MORE QUESTIONS THAN ANSWERS ABOUT THE MEC BANKRUPTCY

This posting begins by listing excerpts from the “Frequently Asked Questions” that Magna Entertainment has provided about its bankruptcy filing (the complete list of questions and answers can be found at http://www.magnaent.com/NR/rdonlyres/111964CB-D2CF-4434-90D4-4BC8117E067D/22301/Ch11FAQ.pdf).  At the end of the FAQs, I pose several questions that I would like to have addressed, particularly by an attorney with bankruptcy expertise. The reason for my curiosity is that the FAQs and the explanations appear to raise more questions than they answer.

What is a Chapter 11 filing?

A Chapter 11 filing provides a debtor company (such as MEC) a vehicle for operating its business under protection from its creditors while developing a plan to resolve its financial and liquidity problems. Immediately upon a Chapter 11 filing, an “automatic stay” is imposed which halts the collection of creditors’ claims and protects the debtor company from its creditors. During Chapter 11, the debtor company is able to continue to operate while it restructures its debt. In a successful Chapter 11 case, the bankruptcy court will confirm a plan of reorganization that enables the debtor company to emerge from Chapter 11 and operate in the future relieved of many of the burdens that precipitated its Chapter 11 filing.

Why did MEC file for Chapter 11 protection?

MEC filed for Chapter 11 protection in order to implement a comprehensive financial restructuring. Simply put, MEC has far too much debt and interest expense. Under Chapter 11 protection and with the Court’s approval, MEC will
continue to operate in the ordinary course of business while working with its creditors and other stakeholders to complete a restructuring.

MEC believes that this Chapter 11 restructuring will bring its level of debt in line with current economic realities and take pressure off its operations, which have historically been burdened with significant interest expense and financing fees. In today’s challenging economic environment, many companies are using Chapter 11 to substantially reduce debt and position themselves for future growth.

Is MEC going out of business?

No. During the Chapter 11 restructuring process, MEC’s day-to-day operations are expected to continue without interruption.

What is the difference between Chapter 11 and Chapter 7?

Under Chapter 11, a business continues to operate and management remains in control of the business, subject to required bankruptcy court approvals, while the company’s debt is restructured. Under Chapter 7, a business immediately closes, and a trustee is appointed to manage the Chapter 7 process, which is a liquidation of assets.

MEC is restructuring under Chapter 11 and a trustee is not expected to be appointed.

Will MEC be selling any of its racetracks or other assets?

In connection with the Chapter 11 filing, MEC has entered into an agreement with MID to sell a substantial portion of its assets. MID has made a “stalking horse bid” to acquire the following MEC assets: Gulfstream Park, Golden Gate Fields, Palm Meadows Training Center, Lone Star Park, AmTote International, XpressBet, The Meadows holdback note and MEC’s real estate joint venture with Forest City Enterprises.

The balance of MEC’s assets that MID has determined not to purchase at this time include Santa Anita Park, The Maryland Jockey Club, Remington Park, Thistledown, Portland Meadows, StreuFEX, Magna Racino and MEC’s other Austrian assets, lands in Ocala and Dixon, and MEC’s joint venture interests in HRTV, TrackNet Media and The Shops at Santa Anita with Caruso Affiliated.

MEC’s assets, including the assets MID has chosen to acquire pursuant to its “stalking horse bid”, will be the subject of a marketing and sale process conducted by Miller Buckfire & Co,, LLC, MEC’s financial advisor and investment banker. During the marketing and sale process, MEC is expected to continue to operate in the ordinary course.

What is a stalking horse bid?

A “stalking horse” is an initial bidder who negotiates an asset purchase agreement with the debtor company. The stalking horse bid is subject to higher and better offers. If the stalking horse bid is topped, the stalking horse also has the ability to increase their bid.

Were any of MEC’s subsidiaries or operations left out of the Chapter 11 filing?

