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Lottery Concession Tipped To Transform Brazil’s Gambling Landscape

Intellectual Property
Gambling Compliance

​By James Kilsby

A process to privatize Brazil's instant lottery market marks an historic turning point for the country's stunted gambling sector but a challenge for potential operators who will need to work out how to account for future gaming expansion in their bids, experts say.

Brazil enters the home straight of the process this week when officials stage a public hearing in Rio de Janeiro today on plans to sell off an exclusive instant lotteries concession, before kicking off a series of international investor road shows to market the opportunity.

The privatization of Brazil's instant lottery market is arguably one of the most significant changes to the country's gambling market in decades.

Public bank Caixa Econômica Federal has had a monopoly to operate all national lottery games in Brazil for the past half-century.

But an upcoming auction process, which is slated for mid-December, will see a 25-year concession for so-called "Lotex" instant games awarded to a private group, with state-owned Caixa excluded from bidding.

"It's a breakthrough because for the first time we will have a totally private lottery operator," said gaming law expert Luiz Felipe Maia of FYMSA Advogados in São Paulo.

"This is a game-changer for Brazil."

The Lotex concession comes as broader proposals to expand Brazil's restricted gambling market remain under consideration in Congress, with the role of Caixa in future regulatory regimes for online gaming and sports betting one key point of debate.

It is, therefore, especially significant that Brazil's government has opted for the concession model, rather than sticking with an original plan to sell off equity in a new instants division of Caixa, said Fabio Ferreira Kujawski of Mattos Filho law firm in São Paulo.

"The decision to keep Caixa Econômica Federal out of Lotex's operations was interpreted by the industry's players as a sign of the Brazilian government's openness to private initiative," Kujawski told GamblingCompliance.

Consortia bidding on the Lotex concession must be at least 15 percent-owned by a company that has previously operated a scratch or virtual instant lotteries business with monthly sales in excess of R$100m (roughly US$32m).

But the winner will be determined by a public auction, rather than a scoring system based on the quality of bidders' experience or their business plans.

Brazilian officials are proposing a minimum upfront concession fee of R$916m, with the 25-year license going to the qualified bidder making the highest offer above that amount.

Ernst & Young (EY) consultants hired to advise Brazilian officials on the privatization expect annual sales of Lotex games to reach R$5.2bn by the fifth year and R$6.4bn by year ten.

The concession-holder will be entitled to keep 18.3 percent of all sales, from which it would need to cover retailer commissions, operating and marketing costs, and pay various corporate taxes.

The appeal of the instants lottery concession is obvious given the lack of competition from other forms of lawful gambling in a country of nearly 210m people.

Still, several challenges are apparent as well.

For one thing, a concession-holder would need to make a significant infrastructural investment to build Lotex's sales and distribution network across Brazil's continent-size terrain.

EY's revenue estimates assumed Lotex games would be available at 65,000 points of sale after a five-year period.

But Maia of FYMSA Advogados said that companies may want to guarantee before bids are due that Lotex games can be sold via instant-ticket vending machines (ITVMs) and in grocery stores, without a need to create standalone retail outlets.

EY also estimated that just over 4 percent of total Lotex sales would come from virtual instant games played online.

Yet the scope of permitted virtual games has not been defined, raising the question as to whether Lotex's operator could offer online games more like those played on a video lottery terminal than a scratchcard.

"If you can do that, then you can have an online casino with the Lotex license," Maia said.

Another potential question in the minds of Lotex bidders will be what actions Brazil's government plans to take to shutter the instant operations of state lotteries in Rio and Minas Gerais that federal officials have long contended to be unlawful.

Then there is the prospect of future changes to Brazil's gaming landscape.

Two closely-watched bills to regulate casinos, bingo halls, video gaming machines, online gambling and " jogo do bicho " numbers games are currently pending in Brazil's Senate and Chamber of Deputies.

Meanwhile, the Ministry of Finance is known to have drawn up a separate proposal limited to sports betting, potentially using the Lotex concession system as a model to follow.

Lotex offers a chance to establish an early presence in a market that has long been seen as a sleeping giant of the global gambling industry.

However, bidders will also need to account for the potential risk of expanded competition from other gaming verticals, perhaps in the early years of the concession when Lotex remains in a ramp-up phase.

"It's hard to define the value [of the Lotex concession] when you have so many doubts regarding the addressable market," said Maia.

"You don't know when gaming is going to be regulated, and you don't know how it's going to be regulated."

These issues could be among those raised at the public hearing being staged today in EY's Rio offices, to review draft bidding terms and a draft Lotex concession contract that were both published earlier this month.

