitlements being able to
exclusively apply for an extension of their own entitlements,
b) All current entitlement holders being able to apply for any term-extended
entitlement in the market, including their own, or
c) All current entitlement holders and potential new entrants holding a venue
operator's licence being able to apply for any entitlement extension including
their own
In the view of AHA (Vic) option a)- Venue operators who currently hold 2012-2022
entitlements- is the only tenable option on an opt-in basis.
The purpose from the industry perspective of seeking an entitlement extension
beyond 2022 is to address financial, investment and operating uncertainties.
To introduce the potential for entities to bid for term-extended entitlements other
than those they are currently licensed to operate will create significant additional
uncertainty and confusion and provide avenues for speculators to disrupt and/or
manipulate the process outcomes.
Further dysfunction would occur if freehold owners sought to secure their interests
by potentially out-bidding their existing tenant and triggering a premature breach of
the venue lease to their advantage.
20
2012-2022 Gaming Machine Entitlement holders not seeking to extend the term of
the entitlements would be entitled to so act by not opting into the entitlement
extension process.
Whilst options b) & c) above may theoretically promote increased competition and
drive prices higher to the benefit of the State, the reality will be an exacerbation of
confusion and uncertainty that will destabilise gaming going forward to the
detriment of both State and gaming venue operator interests and in turn the
Victorian community.
The on-market purchase of the leasehold or freehold/leasehold of an existing gaming
hotel is the most common means of new entrants accessing Gaming Machine
Entitlements and the hotel-based gaming sector.
The Gaming Entitlement Transfer Pool also provides a viable, efficient and equitable
means by which new entrants may acquire entitlements or for existing gaming venue
operators to "top-up" entitlements.
Question 8:
What proportion of entitlement holders might want to extend the term of their
existing entitlement? What segments of the market will the desire to extend the
term of entitlements come from (e.g. metro vs. regional; clubs vs. hotel sector,
etc.)?
AHA (Vic) Response:
AHA (Vic) anticipates that all operators of hotel-based gaming venues will opt to
extend the term of their Gaming Machine Entitlements subject to the
reasonableness of the price to be paid and the length of term extension offered.
Hotel-based gaming operators will not accept any term extension at any price.
All regional as well as metropolitan hotel-based gaming operators could be expected
to take up an extension of term provided it satisfies their financial and operating
objectives.
Community Clubs Victoria and the RSL are best placed to advise regarding the
anticipated actions of the committees of licensed clubs with gaming machines in
respect of taking up an offer to extend the term of club-based entitlements.
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Question 9:
Within the regulatory constraints on the ownership of entitlements, should existing
entitlement holders and potential new approved entrants be able to apply for an
extension to an entitlement that is not theirs?
AHA (Vic) Response:
As detailed at Question 7, AHA (Vic) is firmly of the view that only current holders of
Gaming Machine Entitlements should be able to apply for an extension of the term
of those entitlements currently licensed to them.
To allow other parties to seek to extend the term of entitlements would result in
considerable dysfunction in regard to entitlement ownership and operation.
Question 10:
Within the regulatory constraints on the ownership of entitlements, what
proportion of entitlement holders would seek to increase or decrease the number
of entitlements they hold as part of an entitlement extension process? For
example, would venue operators seek to compete for entitlements that are
currently not theirs? What segments of the market will the desire to apply for an
extension to an entitlement that currently is not theirs come from (e.g. metro. Vs.
regional; clubs vs. hotels sector, etc.)?
AHA (Vic) Response:
With AHA (Vic) firmly of the view that only current holders of Gaming Machine
Entitlements be entitled to seek an extension of the term of those entitlements
which they currently hold, the process for acquiring extended-term licences should
not be a vehicle for decreasing or increasing the number of entitlements held.
To the extent that an operator chooses not to extend the term of all or a portion of
their entitlements, the non-extended entitlements will expire in 2022, unless the
Government initiates a further term extension process in 2020-2022.
