08/11/2017 5:06PM

Keeneland takeout hike gets rise out of players

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Keeneland/Coady Photography
Keeneland angered many horseplayers earlier this week when it announced an across-the-board takeout hike scheduled to start with its fall meeting.

The criticism came fast and furious. And not unexpectedly.

“A step to ruin,” one Twitter user said. A Twitter user going by the handle mylifemyrules99 said, "The rich get richer and we pay for it." Twitter user Greg Hartman wrote that he “would never bet Keeneland again” and claimed that the track was “railroading horse players.”

The cause of all the social-media sturm and drang? Keeneland’s decision to raise its takeout rates across the board to the maximum allowed under Kentucky law – 17.5 percent for win, place, and show wagers, up from 16 percent, and 22 percent for all other bets other than the pick five, up from 19 percent – effective with the fall meet at the track.

Horseplayers were incensed for all the obvious reasons. Takeout is the percentage of money extracted from the parimutuel pools before payoffs are distributed to winning bettors. Any increase to the rate depresses payoffs to winners and makes it harder for bettors to break even or post a profit while increasing the amount of money flowing to the racetrack. In this case, a win bet that paid $10 last spring will pay $9.80 this fall. An exacta that would have paid $18 at last spring’s meet will now pay $17.30. A trifecta that paid $75 last spring will pay $72.20 this October.

Apart from the dollars and cents, the decision stung in another way. To many, it was a betrayal.

Through its own efforts, Keeneland, whose grandstand is a striking stone-and-steel architectural gem nestled in the low hills of Kentucky’s horse country just outside of Lexington, has carefully cultivated a customer-friendly image over the past two decades. The decision to raise the takeout, ostensibly to fund purse increases, has cracked a fan-friendly veneer that once seemed impregnable.

Those cracks also appear to extend to the association’s financial health, once a matter never in doubt. While track officials maintained this week that the takeout hike was not due to any pressing financial needs, the company has taken several steps recently to improve its cash flow, including, just two months ago, putting in place a minimum commission for each horse sold at its auctions, six years after it bumped up its sales commission rate.

Furthermore, tax forms for the company’s charitable foundation show that it has cut back dramatically on distributions over the past five years.

With horseplayers threatening to boycott the fall meet, Keeneland’s decision to raise its takeout has the potential to backfire, turning fans and their bankrolls away at a time when Keeneland is looking to bolster its coffers. However, to the consternation of those fans hoping to extract a pound of flesh from Keeneland for its decision, the impacts of a takeout change do not often follow the path suggested by the most broadly accepted economic theory, largely because the racing industry at large has adopted, somewhat clumsily, a business model in which a small, big-betting slice of the horseplaying public is insulated from most of the effects of a takeout hike.

In fact, real-world evidence suggests that Keeneland’s decision will pay off, at least in the short run, if the association’s intent is to raise revenue. It’s another matter entirely whether Keeneland will be able to weather the long-term effects of alienating a portion of its fan base that is increasingly accusing the racing industry of ignoring its concerns.

Financial headwinds

Keeneland is organized as a private, not-for-profit company, and its financial results are famously opaque, available to only a handful of people. Association executives have never publicly commented on the company’s financial condition or its operating results in any detailed manner, going back decades. Keeneland officials have said that nearly all of the association’s retained earnings are invested back in the company’s operations, which include the maintenance of the racetrack and the sales grounds, to further its historical mission of promoting horse racing and breeding in the heart of central Kentucky.

While there is no overt evidence that Keeneland is encountering serious financial difficulties, several of its revenue streams have been under strain over the past decade, at a time when the association has also made major investments. Those two trends have occurred against the backdrop of a major contraction in the racing and breeding industries.

The stage was set in 2006, when Keeneland announced and completed a major renovation between its spring and fall meets. At the time, auction receipts for the company’s sales that year had surpassed the $800 million mark for the first time, a doubling of the figure from a decade earlier. The renovation project entailed reconfiguring Keeneland’s main track and rebuilding it from the sub-surface up, including an entirely new drainage system, to accommodate a synthetic surface. The project also included a major investment in video and timing equipment and the installation of a new infield odds and video board that remains the most state-of-the-art in the industry. Keeneland officials have never disclosed what the project cost.

In 2007, auction receipts hit a record of $815.4 million. But the next year, in September, the stock market collapsed, and auction receipts dropped to $600.3 million. Two years later, auction receipts had dropped to $381.6 million, less than half the 2007 total. Over the next several years, bloodstock prices recovered, hitting $534.5 million in 2013. But the totals have remained stuck at that level since then, indicating that Keeneland is now facing a new normal, even if recent auction results have suggested that the market may be on an upswing.

