Victorian Gaming Machine Arrangements Review. Clubs Australia Submission

Victorian Gaming Machine Arrangements Review Clubs Australia Submission February 2016

Contents Executive Summary... 2 About Clubs Australia... 2 Overview: Victoria s Community Club Sector... 3 Introduction... 6 Venue Operator Model... 7 Regulatory Settings... 8 State-Wide Limit... 8 Venue Limit... 9 Metro-Regional Limits... 10 Club-Hotel Limits... 10 Ownership restrictions... 11 Distribution of Gaming Machine Revenue... 12 Valuation of Entitlements... 12 VAGO Revenue Forecasts... 12 Regulatory Risk... 13 Community Club Business Model... 16 Venue refurbishment... 16 Market Value... 16 Taxation structure... 18 Preferred Transaction Structure... 20 Term of Entitlements... 20 Price of Entitlements... 21 Allocation of Entitlements... 21 Payment Terms... 22 Transfer Market... 22 Appendix... 23 Mordialloc Sports Club community support Warragul Country Club local sponsorship Bendigo Advertiser, Pokie Debt - The Bendigo Club buckles under $800,000 debt to Government 14 January 2016, page 1. 1

Executive Summary clubs that are strongly engaged with their community can act as mediating institutions which can alleviate some of the negative impacts of gambling. Department of Justice, Socio-economic impacts of access to electronic gaming machine in Victoria, 2011 p.93 Clubs Australia submits that any reforms to the gaming machine arrangements in Victoria should seek to secure and enhance the important social-economic contribution made by notfor-profit community clubs. The clubs community gaming business model and the need for clubs to fund loss-making sporting, pastoral or cultural purposes is not adequately recognised in the current gaming machine arrangements. The extent to which the major purpose of club requires revenue from other sources is a key reason community clubs entered gaming, often encouraged by Government as a way to fund these shortfalls. Continuing to treat clubs and hotels on an equal regulatory basis causes clubs to be commercially uncompetitive. Clubs Australia believes Victorian regulators and decision makers should look to New South Wales, Queensland and the Australian Capital Territory to see how a well-supported club industry can better meet the needs of communities and Governments. Government should seek an independent third-party valuation of gaming machine entitlements that properly accounts for the economic and regulatory risks facing the Victorian gaming industry. Affordability, establishing an accurate club-hotel differential in gaming entitlement conditions and reduced regulatory risk are the key desires of clubs. Clubs Australia is of the firm view that it is in the public interest to have gaming machines located in not-for-profit community clubs. About Clubs Australia Clubs Australia is the national peak industry body representing the interests of Australia's 6,000 licensed clubs. Clubs are not-for-profit community based organisations whose central activity is to provide hospitality and infrastructure for members and the community. Clubs contribute to their local communities, through employment and training, direct cash and in-kind social contributions and through the formation of social capital by mobilising volunteers and providing a diverse and affordable range of services, facilities and goods. Club members are people from all walks of life and with many different interests. Clubs, as local community organisations, are highly responsive in addressing the needs of their members, guests and broader community. Clubs have an established history as a responsible provider of gambling services to the Australian community. 2

Overview: Victoria s Community Club Sector Clubs are made of communities. They exist to deliver facilities and services their community desires. Clubs are owned by members and are one way communities can band together. Community clubs in Victoria are a diverse group, created for community purposes particularly for sport their reason for being. Clubs are owned by their 1.8 million members, established as not for profit, or in some cases as registered charities. 1 There are 240 community clubs in Victoria operating hospitality venues with gaming machines, open to members and the public alike. 2 Revenue is used to reinvest into club facilities, staff and services, or donated to community, sporting and charity groups. Community clubs contribute to their local communities through employment, cash and in-kind donations, and through the formation of social capital by mobilising volunteers and providing a diverse and affordable range of services, facilities and goods. Around 70 per cent of community clubs with gaming exist to fund sport, involving facilities worth hundreds of millions of dollars including more than 354 bowling greens, 204 golf courses and over 220 football, cricket, baseball, hockey and soccer fields, as well as basketball stadiums, thoroughbred, harness and greyhound race tracks, tennis, netball and squash courts. 3 The remaining 30 per cent of community clubs with gaming are established by the Returned and Services League to provide facilities and funding for commemorations, memorials and services to veterans (23%) and by migrant communities to provide cultural and community spaces to Italian, Polish, Croatian, Scottish, German and Irish populations (7%). The Committees and Boards that oversee clubs are volunteers and although more than 15,000 staff 4 are employed by community clubs in Victoria, further volunteers are mobilised to help run and maintain the operations and facilities of gaming clubs. The 50,000 club volunteers across Victoria give almost 1 million hours of their time and their skills maintaining grounds, on repairs and upgrades and providing services such as canteens to allow clubs to provide sporting competitions and world class facilities. 5 The contribution clubs make to local communities and regional economies is significant. Around 6,000 people in Victoria s regional cities and towns rely on clubs for jobs, 6 with estimated wages worth $200 million each year and 360 people gain their qualifications through traineeships at clubs. 7 Example: Clubs Contribution in Ballarat In Ballarat alone, 4 clubs employ more than 340 people, with a combined payroll of nearly $7 million in 2014/15. More than $27.6 million was spent in local businesses by clubs and the value of services and donations to charities and community groups was over $4.7 million. This contribution was generated from a club membership base of almost 40,000 and supported by around 1,800 volunteers helping to sustain vibrant local sporting competitions, community facilities and social inclusion. Source: Ballarat Clubs data and Clubs Australia analysis 1 KPMG National Club Census 2011: Report on the economic and social contribution of licensed clubs in Australia, July 2012, p. 2. 2 VCGLR venue data http://www.vcglr.vic.gov.au/home/resources/data+and+research/data/index.html 3 KPMG 2012 Fig 2.9, p.23. 4 Ibid p.57 5 Ibid p. 86-7 6 Ibid p. 58 7 Ibid p.57 3