The non term-extended entitlements and the venues at which they are deployed will
necessarily significantly decline in value in the run-up to 2022 compared to term­
extended entitlements.
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Question 11:
Would a uniform length of extension for the entitlement term or a variable length
be more appropriate noting that industry would be required to pay a fair market
price for any entitlement extension?
Question 12:
If a uniform length of extension is preferred, would a shorter or longer entitlement
term extension be more appropriate noting that industry would be required to pay
a fair market price for any entitlement extension? Please provide reasons for your
preferences.
Question 13:
If venue operators have a choice of extension length, what lengths should be
available noting that industry would be required to pay a fair market price for any
entitlement extension. Please provide no more than four length options.
AHA (Vic) Response:
As detailed in responses to questions 1to 4 there is from the gaming venue operator
perspective an imperative to build business certainty, security and sustainability into
Victoria's venue-based gaming industry.
The 8 year and declining horizon to 2022 is increasingly militating against a
willingness by financiers to fund investment and development.
As identified in the Issues Paper, Victoria is the only Australian mainland jurisdiction
where the gaming entitlement/licence term is less than perpetual.
In Victoria liquor licences are issued in perpetuity, with on-going licensing subject to
compliance with the Liquor Control Reform Act 1998, including payment of an annual
risk-based licensing fee by the licensee.
The rationale for successive Victorian Governments to date adopting a restrictive
term-based entitlement/licensing approach to venue-based gaming i.e. 1992-2012
and 2012-2022, is not apparent.
It can be but surmised to be a consequence of the uncertainty by the then
Governments (Labor- 1992 & Labor- 2010) regarding the commercial viability of the
gaming models put in place and/or lack of confidence in effectively responding to
problem gambling concerns into the future.
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By 2014 the time-limited term is itself exacerbating concerns regarding the long-term
viability of the venue-based gaming business rather than contributing to certainty.
Historically it may be understandable that a twenty (20) year term was put in place
when venue-based gaming was introduced in Victoria in 1992.
The then Totalizator Agency Board of Victoria and Tattersalls operator model was
based on real-time monitoring unique at that time in Australia, with uncertainty as to
the longer term viability of both the model and gaming itself in Victoria prevalent at
the time.
The rationale for the Brumby Labor Government in limiting the 2008-announced
owner operator model from 2012 to a 10 year term is unknown and not detailed in
public documents detailing the proposed changes.
Again it can only be surmised to be as a consequence of uncertainty by the then
Government as to the viability of the announced owner operator model,
notwithstanding its application across Australia at the time, and retaining the option
to revert to the previous operator model or an alternative if the owner operator
model failed.
In the Issues Paper the criteria identified by the Government in determining the
length of an extended entitlement term include:
•
•
•
•
Ensuring that a licensee has sufficient time to "breakeven";
Achieve some parity with the length of relevant asset life (estimated to be 4
to 5 years per gaming machine);
Ensuring there is a fair revenue return from gaming machines; and
Providing long-term opportunities for Government to allocate future licences
in a manner that reflects any potential changes in policy, objectives,
technological changes or consumer preferences.
The proposed valuation model has the capacity to take all the above issues into
account to deduce a valuation, except the "...potential changes in policy objectives,
technological changes" criterion.
The latter are surely risks to be addressed by the venue-based gaming industry
rather than the Government.
Such policy and technological changes into the future may well negatively impact on
venue-based gaming revenues; however if gaming venue operators are willing to
accept these additional risks there is no valid reason to discount the term of the
entitlement to take account of them.
To the extent that there is a so-called "safety" concern in regard to enshrining
gaming into the Victorian licensed hospitality offering in perpetuity, recent decisions
24
of successive Victorian State Governments, including a total ban on ATMs at gaming
venues from 1July 2012 and the introduction of voluntary pre-commitment from
December 2015, in conjunction with the extensive array of problem-gambling
directed initiatives implemented over recent years, sees Victoria well exceeding
national benchmarks for safe and responsible gaming.