Other large cash outlays have occurred in the past three years. Keeneland ripped out its synthetic surface in 2014 and returned to a dirt track. A typical estimate for a project of that type is $3 million to $5 million. The decision to abandon the surface came two years after Keeneland withdrew from a partnership with a British company to market the artificial surface, called Polytrack, after demand for the product dried up in the United States.

That partnership itself also lost a civil judgment in 2012 to the trainer Michael Dickinson, who claimed that the company had violated patents Dickinson held on the mixture of substances used as ingredients in an artificial surface. In 2017, a U.S. District judge in Kentucky allowed Dickinson to pursue a $400,000 judgment in the case, striking down Keeneland’s motion to dismiss the ruling based on its withdrawal from the partnership.

Also in 2014, the association announced a partnership with a Lexington harness track, The Red Mile, to open a gambling parlor housing nearly 1,000 so-called “historical horse racing machines,” devices that closely resemble slot machines. The parlor, which required a $45 million renovation of The Red Mile’s grandstand, opened in late September 2015.

According to KHRC records, the partners earned commissions of $10.5 million on $137.3 million in wagering through the machines in fiscal year 2016, which ran from July 2015 to June 2016. In the just-completed fiscal year, the partners earned commissions of $18.4 million on $250.3 million in wagering, according to the records. The commissions represent revenue from the machines, devoid of the impact of the expenses of operating the parlor.

Bill Thomason, who was hired as chief financial officer for the track in 2010 and elevated to chief executive upon the retirement of Nick Nicholson in 2012, declined to discuss details of Keeneland’s financial operations earlier this week. But he said that Keeneland believes that wagering at the parlor will continue to grow for several years, along the same lines as the growth rates posted by other parlors in Kentucky offering the machines. Kentucky Downs, which is located near the border with Tennessee and first installed the machines in September, 2011, had total wagering handle of $519.8 million in the just-completed fiscal year, earning commissions of $41.5 million.

“That will grow, and it will continue to grow for the next three to five years,” Thomason said.

While Thomason dismissed any notion that the company is struggling financially, a review of the tax forms for the company’s charitable nonprofit, the Keeneland Foundation, reveals that distributions from the fund have slowed dramatically in the past five years. In 2010, according to the tax forms, the foundation had qualifying distributions of $624,830. The number has shrunk every year since – to $453,695 in 2011, $213,739 in 2012, $146,209 in 2013, and finally, to $58,600 in 2014, the last year for which the forms are publicly available.

The recent decline fits a pattern that occurred from 2007-09, when auction sales peaked and then plummeted. In 2007, when auction proceeds reached an all-time high, distributions from the fund totaled $962,378. The next year, when the stock market crashed, the distributions dropped to $477,945. In the next year, when credit was tight and the auction market cratered, distributions plummeted to $45,500.

In response to a question about the company’s general financial health, Thomason said, “Keeneland has always been conservative, and Keeneland will always be conservative.”

In Keeneland-speak, that likely means the company is far healthier than most companies and is still sitting on large cash reserves. However, it also means that Keeneland has likely spotted some weaknesses in its hull and is intent on patching those flaws before they begin leaking. 

Purse hikes

When Keeneland confirmed the takeout hike earlier this week, Bob Elliston, the track’s vice president of racing and sales, explained that the additional revenue raised from the increase would help the track boost its purses. Elliston noted that the track believed that even with the higher takeouts, the track’s rates would be competitive with the rates on other major racing circuits.

“You have to look at it comparatively,” Elliston said. “We’re going to be on par with New York, with Oaklawn, and we think we will continue to offer bettors a good product, if you look at depth of field and the quality of the fields.”

Keeneland’s main competition during its fall meet is Belmont Park in New York and Santa Anita in California, although Santa Anita runs three hours later than Keeneland. Belmont has a 16 percent takeout on win, place, and show bets, and Santa Anita Park has 15.43 rate on the same bets. Belmont’s exacta rake is 18.5 percent, with other vertical exotics at 24 percent. Santa Anita has a 22.68 percent takeout on exactas and a 23.68 takeout on other vertical exotics and most horizontal bets.

Elliston said that Keeneland had contributed $30 million over and above the typical contractual obligations to its horsemen over the past five years, in an attempt to continue to offer higher purses each meet. While most tracks split their commissions roughly down the middle with horsemen, Keeneland officials have said in the past that all or nearly all of its wagering commissions are used to fund purses, although that is not exactly the case, according to Thomason.