A separate, three-week consultation is also being opened today by the Ministry of Finance on a draft regulatory decree that would govern the operation and marketing of Lotex games.

On Thursday, officials will then be in London for the first of two international road shows to discuss Lotex with interested parties. A second event will be staged next week in Las Vegas to coincide with the annual Global Gaming Expo (G2E) trade show.

"There are many challenges and opportunities with this specific process, given that Lotex is a new entity, and

the upfront fee is more typical of a mature and established operation," said Walter Bugno, CEO of international operations for IGT.

Observers believe that international investors and lottery providers are more likely to participate in the Lotex bidding alongside Brazilian partners who can provide local know-how in business, logistics and government relations.

Walter Bugno, CEO of international operations for IGT, said that in his company's experience, "it's helpful to find a local partner paired with the right international opportunity."

"However, while we've been following the Lotex opportunity with great interest, we have not yet reached a final decision on whether to participate in the tender," Bugno added, pointing to the size of the minimum upfront fee as one potential obstacle.

Rival Scientific Games did not respond to a request for comment but is also understood to retain an interest in the Lotex concession.

Other interested lottery providers include instant ticket specialists Pollard Banknote and India's Eagle Press.

As for Intralot, a spokesman said the Athens-based company "remains interested in the opportunity of Lotex and [is discussing] various options in terms of partnership schemes that will contribute towards a strong bid."

The final stages of the Lotex process are set to take place as Brazil remains engulfed in political scandal and scrambling to plug a ballooning budget deficit of R$159bn for 2018.

Local media reports have suggested that government officials were disappointed when they were presented with the potential valuation of the Lotex concession a few months ago, having originally hoped to raise more than double the current minimum bid amount of almost R$1bn.

Still, the Ministry of Finance is bullish that the process will lead to strong growth in the Brazilian lottery market and associated social funds over the course of the next decade.

"It is hoped that the auction will attract the largest international operators of instant lotteries, leading to a significant premium on the value of the concession, an increase in competition in the lottery market and the modernization of this sector in Brazil," the ministry said.


GamblingCompliance: What is it about the potential of Brazil's lottery market that makes the Lotex instant lottery concession an interesting opportunity?

Walter Bugno, CEO – International, IGT: Through privatizing Lotex, the Brazilian government has an opportunity to significantly boost economic growth. In many jurisdictions around the world, lottery privatization has had a positive impact on these regions' overall results. Privatization has increased state revenues and job creation, and improved stakeholders' overall economic position. Typically, private operators have more experience running this business and less budget constraints than a public authority, which also helps to generate positive results.

Among the G20 countries, Brazil is one of the most important and biggest in terms of market potential. Through extensive research, we have found that Brazilian players are similar to Spanish players, as well as Latin American players in general. Looking more generally at Brazil's potential gaming expansion, we see opportunities to combine our expertise from similar markets with research of Brazilian players to provide entertaining and compelling solutions that can help Brazil grow its new programs.

GC: Does IGT anticipate entering the Lotex bidding alongside a local partner in Brazil?

WB: From our experience in other jurisdictions, it is helpful to find a local partner paired with the right market opportunity. However, while we have been following the Lotex opportunity with great interest, we have not yet reached a final decision on whether to participate in the tender. We are reviewing the conditions that were recently published and will make a determination shortly.

GC: Are there any particular challenges that need to be taken into consideration as part of the bidding? For example, how do you account for potential expansion of Brazil's gaming market through casinos, bingo halls, etc., over the course of the Lotex concession contract?

WB: There are many challenges and opportunities with this specific process, given that Lotex is a new entity, and the upfront fee is more typical of a mature and established operation. In addition, the tender is considered "exclusive" at the federal level, yet some individual Brazilian states currently operate their own instants programs, and other states could potentially do the same. Finally, because regulatory changes to other gaming verticals are imminent, the successful bidder needs a deep understanding of the market while drawing from extensive experience in instants as well as other verticals across similar regions.

Regarding overall gaming expansion, the Lotex concession represents a first important step, and sends the right signals to the market and to the gaming industry. We believe that Brazil cannot try to keep its boundaries closed during an era of constant connectivity, where neighboring countries have their own gaming activities.

With the potential expansion of gaming regulations for other verticals like casino and video bingo, Brazil can generate new revenues and ensure economic stability. The gaming industry's technology has achieved high levels of external and internal certification and controls, and the government can leverage this technology to oversee the gaming industry's fair and safe operation. Lotex is an important step that will help to set the gaming industry in Brazil on the right path.