Yes. The following MEC operations were not included in MEC’s Chapter 11 filing:

• Lone Star Park
• Portland Meadows
• XpressBet
• AmTote Canada and AmTote Australasia
• Magna Racino and MEC’s other Austrian operations
• HRTV (50% joint venture)
• TrackNet Media Group (50% joint venture)
• Joint venture with Caruso Affiliated at Santa Anita Park
• Meadows Racing Operations

The fact that MEC has filed for Chapter 11 rather than Chapter 7 seems to imply that it intends to stay in business. In fact, it says: “MEC filed for Chapter 11 protection in order to implement a comprehensive financial restructuring.” First issue: suppose a financial restructuring succeeds under court supervision and with the approval of creditors. If MEC were to emerge from bankruptcy at a future time, what most likely would constitute the assets of the streamlined company? Would most of the subsidiaries and operations not included in the MEC Chapter 11 filing be the core assets? Second issue: Why is MID making a stalking horse bid for some of the assets in the bankruptcy filing and for some of the assets not in the bankruptcy filing? What is the distinction? Third issue:  How is MEC able to keep some of its properties out of the bankruptcy filing?  Will the creditors go along?  Fourth issue: a bankruptcy law website states that fewer than 10% of Chapter 11 filings prove to be successful. Isn’t this a strong indicator that the debt-plagued MEC is ultimately going to be liquidated?

IN SEARCH OF A FUTURE

(Continued from “Why Horse Racing Declined,” Horse Racing Business, March 21, 2009.)

Andrew Grove, chairman emeritus of Intel, explains the term strategic inflection point:

… a strategic inflection point is a time in the life of a business when its fundamentals are about to change. That change can mean an opportunity to rise to new heights. But it may just as likely signal the beginning of the end. Strategic inflection points can be caused by technological change but they are more than technological change. They can be caused by competitors but they are more than just competition. They are full-scale changes in the way business is conducted, so that simply adopting new technology or fighting the competition as you used to may be insufficient. They build up force so insidiously that you may have a hard time even putting a finger on what has changed, yet you know that something has. Let’s not mince words: A strategic inflection point can be deadly when unattended to. Companies that begin a decline as a result of its changes rarely recover their previous greatness. But strategic inflection points do not always lead to disaster. When the way business is being conducted changes, it creates opportunities for players who are adept at operating in the new way. This can apply to newcomers or to incumbents, for whom a strategic inflection point may mean an opportunity for a new period of growth. You can be the subject of a strategic inflection point but you can also be the cause of one.

Horse racing in the United States is either at an inflection point or on the downside of one, all but certainly the latter. The sport could plug along for a while with sustenance from a loyal but aging core of fans–and in some places from alternative forms of gaming–but wither away. On the other hand, with the right business models, horse racing could solidify itself as the 21st century progresses, even though a return to its previous greatness is unachievable.  Which scenario eventuates will ultimately determine the fate of the entire bloodstock business because wagering handle is ultimately the economic raison d’être for all else.

The most likely scenario is that racetracks offering an attractive value proposition will do well and vanilla tracks without one will perish. Another way to say this is that only racetracks with a distinctive business model will survive.

In the racing press and at racing conferences, there are often comments that racing needs a new business model. When you examine what is being said, most of the time the term business model is intended to mean a profit model. A business model is broader and encompasses a customer value proposition, a profit formula, strategies, and the human resources and processes that deliver value to customers.

A recent Harvard Business Review article titled “Reinventing Your Business Model” did an exceptional job of explaining the term, which consists of several interacting parts or elements.

First, a business model starts with a customer value proposition…or what benefits customers in the target market are getting out of consuming the product or service. Put differently, what need and/or want is being satisfied. Why does one prefer to go to a racetrack rather than bet online-and vice versa? Clearly, these are different value propositions.

Second, a business model contains a profit formula, which, in turn, consists of a revenue model, a cost structure, and a margin model. Racing has multiple profit formulas, depending, for instance, on whether wagers are made on track or off track and on whether a wager is a straight win, place, show bet as opposed to an exotic bet. Further differences depend on whether an at-the-track wager is made on a live race or a simulcast race and whether the person who bets through an advance deposit wagering service lives within a certain distance of a racetrack.

Third, a business model encompasses key resources “needed to deliver the customer value proposition” and the key processes that “make the profitable delivery of the customer value proposition repeatable and scalable.” In the case of racing, key processes and resources are, for example, information and communications technologies and the skilled professionals in charge of them.

Following are some business models that have proved to be successful in horse racing:

Del Mar, Keeneland, Saratoga, and to some degree Oaklawn and Monmouth are racetracks with a high probability of ongoing profitability because they have well-defined and proven business models, and in particular attractive customer value propositions. These are boutique lifestyle racetracks that have short meets and a pleasant on-track ambience. The high quality of racing contributes to the profit model by enticing off-track wagering.

