11/12/2009 1:00AM

Merger strengthens Churchill

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Churchill Downs Inc. is poised to become the dominant account-wagering company in the United States if a planned merger with Youbet.com is approved by regulators and the two companies' shareholders.

The merger, announced Wednesday evening and discussed by officials of both companies in conference calls on Thursday morning, will create an account-wagering business that would have had combined handle of $679 million in 2008, when Churchill's account-wagering operation, Twinspires.com, handled $241 million and Youbet.com took in $483 million. The current market leader, Television Games Network, handled $503 million in 2008.

The merger will further strengthen Churchill's powerful industry position by widening profit margins in its account-wagering business and giving the company more leverage in negotiating rights to carry signals from other tracks on its new

combined wagering platform.

Churchill, which owns four racetracks, has focused on its account-wagering business since 2007. In that year, Churchill formed a partnership with Magna Entertainment Corp. to buy and sell simulcast signals, launched Twinspires.com, and purchased three competing account-wagering companies to expand its customer base.

The new transaction could close early in 2010, pending approval by shareholders of both companies and antitrust regulators. The deal values Youbet.com at $126.8 million, or approximately $2.84 per share at current share prices. Under the agreement, Youbet.com shareholders will receive approximately one share of stock in Churchill Downs Inc. for every 17 shares of stock in Youbet.com they already own, plus 97 cents in cash per share.

Bob Evans, Churchill's chief executive, said on Thursday morning that he believes betting will continue to migrate from ontrack and offtrack sites to account-wagering companies. Account-wagering companies process about 14 percent of the industry s $13 billion in annual handle after steady growth over the past decade.

Evans said that Churchill believes the merger will position the combined company as a dominant player in the online betting market, especially if legislators relax restrictions on the practice. Horse racing is currently the only legal form of online betting in the United States, but some racing officials believe that other forms of online gambling, especially poker, could be legalized soon. Churchill's largest competitor, TVG, is owned by Betfair, the British bet-matching company, and Betfair has made no secret of its plans to push for the legalization of other types of online betting, especially exchange betting, in which customers bet against each other.

"We need to be positioned to take advantage of other online business opportunities as they develop," Evans said.

The announcement of the merger was made on the same day that Youbet.com reported that it had net income of $878,000 in the third quarter of this year on revenue of $27.9 million, compared with net income of $2.7 million on revenue of $29.3 million in the third quarter of last year. Susan Bracey, the company's chief financial officer, said that revenue was down in in part because of higher costs associated with the company's rebate programs, which are designed to keep high-rolling players from defecting to competitors.

Although Youbet.com has been praised as one of the market leaders in account-wagering for the past decade, the company has never generated substantial net income because of tight profit margins that have only grown tighter. The biggest problems have been the rise of rebating, which lowers the amount of money that account-wagering operators retain from bets, and higher fees for racing signals. On Thursday, Evans said that Churchill would be able to claim $20 million in tax credits over the next 10 years because of net operating losses that Youbet was still carrying.

Betting through account-wagering operations has been the only growth segment of parimutuel wagering over the past 10 years. But growth has lagged recently as wagering has contracted more than 10 percent over the past 12 months. Companies like Churchill that also own racetracks are better positioned to offer account-wagering because they are able to retain the fees that are paid to third-party operators like Youbet or TVG to process bets, typically 3 to 6 percent of wagering.

Churchill should be able to use the size of the new combined companies to seek low rates to carry signals from other racetracks.

Churchill Downs's other main account-wagering competitor, XpressBet, is owned by Magna Entertainment Corp., the bankrupt racetrack operator that is seeking to sell many of its properties in order to reorganize. Churchill is also a

partner with Magna in a simulcast-marketing company, TrackNet, and television broadcast company, HorseRacing TV

The transaction also includes United Tote, a bet-processing company Youbet.com acquired three years ago. United Tote currently provides bet-processing services for Churchill Downs and all other racetracks in Kentucky, but Churchill's others tracks Calder in Florida, Arlington in Illinois, and Fair Grounds in New Orleans have bet-processing contracts with United s competitors. Evans said that those contracts expire over the course of the next several years.