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Thursday, December 14, 2006

The Indiana Lottery

Well, this makes more sense. I'm still not sure how I feel about it, and the finances for a bidder get a bit murky.

The proposal is to lease the operations of the lottery for an up-front payment (which the state apparently expects to be at least $1 billion), plus $200 million a year, plus a percentage of the gross (the percentage mentioned is 5% of the gross above $700 million per year).

The up-front payment goes (60%/40%) into two scholarship endowments aimed at encouraging students to remain in Indiana after then grduate.

As with the toll road lease, I'm not sure I see how an outside operator could make much of a profit, if any, on this deal. Right now, the distribution of the revenue from the lottery is as follows:

61% Prizes
26% State of Indiana General Fund
10% Retained by ticket sellers
2% Administrative expenses
1% Advertising and promotion

Based on the current payments to the general fund (about $190 million), total ticket sales are between $725 million and $750 million per year. At $750 million, and assuming $200 million to the state, $450 million to prizes, and $75 million to ticket agents, we have $25 million left over for administrative expenses and advertising. The proposal calls for the $200 million annual payment to continue. Reducing the payout rate is possible, but would make the Hoosier Lottery less competitive compared to other states, and is therefore not real likely.

So we're left with about $100 million to play with. The ticket agent 10% rake-off might be cut, let's say even in half. That's $37.5 million more for the lottery operator. Assuming that the $25 million does in fact cover operting costs and promotion, that's a 5% rate of return on revenues, which isn't bad.

Except--if you pay $1 billion for the opportunity to do this, you're giving up $50 million or so in interest income. Forever. Suddently, it's not so good a deal.

How do you make a profit? You could boost promotion, in order to sell more tickets. You could create new lottery possibilities. I don't think you can cut out the ticket agents, because you do need a retail network in order to sell tickets. If you could boost lottery sales to $1 billion, maintaining the 60% payout, the $200 million (plus 5% of revenues over $700 million--about $15 million, in this scenario), cut the agent's share to 5%, and hold administration and promotion to $50 million, what would you have? Expenses of $915 million and revenue of $1 billion...might be worth it.


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