With both the conduct of gaming and the operation of the licensed businesses being
subject to the rigorous and demanding controls of both the Gambling Regulation Act
and the Liquor Control Reform Act, there are checks and balances in place to ensure
on-going compliance with the law and the delivery of responsible gaming.
In considering options for the length of time over which Gaming Machine
Entitlements may be extended, the Government puts forward three (3} alternatives:
•
•
•
A short extension period (5 to 10 years}
A medium extension period (10 to 20 years}
A long extension period (20 to 25 years}
AHA (Vic} strongly contends that the Gaming Machine Entitlements should be
extended in perpetuity.
Such an extension would establish equivalency between the Victorian gaming term
and those operating in all other Australian mainland states.
An in perpetuity extension would align Gaming Machine Entitlements with the liquor
licence that underpins both gaming and liquor trading in licensed businesses.
An in perpetuity extension would stimulate the Victorian gaming hotel sales market
and attract significant new investment, particularly from existing New South Wales
and Queensland operators who are currently deterred from seeking to enter the
market through the arbitrarily time-limited life of Victorian entitlements.
The Government in the Issues Paper also identifies a concern of the Government
that:
"... significant barriers exist to implementing perpetual entitlements in Victoria, not
the least of which would be the substantial up front cost that venue operators would
need to pay to ensure the State received fair value".
In AHA (Vic}'s view the Government is being premature in adopting such a position
prior to the conduct of an independent assessment of the value of term-extended
entitlements.
The Government should not assume that Gaming Machine Entitlement holders are
unable to fund an in perpetuity extension until the cost of such an extension is
known.
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In light of the above, AHA (Vic) will seek to negotiate the maximum term extension
acceptable to the Government.
Based on the above AHA (Vic) proposes an extension of gaming machine
entitlements beyond 2022 in perpetuity on an opt-in uniform basis.
Question 14:
What is the preferred payment method for a possible entitlement extension: an
upfront payment or instalment payments across the life of the extension?
AHA (Vic) Response:
The Issues Paper identifies two options regarding payment terms for an entitlement
extension:
•
•
An upfront payment at the time the extension is confirmed, or
Instalment payments across the life of the extension.
With each gaming venue, whether hotel or licensed club, having unique financial
arrangements and gearing in respect of the business, a flexible approach to payment
terms by the Government is appropriate.
Venues have widely varying availability of free asset backing to support further
borrowings to finance a term extension.
AHA (Vic) seeks the adoption of a flexible approach by Government in regard to
funding models ranging from a term payment scheme based on the current term
payment scheme for entitlements granted in 2010 through to a securitisation-type
payment model by a third-party financier whereby on an opt-in basis gaming venue
operators will commit their term-extension payment obligation to a pool from which
a bond offering will be created.
The benefits of such a securitisation facility are:
•
•
No additional asset backing is required from venues to underpin the required
financing, and
A significant proportion of the total payment due to the Government
through term-extension payments will be payable up-front.
26
The proposal envisages no obligations on the State beyond empowering the monitor­
lntralot, to sweep relevant venue gaming accounts monthly to collect the amount
due to bond holders.
Question 15:
Would an administrative process for the extension of entitlements be appropriate?
Are there any other advantages or disadvantages to this model?
AHA (Vic) Response:
The Issues Paper well describes the respective strengths and weaknesses of both an
administrative allocation model and a competitive allocation model.
In 2010 the then Government implemented a complex market-driven competitive
allocation model for all hotel-based gaming entitlements and the majority of club­
based entitlements, with the balance of the club entitlements allocated through an
administrative allocation model i.e. the Pre-auction club offer.
VAGO has highlighted the deficiencies of that hybrid of both competitive and
administrative allocation models.
The view of AHA (Vic) is that in order to avoid the controversy, uncertainty and the
potential for unfulfilled expectations on both the Government's and Gaming
Machine Entitlement holders' part, the adoption of an administrative allocation
model is now the only viable option.
