One of my earliest recollections of the race track is walking out of Sydney’s Rosehill Racecourse crying because I had lost $12. I was 13 and, ever since then, I've been trying, unsuccessfully, to get my revenge on the bookies that stole my money.

The battle between bookie and punter is something that’s always fascinated me, and it has provided the foundation for my obsession with value investing. Successful punters (not me, but there are a few) exploit the difference between price and value just like value investors. The price being the ‘odds’ the bookies offer you and the value being the true chance of a horse winning the race (the big difference is that the stockmarket goes up on average whereas punters have to be net losers). Like the stockmarket, the bookies are mostly pretty efficient. But with enough research and patience, professional punters will occasionally come across a situation where the bookies get it wrong.

Attractive model

The TAB, or totalisator, doesn’t face that problem. Here, you don’t know what price your horse is until after the race has been run and won. You can, of course, get an estimate of what it would be at any point in time but that price can change after you’ve placed your bet. The way a totalisator (the pari-mutuel system a TAB uses) works is simply to aggregate everyone’s money after the race has been won, take out the profit due to shareholders and divvy the remainder up amongst those that backed the winner.

Well before I started thinking about competitive moats, this struck me as an attractive business model: Australians love to gamble; the only place you can gamble, apart from a racecourse, is at the TAB; and the TAB can’t lose. Not only that, but the correlation between disposable income and gambling is strong – the more people have to spend, the more they gamble (the percentage has actually been increasing over the past 20 years, although racing’s share has been declining). In short, TABs were businesses you’d love to own. That, at least, is what I thought.

Whenever there’s a large moat around a business, it’s worth asking why that moat exists. In this case, the answer is simple: tax-inspired government regulation. The only reason there is only one TAB in each state is because the respective governments have legislated to have it that way. If there was an alternative that took less than the 15% the TABs take out of the pools, punters would use it. In a fully deregulated market, gambling would be a highly competitive industry like it is in the UK.

Despite the governments’ best efforts, we’re headed that way. The internet is slowly deregulating the gambling business, and there’s little governments can do about it without fostering a thriving black market.

Punting elsewhere

I’m a fair-weather punter these days, but still like to get involved at carnival time. I’ve had a bet on each of the eight weekends of Sydney’s autumn carnival – two days at the races and six from home or a friend’s house – and, for once, I’ve kept my nose in front. Apart from this unusual eventuality, though, what has struck me most is that I’ve hardly used the TAB at all. Of my total turnover, 80% would have been through online bookmaker IAS Bet and betting exchange Betfair. The remainder was bet on course; a small percentage with the TAB thanks to better prices on offer, but the vast majority with bookmakers.

Not only do I get better prices but, when I’m not at the racecourse, I get to sit in the comfort of a lounge room, bet at my own leisure and watch the races on television. For me, there’s no going back to the TAB. And if the statistics are anything to go by, I’m not on my own. Annual NSW wagering growth averaged more than 5% in the 20 years to 2003*. From 2003 until 2007, that growth rate dropped to 2% (pre-equine influenza)*. People aren’t punting less, they’re just punting elsewhere.
For Australia’s protected gambling businesses, this is bad news.

They’re not about to disappear overnight – massive distribution networks and familiarity will ensure that – but margins and market share are under threat and there’s no way the trend will reverse. Equine influenza and smoking bans have caused plenty of immediate problems but, underlying it all, the old grey mare ain’t what she used to be.
*Source: 2004 TAB takeover defence and Department of Gaming and Racing industry statistics