Across Victoria community clubs with gaming fund and support smaller clubs that operate within the larger club venue, best described as clubs within the club. They include knitting groups, amateur sports teams, and darts and billiards competitions. There are also numerous local groups that are backed by clubs with cash or in-kind contributions. At the Mordialloc Sports Club, there are 4 clubs within the Club that are supported year in, year out senior cricket, football, netball and junior sports teams. On top of these a further 39 local groups 19 sports clubs, 8 charities and 11 local schools received $280,000 in cash and in-kind contributions in the last financial year alone. Similarly, the Warragul Country Club, along with its 6,000 members supported 62 different local groups during 2015 including schools, charities and sports teams with donations totaling $40,000. 110 people rely on the club for jobs, it spends $4 million in local businesses and 21 volunteers give their time and skills to help. 8 The contributions of the Mordialloc Sports Club, known locally as Mordy HQ, and the Warragul Country Club are typical of the contributions made by community clubs across the state each year underpinned by gaming revenue and impossible without it. Clubs account for 20 per cent of the not-for-profit sector nationally, with the community gaming model ensuring that a significant proportion of our civic and sporting groups are funded. A large proportion of clubs with gaming are bowls clubs. According to Bowls Victoria, more than 46,000 Victorians play bowls and there are 200,000 social experiences each year. Club competition events comprise strong Country and Metro Saturday Pennant with 34,000 participants and Midweek Pennant comprising 22,000 participants across the season from September to April. 9 Bowls is a great opportunity to socialise and stay physically active. Community clubs with gaming subsidise many of the facilities and competitions upon which bowls in Victoria depends. Case study: a metropolitan Bowls Club A top bowls venue in metropolitan Melbourne, provides nationally recognised pennant standard bowls facilities worth more than $840,000 and has bowls operating costs in excess of $250,000 per year. These costs are offset by volunteer labour to assist in running competitions, green keeping and maintenance. Income from bowls subscription and facility fees is $90,000, leaving the bowls operating costs with an annual loss of $161,000. Bowls is simply not offered by for-profit businesses as it makes substantial losses and has a high cost of capital. The future of bowls relies on clubs. Golf has similar issues in providing and maintaining facilities. More than 143,000 Victorians play golf, predominantly men (77%) and more than 108,000 (76%) of these players are aged 45 and over. 1 Case Study: two Golf Clubs A successful metropolitan golf club with gaming generates revenues from golf memberships of $1.46 million and has operating costs of $1.85 million. The deficit of more than $385,000 is met from other parts of the club. A full 18 hole round is 7km at this club, providing excellent exercise for its mostly male golf members. 8 See Appendix 9 Bowls Victoria website http://www.bowlsvic.org.au/about-us 4

In regional towns, golf revenues can be more difficult to generate. A case in point is a country golf club which had golf income in the last financial year of only $103,000 but this was not enough to offset expenses totalling more than $465,000 which included significant one-off capital expenses for machinery of $132,000. The golf section of the club, its reason for being, had a loss of $362,000 which was covered by surpluses from the gaming and food and beverage sections of the club. Clubs Australia submits that community gaming and the need for clubs to fund loss-making sporting, pastoral or cultural purposes is not adequately recognised in the Victorian gaming machine arrangements. The extent to which the major purpose of the club requires revenue from other sources is a key reason community clubs entered gaming, often encouraged by Government as a way to fund these shortfalls. Clubs Australia believes Victorian regulators and decision makers should look to New South Wales, Queensland and the Australian Capital Territory to see how a well-supported club industry can better meet the needs of communities. Much of the information cited on the club movement in Victoria is from the 2011 National Club Census. KPMG has again been engaged by Clubs Australia to complete a 2015 update of the National Club Census. The results will provide further information on the structure, activities and health of the Victorian clubs including comparative State by State analysis. Clubs Australia believes this information is necessary for the Review to consider and requests the opportunity to provide additional information from the 2015 Census as soon as it becomes available. 5

Introduction Clubs Australia is of the firm view that it is in the public interest to have gaming machines located in not-for-profit community clubs. The benefits from gaming machines in clubs flow back to the local community through investment in community services and infrastructure as outlined in the previous section. Clubs invest gaming machine surpluses in sporting facilities, returned-services activities, meeting rooms and sponsorships; this removes pressure on the State Government and local councils to fund such initiatives and maintain costly facilities. In 2011, a report commissioned by the Department of Justice, entitled Socio-economic impacts of access to electronic gaming machine in Victoria, found: The gaming industry in Victoria is located within a variety of venues. Each of these venues has different operational characteristics and service orientations and therefore differs in terms of the level to which they are embedded within their communities. The research findings revealed that community clubs, especially those that are strongly embedded within their community and undertake a community hub function, produce more benefits to the community than some other types of venue. It has become apparent from the results of this study that clubs that are strongly engaged with their community can act as mediating institutions which can alleviate some of the negative impacts of gambling. These clubs are considered to be part of the community and utilise EGM gambling revenue to provide better services to their members and also the broader community through offering subsidised services, community activities, gifts and sponsorships and a chance for the individuals to be involved in the community through volunteering. They are a vital part of the social fabric in these communities and have reached this status through the security that EGM gambling revenue has provided. 10 Clubs Australia submits that it is in the interest of all Victorians for the maximum possible proportion of gaming machine expenditure to flow through the club channel. The 2011 National Club Census undertaken by KPMG found that community clubs make a $2.3 billion social contribution nationally, with a total social and economic contribution of more than $9.5 billion. 11 Clubs Australia submits that the differences between clubs and hotels are not sufficiently recognised by the current gaming machine arrangements in Victoria. Continuing to treat community clubs and hotels on an equal regulatory basis causes clubs to be commercially uncompetitive whether they are embedded in their community or not. Victoria s regulatory regime must recognise clubs substantial social contributions to the sporting, cultural and pastoral wellbeing of their members and communities, if it is desired that those contributions continue to be made. The only concession received by clubs under the existing gaming machine arrangements in recognition of their community contributions is the 8.33% tax free threshold. Otherwise, clubs are treated the same as for-profit hotel businesses. In other states with well supported community club sectors, the club channel receives concessions in numerous areas of gaming regulation, to encourage the positive aspects clubs bring to the state as a whole and to communities. According to the 2011 National Club Census conducted by KPMG, just over half of clubs are struggling financially or show financial viability risk factors. These risk factors were first established by the Independent Pricing and Review Tribunal (IPART) in studies of community clubs in NSW. 10 Department of Justice, Socio-economic impacts of access to electronic gaming machine in Victoria, 2011 p.93 11 KPMG 2012, p. 1. 6