Churchill Downs Inc. has at least two business models that sustain it. The first one is built around the customer value proposition and the profit formulas associated with its signature event, the Kentucky Derby, which is a single weekend per year. The other Churchill Downs Inc. business model is based on year-round racing from its four racetracks and from alternative gaming.

Mountaineer Casino Racetrack and Resort, Philadelphia Park, Indiana Downs, and others, offer a racino business model. So far, this is a successful approach utilizing a different customer value proposition with a different profit formula. This inherent risk, of course, is that state governments may decide to forgo subsidizing horse racing with gaming income.

Another useful business model is employed by racetracks that have essentially opted to be television studios for the purpose of sending out signals to off-track sites. These racetracks have live racing at odd hours and often on Tuesdays to fill out simulcast schedules during these slow times. They usually try to avoid head-to-head competition with more popular racetracks. Their strategy is to “be where they aren’t” and to provide a low-cost commodity signal to gamblers.

The European and Asian racetracks also differ in terms of customer value propositions, but, unlike most racetracks in the United States, they prefer short meets. Whether the European and/or Asian customer value propositions could be successfully transplanted to the United States is unanswered, but might be experimented with to see. Keeneland has two short meets per year and does spendidly.

Each racetrack must carve out its own business model, built around its particular external environment and internal strengths, in order to continue on in business. In other words, racing does not have a business model per se, but rather, it has business models, just as Wal-Mart, Nordstrom, Target, etc. have their own templates that made them outstanding. The profit formula is similar across racetracks, whereas customer value propositions are very different. Importantly, it is a fallacy to think that a business model that works well in one venue can be cloned in another location and the results will be the same.

Examples are easy to find of racetracks that do not have a clearly-articulated business model formulated around an attractive customer value proposition. Such tracks with a generic approach will likely vanish. In addition, a few racetracks have a winning business model, but they are too valuable as real estate plays to survive as racetracks.

Forecasting and predicting are always risky propositions because the future is unknowable. With this disclaimer, if present trends can be extrapolated, the most likely outcome for horse racing in the United States is a downsizing–just how severe is indeterminate.

Based on the assumption that more racetracks will be closing than opening in the United States, there will be fewer racetracks: marginal racetracks without a compelling customer value proposition won’t be able to survive. Ohio, for instance, with seven racetracks will surely have attrition and, likewise, California and Kentucky have tracks on the bubble.

This rationalization should translate into a reduced bloodstock component. The market for well-bred racing prospects with good conformation should remain strong, but, as the shakeout in racetracks occurs, demand for pedestrian racing stock will probably see a precipitous decline, as the law of supply and demand works. A beneficial offshoot would be fewer unwanted horses.

While the number of racetracks and the bloodstock industry in the United States should shrink, total betting handle and purse averages may actually increase because of remote wagering on the surviving North American racetracks, as well as  on international signals. In my view, the racing industry in the United States will be considerably smaller as the 21st century progresses but will have a more solid economic foundation than it does today. 

Next week’s (April 4, 2009) article “Crafting and Tailoring Racetrack Customer Value Propositions” explores this all-important subject in more depth and looks at such issues as positioning racing as a sport or gambling, customer service, horse slaughter, breakdowns, medication, and handle takeout. It is the third and final article in the Horse Racing Business series of March 21, March 28, and April 4, 2009.

Copyright © 2009 Horse Racing Business.

WHY HORSE RACING DECLINED

In its halycon days from about 1900 to 1960, horse racing was a leading spectator sport in the United States, following only Major League Baseball in total attendance. Sports fans knew of and many followed the exploits of equine stars like Seabiscuit and War Admiral, Citation and Stymie, Nashua and Swaps, and Greyhound and Adios. Some of the best sportswriters covered horse racing and their prose was often elegant.

Now, except for premier events, the on-track crowds are sparse and the television audiences are small. Newspapers in general have fallen on hard times, owing to the Internet, and few of them have the economic strength to employ a dedicated racing writer. The number of racing fans in the United States may be less than 3 million out of a country of 302 million people. Among the overall population, the name recognition of even top Thoroughbred racehorses is low (with the occasional and brief exception of a Smarty Jones) and the situation is much worse for Standardbreds and Quarter Horses.