To the extent that the application of the model delivers fair-value to both the
Government and gaming venue operators it will have satisfied the objectives of the
process.
To adopt a competitive allocation model will again subject the Government and
gaming venue operators to the vagaries of the 2010 auction.
As detailed earlier, AHA (Vic) proposes an administrative allocation model based on a
net present value/discounted cash flow methodology to determine the aggregate
value of gaming machine entitlements based on average input variables.
AHA (Vic) proposes that upon determination of the aggregate value of the term
extension that value be allocated across the relevant gaming venues based on their
proportion of aggregate net gaming revenue derived from gaming machine
operations for the period 2012-2014 and beyond.
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It may be that the independent identification of the average input variables reveals a
fundamental difference between those of hotel-based and club-based gaming
venues.
If so, it may be that the two are required to be treated separately in determining the
average aggregate value for the term-extension and the subsequent allocation across
venues.
Gaming venue share of aggregate gaming revenue is an appropriate basis of
allocation in that it accurately reflects whether the venue is:
•
•
•
•
Metropolitan: Regional
Large venue: Smaller venue
Pub-based: Club-based
Corporate: Independent etc.
Question 16:
What are the key issues and variables for consideration in determining the price to
be paid under an administrative process?
AHA (Vic) response:
The objective of the application of an administrative process for determining the
value of an entitlement term extension must satisfy the Government's objective of
balancing the maximisation of value for the Victorian community, whilst ensuring the
continued competitiveness of the Victorian gaming industry going forward.
AHA (Vic) proposes that the administrative process be underpinned by an
independent net present value/discounted cash flow analysis based on average
revenues and cost inputs to determine aggregate value, with that aggregate value to
be allocated across gaming venue operators based on individual venue share of
gaming machine revenue.
Whilst each gaming venue will vary in respect of gaming revenue and cost inputs, the
allocation of the aggregate value across venues based on share of total gaming
revenue will ensure equity.
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Question 17:
Should the price formula enable different prices to be set for different classes of
entitlements?
AHA (Vic) Response:
Gaming machine entitlements are primarily classified as Hotel-based entitlements or
Club-based entitlements.
Other bases of classification may include:
•
•
CBD and metropolitan venues: provincial and regional venues
Group-operated entitlements: independently-operated entitlements
The allocation of the aggregate valuation across gaming venues on a per venue share
of gaming revenue will equitably have regard to such classifications.
Question 18:
Would a competitive process for an extension to entitlements be appropriate?
What would the advantages and disadvantages be?
AHA (Vic) Response:
Based on learnings from the 2010 Gaming Machine Entitlements auction process,
including the Pre-auction club offer, there must be considerable doubt that a
competitive process for the allocation of extended-term entitlements can satisfy the
Government's stated objectives in regard to the extension of the term of Gaming
Machine Entitlements.
From a theoretical perspective the competitive process should result in an outcome
where buyers bidding against each other will pay up to the maximum price in line
with their required rate of return to acquire what is a highly restricted product.
However, the 2010 auction experience and the subsequent VAGO report highlights
that the competitive drivers in play are of such variability and uncertainty that it
cannot be presumed that a market-driven competitive process will produce an
aggregate value in line with Government expectations or have the empirical
underpinning of an accounting/economic-based administrative process.
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AHA (Vic) does not support the adoption of a competitive process to allocate term­
extended gaming machine entitlements.
Question 19:
Should a competitive process enable venue operators to bid for different
entitlements, how much competition is expected for an extension to the term of
entitlements? Where would this competition come from? It would be helpful to
provide information to these questions at the level of analysis available (eg. hotel
vs. clubs sector, regional Victorian vs. Metropolitan Melbourne, particular capped
areas and Local Government Areas, etc.).
AHA (Vic) Response:
AHA (Vic) is firmly of the view that term-extended Gaming Machine Entitlements
should only be available to the holder of the current entitlement that is being
extended.