The fragility and ongoing sustainability of the club movement s financial situation in Victoria is clearly illustrated by the 17 per cent or about 40 clubs with gaming that currently cannot pay their entitlement instalments. Further, at least 23 other clubs have exited gaming or have closed since around 2010, though this figure is expected to be higher as records are difficult to obtain. While there are a diversity of views within the club movement on how to improve the regulatory settings for gaming machines and strengthen the viability of community clubs, that there is a significant problem with financial sustainability in the club sector is not disputed. In our view, any reforms to the gaming machine arrangements in Victoria should seek to secure and enhance the important social-economic contribution made by not-for-profit community clubs. Venue Operator Model Clubs Australia supports the retention of the venue operator model. The venue operator model has been an effective gaming machine industry structure in Victoria in-sofar-as it has allowed clubs the opportunity to exert greater control of their gaming operations and, as a result, their overall financial future. While Clubs Australia supports the retention of the venue operator model, there are a range of issues that negatively impacted clubs arising from the way the Victorian Government elected to introduce and maintain it. The transition and the statutory regime surrounding the new venue operator model caused an uneven flow of benefits across venues, which continues to disadvantage many community club venues. Given the disparate impact of past reforms on clubs and the large number of clubs in financial difficulty, we believe Victoria s regulatory settings need to be more sensitive to the legal and structural differences between community clubs and for-profit hotel venues to address these patently unfair and clearly unintended impacts. Legislative options to recognise the differences between private and community gaming interests are well known and long-established in other States to obtain social as well as economic benefits from gaming. While this submission contains a number of alternatives, Clubs Australia can provide additional details and options should the Government wish to explore these issues further. 7

Regulatory Settings State-Wide Limit Clubs Australia supports the maintenance of a state-wide limit on the number of gaming machines in Victoria. Victoria has the lowest number of Electronic Gaming Machines (EGMs) on a per capita basis in Australia, with the exception of Western Australia. However, this should not be interpreted as an indication that the current levels of supply are failing to meet demand. Victorian gaming machine expenditure, as a percentage of household disposable income, is the second highest in the country behind only New South Wales; 12 indicating that the limited number of entitlements in Victoria are sufficient. Clubs Australia believes that Victoria is a mature market with respect to gaming machines. In our view, additional supply of entitlements is unlikely to stimulate significant incremental demand. While the Victorian population is likely to grow over the new gaming machine entitlement period, this is likely to be offset by the declining gaming participation rates and inflation adjusted per capita gaming machine expenditure. The Victorian gambling prevalence surveys show a significant and persistent decline in the proportion of the adult population that play gaming machines. 13 Figure 1: Victorian Gaming Machine Participation Rate 45% % of Adult Population 34% 21% 17% 1999 2003 2008 2014 Year Source: Productivity Commission, VRGF In addition, inflation adjusted gaming machine revenue in Victoria has been in decline since 2001. 12 Australian Gambling Statistics, 31st edition, Queensland Government Statistician's Office, Queensland Treasury p.152 13 Hare, S (2015) Study of Gambling and Health in Victoria: Findings from the Victorian Prevalence Study 2014, Victorian Responsible Gambling Foundation and Victorian Department of Justice and Regulation. 8

Figure 2: Real EGM Revenue: Victoria 2001-2015 Billions $3.70 $3.50 $3.30 $3.10 $2.90 $2.70 $2.50 Jun-01 Jan-02 Aug-02 Mar-03 Oct-03 May-04 Dec-04 Jul-05 Feb-06 Sep-06 Apr-07 Nov-07 Jun-08 Jan-09 Aug-09 Mar-10 Oct-10 May-11 Dec-11 Jul-12 Feb-13 Sep-13 Apr-14 Nov-14 Jun-15 Source: Clubs Australia, VCGLR, ABS There is no evidence to suggest that there will be any real growth in demand for gaming machines in the foreseeable future. Therefore, changes to supply with respect to the number of entitlements would create additional risk and uncertainty in valuing entitlements. An increase in supply of entitlements would erode the cash flows that each entitlement generates as Victorian gaming machine revenue is dispersed across a greater number of entitlements. In addition, given the existing taxation regime is based on revenue per EGM an increase in supply of entitlements and a subsequent decline in revenue per machine will result in tax revenue erosion as less revenue is taxed at the top marginal tax rates. Clubs Australia is of the firm view that there is unlikely to be any increase in real (inflation adjusted) gaming machine revenue during the new entitlement period, and that a substantial decline in real gaming machine revenue is the most likely outcome. Therefore, we believe that there are insufficient grounds to increase the number of gaming machine entitlements above the existing state wide limit. Venue Limit Clubs Australia supports increasing the gaming machine venue limit for community club entitlements to while retaining the existing venue limit for hotels. Providing community clubs with a higher gaming machine venue limit than hotels is well-established public policy for maximising the benefits local communities, as opposed to private interests, receive from gaming. Not-for-profit community clubs return any surpluses from gaming to the local community through investment in community services and infrastructure such as junior sporting programs, sports fields and community meeting rooms as well as support for local groups. New South Wales, Queensland, Tasmania, Northern Territory and Australian Capital Territory all have established gaming policies that further the public interest by allowing not-for-profit community clubs to have a greater number of gaming machines per venue than privately-owned hotels. 9