Following are some of the major factors that account for this deterioration:

1. Urbanization. As the United States evolved from an agrarian society to one based on manufacturing and services, the percentage of the population with ties to farm life dwindled markedly. The vast majority of people today know little about livestock of any kind. Most folks have never lived on a farm and do not have relatives who do. Thus the rural culture that once fostered an affinity for “a good horse” gradually gave way to one in which there was no such widespread interest. Today, NASCAR drivers are much better known among the general public than leading jockeys.

2.  Population Expansion in the Sunbelt. The Sunbelt states have been rapidly growing as compared to the Northeast and Midwest.   This trend is not in racing’s favor. While racing has a foothold in Arkansas, California, Florida, Louisiana, and Texas, high growth states like Georgia, North Carolina, Tennessee, and some others do not permit racetracks to operate and have a culture that has no recent history with horse racing and one that generally opposes gambling.

3. Blue-Collar Blues.  These kinds of jobs have increasingly moved to low-cost offshore nations. Moreover, the loss of blue-collar employment is likely to be permanent. The only sector where unions are gaining members in the United  States is government. I have never heard this reason offered as a cause for racing’s travails, but I am convinced that it is a prominent one.

Thoroughbred horse racing is often referred to as the “Sport of Kings.” Yet the sport, along with harness racing, has traditionally been heavily supported by automobile workers, electricians, and other people who work with their hands. Northfield Park in a Cleveland, Ohio, suburb is located adjacent to a Ford plant. Current and bygone racetracks in Chicago, Detroit, Philadelphia, and similar cities with concentrations of blue-collar workers have suffered as the United States economy has moved away from high-paying blue-collar jobs to a service base. The problems at “working people’s” racetracks have been exacerbated by the current recession.

4. Communication and Information Technologies. Old-timers often correctly cite racing’s tepid reception to the popularization of television in the 1950s as a prime cause of decline. Unlike the National Football League, which embraced TV, racing executives were fearful that it would steal their on-track audiences. However, in recent times, racing has exploited telephone and Internet wagering to great effect; so much so, that the off-track business model has eviscerated the on-track model. But racing had no choice. In the fast-paced milieu of the 21st century, if it were not for remote wagering, betting handle would be a fraction of what it is today. The 2008 contentious dispute between advance deposit wagering companies and horsemen, over the equitable division of takeout, badly damaged handle because races at some tracks were inaccessible to bettors.

5. Competition. Horse racing, for many years, was one of the few legal wagers available in the United States. This quasi-monopoly encouraged a hubris that led to a “take it or leave it” attitude toward customers. Undoubtedly, the legendary poor treatment of customers at racetracks has its origins in this former era. With the proliferation of state lotteries and casinos in various parts of the country (and lately illegal but easily accessible offshore Internet gaming sites), horse racing did not abandon its old ways of doing business…and the result was predictable. In fact, most tracks did not know how to compete for customers. Even today, what racetracks offer to customers in the way of amenities and conveniences is lacking, as compared to casinos.

6. Eroding Leisure Time. Studies have documented what Americans already know firsthand– that they are working more than ever. Vacations are shorter and cell phones and wireless handheld devices keep people tied to work even when they are supposedly off duty. Thus Americans have less time for leisure pursuits than they once did and lazy afternoons at a racetrack during the week are incompatible with this reality.

7. Fading Attention Span. Today’s society, particularly for the young, revolves around almost instantaneous communications made possible by cell phones, computers, and instant messaging services like Twitter, and social networking sites such as Facebook and YouTube. People once were satisfied to attend horse races to socialize and handicap in the 30-40 minutes between races, while spending four or five hours at a racetrack. Except on racing’s biggest days, or at a few lifestyle racetracks like Saratoga , Keeneland, and Del Mar, the 21st century American finds a day at the races too slow to suit his or her tastes. Simulcasting has stepped up the action, but people can also bet on a variety of races from off-track locations.

Racing cannot undo any of these societal transformations to bring back the “good old days.”  The most brilliant strategist cannot reverse the irreversible.  The issue is whether the sport can continue at a critical-mass level in the United States for other reasons, such as attracting more young fans and additional patrons from the fast-growing Hispanic population.

The inescapable conclusion is that horse racing will never again become a major sport to rival football, basketball, and baseball, mainly because the average sports fan is too far removed from the rural culture that appreciated a fast horse and because the window of opportunity is long past. Still, horse racing can be a viable niche sport–or it can fade into oblivion. The March 28, 2009 Horse Racing Business explores this subject in the article “In Search of a Future.”

Copyright © 2009 Horse Racing Business