To provide an opportunity for parties other than existing entitlement holders to
acquire term-extended entitlements through the initial allocation process would
result in confusion and chaos as, for example, freehold owners may seek to acquire
term-extended entitlements to protect their interests, speculators may enter the
market and uncertainty be dramatically heightened for existing entitlement holders
and their financiers.
In the 2010 auction process it is apparent that the Government over-estimated the
competitive tension in the market, notwithstanding that it had obviously been
compromised by the Pre-auction club offer, the 35% large holder cap etc.
There are significant costs involved in seeking to enter the venue-based gaming
market and as the Issues Paper and the VAGO Report highlight, such costs and
approval complexities, including caps and required planning permissions, generally
militate against new entrants, other than through the purchase of an existing gaming
venue on the market.
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Question 20:
Within the current regulatory constraints, would venue operators like to increase
or decrease the number of entitlements they hold as part of a potential extension
process?
AHA (Vic) Response:
One can but speculate as to whether existing gaming venue operators may wish to
increase or decrease their Gaming Machine Entitlement holdings; however AHA (Vic)
opposes the allocation of term-extended entitlements as being a vehicle by which
gaming venue operators are able to achieve such outcomes.
To include such an option in the term extension process would introduce an
unnecessary and significant complexity for no logical purpose.
The existing process for increasing or decreasing entitlement holdings should
continue in a term-extended environment.
Questions 21:
Do venue operators have a high degree of certainty around the value of a potential
extension to the term of their entitlements?
AHA (Vic) Response:
As detailed, AHA (Vic) proposes an average based valuation model underpinned by a
present value/discounted cash flow methodology to determine an aggregate
valuation, with the allocation of that value across venues to be based on specific
venue share of gaming revenue for relevant periods.
Whilst the aggregate valuation will be based on average revenue and cost inputs,
each gaming venue will in their own interests calculate their own NPV estimates and
compare that to the value assigned to them through the aggregate process.
The ultimate decision as to whether or not a holder of gaming machine entitlements
wishes to exchange them for term-extended entitlements is a decision of the holder.
Any term-extension scheme must be on an opt-in basis.
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Question 22:
In comparing the two different models, which model would be more appropriate
for a potential extension to the term of entitlements? Please provide reasons for
your preferences.
AHA (Vic) Response:
AHA (Vic) supports the adoption of an administrative process to determine the value
and to allocate extended-term gaming machine entitlements on an existing
entitlement holder opt-in basis.
AHA (Vic) proposes an administrative process on the basis that such a process:
•
•
•
•
•
Will be the most likely to deliver the Government objective of maximising
value to the Victorian community whilst ensuring a sustainable and
competitive Victorian gaming industry going forward beyond 2022;
Will draw from the learnings of the 2010 auction that a market-driven
competitive process will be based on competitive-tension expectations and
assumptions that may not materialise;
Will provide a reasonable and appropriate level of certainty and confidence
for both the Government and Gaming Machine Entitlement holders in that
the agreed valuation will be based on empirical financial and economic data;
Will ensure equity at a gaming machine venue level in that the allocation of
the agreed aggregate value will be based on each venue's share of gaming
revenue for the relevant period, and
Will allow venues to measure their venue-unique NPV analysis outcomes
with the venue's outcome from the aggregate analysis in determining
whether to opt-in to the term-extended allocation process.
Question 23:
Are there other allocation models that should be examined as part of the
Review?
AHA (Vic) Response:
AHA (Vic) does not propose alternative allocation models.
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Question 24:
Are there other criteria that should be considered as part of the assessment and
why?
AHA (Vic) Response:
Any consideration of a valuation and its payment by Gaming Machine Entitlement
holders to extend the term of entitlements must have regard to regulatory and
sovereign risks into the future.
Whilst the determination of the aggregate valuation will necessarily involve the
estimation of costs and revenues going forward, the Government must provide
reasonable certainty regarding variables under their control that have the
potential to impact on gaming revenues and/or gaming-related costs e.g. gaming
taxation, levies, further regulatory restrictions etc.
33