Table 1: State Venue Limits Comparison VIC NSW QLD ACT TAS NT Club 105 No cap 300 No cap 40 55 Hotel 105 30 45 10 30 20 Source: Clubs Australia analysis The Victorian maximum hotel limit of 105 gaming machines is the most generous of any Australian jurisdiction. Hotels can have more than double the machines they are allowed in any other state. Increasing the venue limit for community clubs will allow them to generate the necessary economies of scale to increase their social and economic contribution and would bring Victoria into line with other states. A venue limit increase for clubs reflects the differential in other states, in gaming revenue between clubs and hotels and in the value of club and hotel entitlements in the transfer market. It would also allow the currently unallocated club entitlements to be utilised. This approach aligns with the Victorian Government s objective to more broadly distribute the benefits of gaming to the Victorian community. This would allow community clubs to compete on a level playing field with the large corporate hotel chains, which have benefited from greater economies of scale as a result of the disparate ownership restrictions between clubs and hotels. Metro-Regional Limits Clubs Australia supports maintaining the existing metropolitan and regional limits. The metropolitan and regional limits on the number of gaming machines across Victoria prevent the concentration of gaming machines within any particular region. This helps to ensure that gaming machines are available to community clubs in all regional areas. At present, 37 percent of all Victoria s gaming venues are located in the country. However, for community clubs the proportion is much higher - about 46 per cent of all clubs with gaming are in the country. This keeps the option available for metropolitan clubs to aid regional clubs if the need arises as has been the case in other states. If the limits where removed there is a risk that gaming machines would become concentrated in particular regions and that clubs located outside of those regions could experience difficulty acquiring entitlements and lose the opportunity to utilise the revenue from gaming to deliver important community assets and services. Club-Hotel Limits Clubs Australia strongly supports retention of club-hotel limits and recommends providing community clubs with preference over hotels when allocating entitlements. The club-hotel limit prevents concentration of EGMs in hotels and it is essential for the limit to remain at 50/ 50 as a minimum. In our view, the preferred approach to allocating entitlements between community and private interests is to first allocate entitlements to not-for-profit community clubs on the basis of need, with the remaining entitlements in each Local Government Area to be allocated to hotels. Giving community clubs first priority in the allocation of gaming machine entitlements would help to maximise the community benefits from gaming. This will help resolve the imbalance of the current regulatory arrangements that inadvertently favour private interests. While there is currently spare capacity within the overall club limit of 13,686 entitlements, it should be noted that there are various regions where clubs have an unfulfilled demand for additional gaming 10

machines. These clubs are unable to meet member demand for gaming often due to the total number of entitlements across both clubs and hotels in the region being capped. In addition, Clubs Australia notes that areas where there is a high demand for gaming machines also raises concerns about the exacerbation of gambling-related harm. However research for the Department of Justice has found that the social capital that clubs create helps mitigate this risk of harm. 14 Ownership restrictions Clubs Australia contends that the current ownership restrictions artificially place community club groups at a competitive disadvantage to corporate hotel chains. They also inhibit club growth, prevent economies of scale, reduce ability to centralise back office functions and entice top quality management. Therefore, we support alignment of the ownership restrictions between community clubs and hotels. The current ownership restrictions which allow corporate hotel chains to own up to 35 per cent (4,790 entitlements) while limiting club groups to 3 per cent (420 entitlements) provide hotels with an unfair competitive advantage. It is inexplicable why this is in the public interest. As noted earlier in our submission, the gaming market in Victoria is in decline, in real terms. There are growing levels of financial viability concern with in the community clubs sector as growth in costs outstrips growth in revenue. The typical economic response to a declining market is a consolidation of suppliers in order to reduce overheads through economies of scale. While at least 23 clubs have exited gaming or have closed since around 2010, there have been fewer mergers and only two new greenfield clubs (one currently under development). For clubs to merge, a special resolution with a three quarters majority of members voting in favour is required from both clubs. The current EGM ownership restrictions place undue limitations on consolidation in the community club sector and make it increasingly difficult for clubs to compete with large corporate hotel chains. The restrictions in this and other areas of the regulatory settings for gaming machines mean that even where a struggling club may be willing to amalgamate with a more financially secure club, based on the current regulatory regime, it is not in both clubs interest to do so. This situation is untenable given the approximately 40 clubs with gaming that currently cannot pay their entitlement instalments. Regulatory impediments to willing club amalgamations should be removed to negate higher barriers to new club gaming entrants so that clubs have the opportunity to continue to serve members and their community. It is a very difficult and time consuming process to create and establish a new club, which is why it is important to ensure club groups can own more venues. This reduces the impact of the higher barriers to entry to gaming for clubs while allowing industry consolidation and innovation in the club movement. If the Government s regulatory settings fail to enhance club sustainability, many community assets run by clubs will likely be forfeited to cash strapped local councils to maintain or be lost to their communities as they become derelict. Aligning the EGM ownership restrictions for clubs and hotels is one of the ways the Government can enhance the sustainability of the community club sector and distribute the benefits of gaming. Based on VCGLR data, there are currently around 17 clubs with more than one venue. A change to equalise EGM ownership limits would remove a significant impediment to growth in the club channel, allow 14 Department of Justice, Socio-economic impacts of access to electronic gaming machine in Victoria, 2011. 11

