Wednesday, January 31, 2007

The Lottery Lease and the Discounts.

Thanks to the Hon. John Fritchey and his post over at Illinoize I was able to get a copy of the lottery sale RFQ.

First an explanation. Any deal like this has a NPV that is how much the cash flow over time is worth like an annuity, (that is $100 million from the lotto paid out over 20 years is not worth $100 million cash today) so the break-even (sort of) price is the NPV. So when I use the word discount that is an reduction in the price I would be willing to pay. Usually due to risk. Using a 3% growth rate of sales and consider the payout to the school fund to be the profit (the same ratio to sales as in 2005) in 75 years, the lottery would have total revenues of $552,603,678,353 and a total 'profit' $184,569,628,5569.

From the RFQ

The State currently contemplates that the Concession Agreement would include a revenue sharing arrangement with the State retaining a percentage of the Lottery's gross receipts in excess of historic gross receipts during a to be determined base year.

This could/should have an impact on the value of the deal. Unless you are giving me a decent inflation rate as part of the calc, this can end up a being a big risk in a 75 year deal. A few years of major inflation at the wrong time may mean I pay the state a decent chunk of my revenues forever, I don't really know how you price that in, but you have to price it in.


The Concession Agreement will include operating standards related to the operation of the Lottery with which the Concessionaire will be required to comply. The Concessionaire also will be subject to a regulatory system of control and oversight by the State.
This one is going to cost you as well. Unless the regulatory structure is well defined in terms of rights and role this would also require a discount on the price. Why? If I buy the lottery I want protections against you using a regulatory club to bring me back to the table on the deal and/or taxing me to death.

Then a disclaimer

(iv) any unaudited financial information or other information with respect
to the Lottery at any time provided by the State or any of the State's Financial Advisors, legal counsel or other representatives is merely an estimate, assumes the successful implementation of the Lottery's long-term business objectives, is not compiled in accordance with United States generally accepted accounting principles and may not reflect the actual results of the Lottery's operations; and
This might be boilerplate, but if I am the one you start moving forward with on this I am going to have my auditor come in and run the numbers. This is too big of a deal to find an oops with down the road. If I can't do this, that's right a discount.

From the highlights.

Exclusive Long-Term and Defensible Franchise: As the sole and exclusive lottery in the State, there is no direct competition to the Lottery. The current legislative framework strictly limits the presence of gaming alternatives. The State anticipates a secure and defensible regulatory and concession framework will be established to maintain the Lottery's unique position as the exclusive lottery gaming in the State and will furthermore provide the concessionaire significant flexibility to operate the business within current law. It is anticipated that the concession term will be up to 75 years.

First question, how much of the 'significant flexibility to operate the business within current law' is dependent on current law? What are my redresses I get legislated out of business? We had a state house that voted to close all of the casinos last year. Unlike a road or a bridge a single action of the state legislature and a stroke of the governors pen can put me out of business or add a competitor.
What if casino gaming expands significantly?
What if you decide to tax me like you tax the casino folks?
What if other units of government start to tax lottery sales?

Your exclusive isn't worth much unless I have protections in the contract on it, even if I do it's a discount if I don't it's a huge discount. Why? Because this is a huge risk, I am at the whim of political opinion and will. If any factor is a showstopper on this whole thing, this would be it. Bottom line, as a buyer I don't know if I could trust the state. I would price the deal on the assumption that I will be out of the lottery with 25 years due to action by the state.

Significant Growth Opportunities: The Lottery’s per capita sales are below US averages, despite the State's per capita income being among the highest in the nation. The Lottery believes there are numerous opportunities to increase per capita Lottery spending and overall growth. For example, under the State laws and policies, the Lottery's sales force and management is currently not permitted to receive incentive-based compensation, which would reward expanded retail
penetration, higher sales, or enhanced profitability per customer. In addition, marketing expenditures remain approximately 1% of sales and have not grown since 2001 despite a positive correlation with sales. It is anticipated that the concessionaire would have flexibility to increase marketing expenditures and advertise through a wide variety of media so long as it is within the limits of state and national laws. In addition, we anticipate that the concessionaire could further drive sales growth through the application of the Lottery's recent market segmentation research, in order to reach a better understanding of and increase connectivity with Lottery patrons.

(Off the finances for a second) If increased marketing spending would help revenue why isn't the lottery doing that now? Also your sales force might sell more if they got paid more or if management was rewarded differently?

Back to finaces, a 5 year history of growth isn't enough to base the entire plan on. Also me doing all of the 'incentive' things is going to cost me more money. There is a finite amount of growth in this market without it becoming a social issue that you will end up legislating on me. As for the market segmentation data, that's great but will you let me really market to it? Even if it is awkward?

Strong Economic Environment: Illinois has a strong and diversified economy. Measured by per capita personal income, Illinois ranks third among the ten most populous states in the US. The State's economy encompasses a diverse range of industries, including manufacturing, financial services, healthcare, transportation, technology, and consumer products. The State of Illinois is home to over 60 of the Fortune 500 companies in the US and is the 17th largest economy in the world if ranked as a nation. The State's population and personal income levels have grown substantially over the last five decades, and are projected to continue to grow at 0.7% and approximately 4%respectivelyspectively. The State currently has its lowest unemployment on record at 4.1%. This is largely due to an addition of 400,000 jobs since 2004, which represents the fastest groMidwesthe Midwest. The State of Illinois' size and relative economic strength further suggest the significant growth potential of the Lottery through increased market penetration.

Even if I buy all of that, it's a 75 year lease! Do you know how much enconomic conditions can change in 75 years? The growth numbers are from the Illinois Department of Commerce and Bureau of Econmoics Analysis, I'll ask my economist what he thinks about things 10 years out, after that it's vodo. Reguardless one things for certain, America is getting older and older folks will be spending less on the lottery.

If it has all this growth potential why aren't we doing a better job taking advantage of it? Oh yeah, we want a quick buck so we don't have to make hard choices today.

If you want a spreadsheet to run your own numbers send me an e-mail.



Yellow Dog Democrat 4:08 PM  

OneMan -- great post, I hope lawmakers and reporters take the time to read it.

Suburbanon,  10:30 AM  

Anyone who has read a prospectus of a business deal would know that none of the statements quoted above are ununual. In fact, most deals like this are so full of conditional statements that you would wonder why anyone would take the risk. But that's the key. People who know the business are willing to take the risk. That's why the state is leasing and people are lining up for the opportunity.

In reality, the State is an inefficient operator of a business, and face it, the Lottery is a business.

By leasing out an innefficient business to a savvy private operator, that State hopes to not only get the up front lease payment (NPV) but also receive a share of the upside they hope a highly efficient operator can wring out of the deal.

The more I look at this deal from the standpoint of an efficient business, the better I like it. But I do have one concern and that is how will the financial windfall be spent. It had better go to education, or else...

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