Thomason said that commissions earned on wagering are combined with all other revenues from the meet. The shares that go to purses come out of that pot, but not at a set formula. It’s a subtle distinction, since it means that if wagering revenues rise a certain percentage, it is not guaranteed that purses will rise at the same rate. Some of that extra money could instead go to Keeneland’s operating budget.

“All of the money goes into one large pool, and we use that pool to fund all of our initiatives, all of our projects, from our technology initiatives, to our customer-service programs, to all of the things we fund at Keeneland,” Thomason said.

Handle figures for Keeneland’s two meets have oscillated over the past five years. In 2012, average daily handle for both meets combined was $8.68 million. The figure rose to $9.27 million the next year, just shy of the record set in 2007, but in 2014, it dropped to $8.35 million. The next year it fell to $7.61 million (not including handle on the two Breeders’ Cup cards), and last year it rebounded to $8.64 million.

Despite those ups and downs, Keeneland continued to raise its purses each year, in a succession of record highs. Average daily purse distribution at the track was $567,924 in 2012, rising to $589,600 in 2013, $631,818 in 2014, $642,336 in 2015, and ending at $650,727 last year. Track officials have said that they intend to continue raising purses as a competitive tool to attract the best horses.

“We have paid record purses in the spring and we paid record purses last fall,” Elliston said, referring to records for the track itself. “In order to continue to do that, we have to increase the price of our product.”

Following Churchill’s lead

Keeneland’s decision to raise its takeout was identical to one made just three years ago by Churchill Downs in Louisville. That decision infuriated bettors, considering that both Churchill and Keeneland had some of the lowest blended takeout rates in the country. But the anger engendered by the Keeneland decision has surpassed that of the ire directed at Churchill, in large part because Churchill already had a reputation, unfairly earned or not, for pursuing its corporate interests above and beyond anything else.

“It was just such a surprise that it came from Keeneland,” said Jeff Platt, president of the Horseplayers Association of North America, a semi-formal group that attempts to present a united front for the concerns of horseplayers. “They’re getting all this money now from [the Red Mile] machines, and then they come after horseplayers, just like Churchill did. It’s a complete reversal of course for them.”

The decision has led to social-media calls to boycott Keeneland’s races this fall, as was the case with Churchill in 2014. And it also has led to claims that Keeneland’s decision will ultimately backfire, because the prevailing theory among horseplayers, rooted in simple economic principles, is that handle on Keeneland races will decline to such a degree that revenue will fall as well, despite the additional money that Keeneland will retain from each wager.
The impact of takeout rates is one of the most sensitive issues in U.S. racing. No one will argue with the basic conclusion of the theory – that higher takeout rates lead to less demand for a racing signal, and therefore lower handle, especially over the long term. The theory is logical, intuitive, and simple. The problem is that recent attempts to cut takeout rates in the real world have not demonstrated to racetrack managers that the move results in both higher handle and higher revenues, which would make the decision a no-brainer to any ractrack.

“It’s been tried in various forms,” said Chris Scherf, head of the Thoroughbred Racing Associations, a racetrack trade group, for 27 years before his retirement last year. “But you can’t find any experiment that ever worked. It’s never moved the needle in any significant way.”

This view is anathema to most horseplayers. And like all economists and those same horseplayers who brook no argument suggesting otherwise, Scherf agrees that in an ideal world, takeout rates for all bets should be far lower than they are now, to make them competitive with other gambling options and to give bettors a greater chance of beating the game.

The problem lies in isolating the impact of takeout changes among the many factors that also significantly affect handle on races – the number of outlets carrying the signal, field size, rebate programs, weather, the winning rates of favorites, where race dates fall on the calendar, the quality of the racing product at competing tracks, general economic conditions, etc. In many cases, it is not possible to tease out the impact of one change in isolation of all the other factors without rigorous economic analyses, and those analyses have so far been few and far between in racing.

Rebate effect

A significant complication in the issue is the racing industry’s own attempts to cater to price-sensitive players through the use of rebate programs, which have the effect of reducing takeout to a select group of players by reducing the margin needed to break even. Those players, who receive cash back on their bets in exchange for wagering millions of dollars a year, have been protected from increases in takeout over the past decade by wagering outlets that increase the rebate at the same rate as the takeout change.

That will not exactly be the case for Keeneland. According to two simulcast officials who spoke on the condition of anonymity, Keeneland will split the revenue from the takeout hike with its simulcast partners. So rebate shops may only raise the rebate by half of the takeout increase. That could depress handle from the players, some of whom use computerized robotic wagering programs that dump hundreds of bets into the pools at post time in an attempt to grind out a low margin.