consolidation and create potential for reductions in management overheads and back office functions amongst clubs. Distribution of Gaming Machine Revenue Valuation of Entitlements There is considerable discrepancy in estimates of fair market value for EGM entitlements in Victoria. The Department of Treasury and Finance assessment of market value of $1 billion contrasted with the Victorian Auditor General s Office (VAGO) of $4.4 billion. Clubs Australia contends that the valuation provided by VAGO is significantly flawed due to a number of factors that have not been considered appropriately and factored into the calculation of the Electronic Gaming Machine (EGM) Entitlement model. This view was supported by the Victorian Department of Justice in its response to the VAGO Audit stating: [T]he Department s view [is] that the assumption underlying the audit s assessment of fair market value is not sound. 15 We also note that Department of Treasury and Finance (DTF) stood by its own valuation of the EGM entitlements: DTF considers that it realistically assessed how much revenue could be raised from the allocation of EGM entitlements with the regulatory and policy environment prescribed by Government at that time. DTF estimated that the EGM allocation would raise about $1 billion in premium revenue, and actual premium revenue raised was $980 million. 16 In our view, the Victorian Government should seek an independent third-party valuation of gaming machine entitlements that properly accounts for the economic and regulatory risks facing the gaming industry. Clubs Australia is not opposed to the discounted cash flow modelling approach used by VAGO to value entitlements, however, we have serious concerns about a number of the inputs and assumptions used by VAGO which completely undermines the credibility and accuracy of their final valuation. VAGO Revenue Forecasts VAGO has forecast EGM revenues based on flawed assumptions leading to an overinflated valuation of EGM entitlements. The VAGO valuation method predicts recurring revenue growth of 3.6%per annum, compounding over 10 years. This is a gross misrepresentation of the reality of gaming machine revenue in Victoria. The reality is that Victorian gaming revenue has been in significant decline over the past 14 years. In real-terms, EGM revenue has declined 29 per cent since its peak in 2002. 15 Victorian Auditor-General s Report, Allocation of Electronic Gaming Machine Entitlements, June 2011, p.82 16 Ibid p.86 12

Figure 3: Real EGM Revenue: Victoria 2001-2015 Source: Clubs Australia Analysis, VCGLR and ABS VAGO failed to properly consider the long-term historical trends when making its forecasts for EGM revenue. The error the VAGO revenue forecasts amounts to over $1 billion in the first 3 years of operation alone. Table 2: EGM Revenue: VAGO Forecast Vs Actual Year VAGO Forecast ($m) Actual ($m) Error ($m) 1 2 769 2 486 283 2 2 869 2 511 358 3 2 972 2 580 392 Source: VAGO, VCGLR Total 1 033 The gap between the VAGO forecasts and actual EGM revenue is expected to widen over the remainder of the current entitlement term; Clubs Australia modelling indicates that by 2022 the difference between the VAGO forecasts and actual EGM revenue will exceed $5 billion. Clubs Australia submits that any reliance on the VAGO valuation of gaming machine entitlements is inappropriate on the basis of the error in revenue forecasts alone. Regulatory Risk Clubs Australia submits that the primary reason for the error in VAGO s estimates is a failure to consider the impact regulatory intervention is likely to have on future revenues. In addition to normal business risks such as economic downturns, changes in technology and consumer preferences, gaming machine operators also bear substantial sovereign risk - the risk of adverse regulatory events. The industry in Victoria has experienced a number of regulatory shocks that have severely impacted gaming revenue. In 2001, smoking bans across all venues in Victoria came into force and had a significant detrimental effect on gaming revenue across Victoria. In 2009, the maximum bet for an EGM was reduced by 50% to $5; this regulatory reform, coupled with the onset of the Global Financial Crisis had a significant negative effect on gaming machine revenue. These regulatory burdens were further compounded by the Victorian Government s decision to remove all ATMs from gaming venues across the state in 2012. 13

Table 3: Adverse Regulatory Event Impacts Year Regulatory Event EGM Revenue Impact 2001 Smoking Bans -13.6% 2009 $5 Maximum Bet Limit -4.3% 2012 ATM Ban -7.1% Source: Clubs Australia Estimates, VCGLR In addition to adverse regulatory events that caused significant reductions in revenues, further unexpected cost burdens have also been levied on community clubs since 2012, as outlined in the table below. Table 4: Additional Regulatory Costs Regulatory Event Cost to Community Clubs ($m) 17 Increased tax rates (2014) 144 Voluntary Pre-commitment (2015) 43 Supervisory Levy (2015) 23 Additional Centralised Monitoring Fees (2012-2015) 17 Total 227 Source: Clubs Australia Estimates In 2014, the Victorian Government increased the rate of taxation on EGM revenue in the top two club tax brackets. Clubs Australia estimates that this will result in community clubs contributing an additional $144 million in combined gaming machine tax revenue during the existing EGM entitlement period. The cost of equipment and software required to comply with the voluntary pre-commitment system is estimated to be approximately $1,250 per machine, with a half day of machine down time for installation. For an average Victorian club with gaming, which has about 48 machines, the cost of this hardware and software is in excess of $60,000 which has been an additional cash-flow and cost burden to clubs. Clubs are also required to pay a daily fee of $0.745 per EGM to the pre-commitment provider Intralot. The total cost of pre-commitment to community clubs over the current entitlement is estimated to be $43 million, comprising $17 million in capital expenditure and $26 million in fees to the operator. These estimates are conservative and likely to be lower than the actual cost to clubs as items such as labour costs or EGM down-time which are difficult to accurately account for are not included. Due to the Victorian Government s failure to properly manage the transition of Victorian Monitoring Licence, clubs were required to pay additional monitoring fee of $35 per EGM per month for a period of three years. This amounted to estimated $17 million of additional monitoring fees paid by community clubs effectively a double payment. 17 Cost estimates since implementation until end of EGM entitlement term (i.e. 2022) at 2016 prices. 14

In March 2015, the Treasurer introduced an annual supervisory levy on community clubs to recover the costs associated with regulating the industry; apparently the $1.2 billion collected in gaming machine taxes is insufficient to cover the cost of the Regulator. These additional costs were not available to be factored into the calculations clubs made when determining whether to purchase entitlements in the competitive allocation process. None of these regulatory measures saw any offset for industry, which has resulted in diminished value for entitlements purchased in 2012 and significant sovereign risk associated with investing in new entitlements. This creates difficulty in obtaining finance for entitlements as the revenue stream from gaming machines is the only asset that is acceptable to financial institutions many clubs have as they rent their land. Together these actions by Government clearly demonstrate a pattern of regulatory intervention, which undermines the ability of community clubs to achieve a reasonable return on their investment in EGM entitlements or obtain finance. This sovereign risk and uncertainty needs to be factored into any valuation of EGM entitlements. In fact, a major difference between the DTF valuation methodology and that of VAGO was that the DTF acknowledged the impact regulatory risk would have on entitlement values: "DTF advice indicated that the level of regulatory risk would also diminish the Government s potential to extract current levels of supernormal profit as a premium (because it would reduce market expectations of future supernormal profits). 18 Clubs Australia submits that the actions of Government have had a greater negative impact than even the industry could have predicted and as a result the value of EGM entitlements has diminished significantly since the time of purchase. In our view, the market value of entitlements for community clubs is now considerably less than the purchase price paid. Community clubs paid an average price of $32,060 in the Government s PACO and auction process, whereas club entitlements currently trade for an average of $14,237 on the transfer market. Clubs Australia estimates that the market value of club entitlements could have fallen by as much as $240 million since the initial allocation. Going forward, regulatory risk is not confined to the intervention of the Victorian Government. There is also a risk that Federal Government could act to undermine the future value of EGM entitlements. For example, the Federal Government could amend the Interactive Gambling Act 2001 (Cth) to allow for online gaming or seek to introduce some other legislative measure such as mandatory precommitment or $1 maximum bet limits that could undermine revenue and increase costs. Such changes could dramatically change the value of gaming entitlements and represent serious risks; especially given the time horizon over which the new entitlements are likely to be issued a period of 10 years or more commencing in 2022. The ongoing regulatory instability facing the gaming industry in Victoria limits community clubs ability to forecast stable cash-flows in the years ahead. This substantial uncertainty reduces the amount that clubs can reasonably outlay for EGM entitlements without putting the financial viability of their operations at risk. Victoria already has an onerous regulatory regime coupled with Australia s highest gaming tax rates, placing the financial viability of many community clubs that are reliant on gaming in a precarious position. 18 Victorian Auditor-General s Report, Allocation of Electronic Gaming Machine Entitlements, June 2011, p.86 15

If the Victorian Government wants to maximise the value it receives from community clubs for EGM entitlements, it must provide certainty to the industry by eliminating, or at least significantly reducing sovereign risk. This could be achieved through a compensation regime for adverse regulatory events, as is the case with other Victorian gaming licenses. Providing this level of certainty to industry would help the Government maximise the returns to Victorian taxpayers. Community Club Business Model VAGO failed to properly consider that unlike commercially operated hotels, community clubs are notfor-profit businesses that exist solely to achieve their reason for being (sport, veterans, culture) and to benefit their local communities. VAGO s overriding view was that the Government should, through the entitlement sale process, seek to capture all of the supernormal profits gaming generates. VAGO s valuation failed to consider that the public policy rationale for allowing clubs to operate gaming machines is so that they can reinvest some or all of the profits to subsidise a range of community assets and services that are otherwise loss making enterprises, such as bowling greens, golf courses, support for junior sport and affordable meals for seniors to name but a few. As clearly demonstrated by the golf and bowls club case studies in the Overview, without gaming in community clubs much of the burden for funding these facilities and activities would otherwise fall on Government or local councils. As a result, VAGO s estimation of the capital and operating costs for community clubs was grossly inadequate. VAGO only assessed the capital and operating costs directly associated with gaming and failed to recognise the additional costs incurred by clubs in providing local community infrastructure and services. While a for-profit gaming business may be able retain a significant portion of its EGM revenues as profits, community clubs use EGM revenue to support a range of community purposes. This means that community clubs, unlike hotel gaming venues, do not earn supernormal profits. In fact the KPMG National Club Census reveals that over 50% of community clubs are experiencing some form of financial distress, which hardly equates to an industry benefiting from supernormal profits. 19 Clubs Australia recognises that it is a matter of Government policy to determine the appropriate balance between allowing clubs to retain the proceeds of gaming for reinvestment in the local community and channelling the proceeds into consolidated revenue. However, we respectfully submit that VAGO s approach of trying to channel the vast majority of the proceeds of community club gaming earnings into consolidated revenue was ill-considered. Further we note, that combination of taxes and entitlement payments means the Victorian Government retains a greater proportion of club gaming machine revenues than any other Australian jurisdiction. Venue refurbishment Clubs Australia believes that the amount allocated by VAGO for venue refurbishments fails to properly take into account the need for capital improvements in community clubs. Clubs operate in an increasingly competitive environment and must continually update and refresh their offering to remain relevant. If clubs simply keep the same décor and infrastructure in place for a decade, then they can expect a dwindling return on their investment. Major capital improvements are essential to the life of a community club, or any other hospitality business, and need to be considered properly in any valuation undertaken. Market Value Clubs Australia understands that EGM entitlements are currently trading at values well below the median price paid by community clubs at the PACO and auction conducted 6 years ago. This 19 KPMG 2012 p.43 16