In the larger view, because the biggest players are insulated from the takeout hikes, that has led to a perverse economic environment in which there is upward pressure on takeout rates, because a racetrack that cuts takeout rates eats into the margin that rebate shops retain. As a result, the burden of any takeout hikes in the modern era falls on bettors who play often and consider themselves vital to the health of the game but do not wager so much that they qualify for the big rebates.

To Scherf, who has long studied the issue, that means the racing industry has to make a decision: If it wants low takeout rates for all, it can’t have big rebate programs for the few.

“You can’t say that you support low takeout rates and the big rebate programs at the same time,” Scherf said. “It’s not a consistent argument.”

“If you take the national blended takeout rate over the last 10 years, there’s no question it’s gone down, when you factor in rebates,” Scherf continued. “There’s no question. And so you ask yourself, ‘Where’s the growth? Where’s all the growth that people talk about from lower takeout rates?’ It’s not there. All it’s done is reduce revenues.”

Success story

Exhibit A supporting low takeout rates is Kentucky Downs, a small track near the border of Tennessee that uses the revenues from its historical racing machines to subsidize purses. Kentucky Downs has kept its takeout rates below the statutory limits despite qualifying under Kentucky law for the higher rates. Its handle has soared over the past six years, as its purses have grown to U.S. record levels and as its product has become more widely distributed. There is no argument that its relatively low takeout rates have contributed to its success, though other factors have contributed significantly as well, including its large fields and popular turf-only racing programs.

But there also are instances in which tracks cut takeout rates and either lost revenue despite handle increases or even had lower handle figures with the new takeout rates in place. Last year, Canterbury Park cut takeout rates for its entire meet but lost money when handle did not increase enough to make up for the loss in revenue. Last fall, takeout rates at the brief Monmouth-at-Meadowlands Thoroughbred meet were cut to 15 percent across the board – takeout rates on trifectas, superfectas, and pick three bets were slashed 40 percent, down from a 25 percent rake – and yet average daily handle dropped 13 percent. The track got hit with a double whammy, taking less money from a lower amount of handle.

Again, many factors impacted handle at both meets, especially at the Meadowlands, where weather and field size had major effects on handle. And the short-term timeline of the experiments compromised the ability to make a firm conclusion about the factors in play. Still, the data that has been produced has not in any way made the unequivocal case that a track can cut takeout and automatically reap the rewards of higher handle and higher revenue, despite a cottage industry of analyses on social media that has parsed the data in countless ways.

For racetrack executives sympathetic to horseplayers’ concerns but simultaneously under pressure to produce their budget numbers, the data of the last few years do not provide clear justification for a takeout cut, at least over the short term, even if the thinking is ultimately short-sighted.

“In an ideal world, takeout rates should be lower,” Scherf said. “I absolutely believe that. But if you look at what happens in the real world, I don’t know if you can jump off that cliff. If you’re the one that makes that mistake, it’s pretty clear the next guy won’t.”

There also is a significant amount of misinformation surrounding the topic. Platt, president of the horseplayers group, stated in an interview this week that a takeout increase “has never been a revenue generator for tracks. It’s never generated revenue increases or purse increases.”

That is a popular view among horseplayers, and one that dovetails with the economic theory, but it also is not true.

Platt specifically cited the case of Churchill in 2014, referring to the company’s 2014 financial statements and its top-line “racing revenue” figure. That figure shows that the company’s racing revenue declined 4 percent in 2014, when compared with 2013, the year prior to the takeout increase. But that figure includes all revenue from racing operations for Churchill’s four tracks – including a dramatic decline in racing revenue at its Arlington Park near Chicago – not the wagering revenue from Churchill itself.

Probably in large part because of the backlash to its decision, handle on Churchill’s races declined significantly in 2014 compared to 2013, with the declines becoming especially stark if handle figures from the full cards featuring the Kentucky Oaks and Kentucky Derby were backed out. Still, the track’s revenue from wagering jumped 5.5 percent that year, from $57 million to $60.1 million, according to the company’s financial statements (the figure includes revenue from out-of-state simulcasting).

Furthermore, contradicting the prediction that the takeout hike would lead to a steady erosion in handle on Churchill’s races, handle and wagering revenue rose in 2015 compared with 2014, and handle and wagering revenue rose in 2016 compared to 2015, according to the company’s financial statements. Purses also rose over those years, according to Kentucky Horse Racing Commission records.

When presented with those statistics, Platt responded: “But what would their numbers have been if they didn’t raise takeout?”

That’s unknowable. What is known is that Keeneland is following a path that does not necessarily predict a decline in revenues, not without the racing industry or its betting public changing in dramatic, fundamental ways.