demonstrates that the real market value of community club gaming machine entitlements is below the VAGO valuation by an order of magnitude. The decline in market value reflects the policy decisions and regulatory burden placed on operators that has reduced revenues and increased costs. The average market price for a gaming machine entitlement based on VCGLR data from the transfer market, 20 and accounting for elapsed time at the point of sale is as follows: $14,237 for community clubs; and $43,096 for hotels This compares to an average price of $32,060 paid by community clubs in the Government s PACO and auction process. Community clubs, particularly those in regional Victoria, paid well in excess of the true market value for their entitlements. In contrast, hotels on average paid less than market value for their entitlements at the previous Victorian Government auction. What is clear from the transfer market is that the true market value of community club entitlements is substantially less than hotel entitlements. In fact, based on the transfer market history club entitlements have a market value of approximately one third of hotel entitlements and represent only 25 per cent of total market value of entitlements in Victoria. Table 5: Estimated Market Value of Entitlements Venue Type Average Transfer Price No. Entitlements Market Value Market Share Community Club $14, 237 13,686 $194,847,582 24.8% Hotel $43,096 13,686 $589,811,856 75.2% TOTAL 27,372 $784,659,438 100% Source: Clubs Australia analysis of VCGLR transfer market data at end December 2015 Based on the value of the average transfer market price, the current market values are $195 million and $590 million for community club and hotel entitlements respectively. This indicates a total market value of $785 million compared to the VAGO estimate of $4.1 billion, a gap of over $3.3 billion but only $215 million different to the DTF valuation. The difference in market value between community club and hotel entitlements is unsurprising. On average, hotels earn twice as much as clubs per entitlement. In addition, hotels do not use gaming to support community infrastructure or services that run at a loss and therefore have a much greater capacity to pay. Clubs Australia submits that the market value assessment of the DTF more accurately represents the economic and regulatory risks faced by community clubs. However, we believe that an independent third-party expert should be appointed to help resolve the major discrepancy in the valuation of entitlements; this approach has previously been recommended by VAGO and supported by the DTF. 20 VCGLR Transfer Register http://www.vcglr.vic.gov.au/home/resources/data+and+research/data/index.html 17

Taxation structure Clubs Australia supports a continuation of the existing progressive tax structure, in particular the club-hotel tax differential and the tax free threshold both of which play crucial role in supporting the viability of community clubs. The Victorian Government already receives the greatest proportion of club gaming machine revenue of any Australian jurisdiction. This occurs through both the taxation regime and the premium paid for entitlements. Figure 3: Comparative Government Share of Club Gaming Revenue VIC SA NT QLD NSW 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% Effective Tax Rate Entitlement Premium Source: Clubs Australia Analysis Clubs Australia supports there being an adjustment to the tax regime involving the introduction of indexing of the revenue thresholds to prevent bracket creep from eroding community clubs share of total revenue. In addition, we believe that an increase in the tax free threshold for small clubs could assist significantly with ensuring their financial viability and help offset the cost of entitlement premium payments. Clubs Australia supports the continuation of the existing progressive taxation regime including maintaining the differential tax rates between clubs and hotels. The differential tax rates recognise that not-for-profit community clubs play an important role in providing vital community infrastructure, services and help build social capital and community connectedness. In our view, the community benefit provided by not-for-profit clubs more than justifies the tax differential with hotels. However, Clubs Australia supports the streamlining of the way in which clubs are required to report community benefits. Research commissioned by the Department of Justice on the socio-economic impact of gaming machines in Victoria found that: [T]he structure and design of the CBS form is focussed primarily on accounting for club costs and is inadequate for capturing the totality of community benefits generated by clubs. However, this does not signify that clubs, in particular community-centric clubs, have no or 18

little community benefit. Rather, these clubs are not able to identify their real qualitative values to the community through current reporting mechanisms. 21 In our view, the way clubs are required to quantify community benefits in order to qualify for the 8.33% tax differential to hotels does not capture the social and cultural advantages inherent in the not-for-profit community club model. The current Community Benefit Statement (CBS) needs to capture the value of in-kind contributions to local groups for fundraising such as those mentioned in the Overview and the work of the more than 50,000 club volunteers. Clubs are one of the dwindling number of public places in many communities where people on fixed incomes can spend time socialising without having to spend any money at all. Consistent anecdotal reports from club workers across the state relate that many elderly members visit their clubs on a daily basis, just for the opportunity for social interaction. It is notoriously difficult to measure a lack of loneliness or the feeling of belonging that many club members experience who do not have anyone else in their lives. These important intangible contributions are ignored in the current Community Benefit Statement and in the broader gaming machine arrangements. Clubs provide social capital for their communities, particularly in regional areas. Clubs provide this through community infrastructure that would otherwise need to be provided by Government. Common examples of this include loss making facilities such as bowling greens, tennis courts, sporting fields and facilities, meeting rooms and golf courses. Large clubs in other states are growing their social services footprint through providing aged care and child care services, which underpin and remove some of the burden from Government. Without clubs and the beneficial externalities that they provide to society, this void would need to be filled by Government and local councils, as it is not profitable for the private sector to provide. The cost associated with providing, maintaining and improving these facilities is significant. It is in the public interest that Government recognises the facilities and benefits that clubs provide to the community and differentiate clubs from their competitors, who are purely focused on a profit motive. The current CBS does not provide an accurate means for clubs to properly convey the benefits they provide to local communities. The current CBS requirements include a number of items under Category B that the general public does not consider a genuine community benefit, which undermines clubs credibility as genuine community organisations. It has been identified by various commentators that without the inclusion of operating costs many clubs would not be able to justify the full 8.33% tax differential. However as noted in the Department of Justice research this does not mean that these clubs do not provide valuable community benefits, but rather that many of the community benefits provided by clubs are intangible benefits that are not directly quantifiable, such as providing loss-making recreational activities for the elderly (e.g. bowls). [W]ithout accounting for business costs, clubs would not be able to meet an 8.33% value of community benefit. However, it is contended from the findings of this research, that this outcome is the result of an undervaluing of community benefit and an inability to adequately reflect the benefit in the CBS the CBS form does not facilitate a reflection of many of the other community benefits that community centric clubs often cannot quantify. Such benefits encompass their role in the community (often that of a community hub) and this intangible benefit has been difficult to identify through dollar values. 22 Clubs Australia strongly supports the continuation of the tax differential between the community and for-profit gaming models as it is the only substantial concession to recognise the non-economic contribution made by clubs. In our view, the Victorian Government should look to streamline the CBS 21 Department of Justice, Socio-economic impacts of access to electronic gaming machine in Victoria, 2011 p.95 22 Ibid, p. 96 19

process, its structure and quantification requirements by ensuring items like in-kind and volunteer contributions are covered. This would reduce the regulatory burden and cost that has been placed on clubs and grossly simplify the administration of the CBS by Government. It would also recognise the important role clubs play in the community. Further detailed consultation with clubs would be needed to achieve a more accurate CBS process. Preferred Transaction Structure Clubs Australia submits the following as its preferred transaction structure: Entitlement Term: Price: Payment Terms: Allocation: Perpetual Percentage of Revenue Monthly in arrears (2022 onwards) Administrative; Existing market participants; Club ownership limits same as for hotels at 35% First preference to community clubs; plus Option for clubs to increase the number of EGMs in each venue. Affordability of entitlements is a key issue for community clubs as illustrated by the situation of The Bendigo Club which was placed in voluntary administration in mid-january this year. Administrators cited the outsized price paid for entitlements as the major cause of the club s financial difficulties. 23 Our preferred transaction structure was developed after extensive industry consultation to address affordability and represents what is in our view a mutually beneficial outcome for clubs, the State and community of Victoria. Term of Entitlements Clubs Australia notes that community clubs in Victoria have a strong preference for gaming machine entitlements to be issued in perpetuity, paid as a percentage of revenue monthly in arrears. Issuing entitlements on a perpetual basis would help improve certainty for clubs, improve access to financing and secure their long-term ability to utilise gaming machine revenues to support their community purpose and benefit local communities. All other relevant jurisdictions have perpetual entitlements. Significant risk would be removed if perpetual entitlements were created from 2022 which would generate certainty and encourage banks to lend and refinance in the sector, enhancing clubs sustainability. A further positive consequence is that both club and hotel venues would be incentivised to invest now and not defer development which creates economic benefits for Victoria which are currently being lost to other states. Should the Government be unwilling to create entitlements in perpetuity, a much longer term would be preferred by clubs with flexible payments made across the term in arrears. 23 See Appendix - Bendigo Advertiser, Pokie Debt - The Bendigo Club buckles under $800,000 debt to Government 14 January 2016, page 1. 20

Price of Entitlements Clubs Australia believes that the most equitable way to price entitlements is as a percentage of club EGM revenue or hotel EGM revenue for the region. Pricing entitlements as a percentage of EGM revenue addresses both the disparity in earnings potential for EGM entitlements in different regions of Victoria as well as between commercial hotel and community club venue types. Clubs Australia believes that the appropriate percentage of revenue should be determined based on revised third party valuation of the entitlements. Different rates would need to apply to club and hotel entitlements. The administrator of The Bendigo Club cited high entitlement prices as the reason for the club having to place itself under voluntary administration. Affordability is critical to community clubs as they rely heavily on cash flow to fund their loss making sport, cultural and pastoral services and facilities. Establishing a reasonable differential between community gaming and for-profit venues which allows flexibility in payment terms is vital to ensure sustainability in the club sector. Allocation of Entitlements Clubs Australia submits that entitlements should be allocated on an administrative basis to existing market participants with clubs receiving first preference. The benefits of an administrative allocation are a simpler lower cost process, greater certainty for venues and less risk for the State in terms of achieving the desired financial outcomes. Restricting the allocation to existing market participants will have a significant effect on financial outcomes for the State under the proposed pricing mechanism, whereby venues pay for entitlements as percentage of revenue in arrears. New operators can acquire entitlements on the transfer market. The transfer market will ensure the efficient allocation of entitlements maximising revenue for both venues and the State. The price (percentage of revenue) set by Government should be based on an independent third-party valuation of club and hotel entitlements separately. The valuation process should include full stakeholder consultation. Clubs Australia submits that providing community clubs with first preference with respect to allocation of entitlements will help to maximise the community benefits. We believe that it is incumbent on the Government to ensure that community interests take precedent over private interests with respect to the allocation of poker machine entitlements. This can be achieved through the allocation process outlined below. Preferred Allocation Process The following steps outline at a high level Club Australia s recommended approach to allocating EGM entitlements in manner that will maximise community benefit: 1. Clubs allocated their existing number of entitlements by default; 2. Clubs can apply for an allocation increase or decrease; 3. Increases are automatically granted if the regional or municipal cap is not exceeded; 4. If area is oversubscribed (i.e. regional or municipal cap exceeded) increases are allocated on a pro-rata basis up to the cap; 5. Following the club allocation process, remaining entitlements are allocated to hotels; 6. Hotels in each LGA are allocated entitlements on a pro-rata basis according to their existing market share of hotel entitlements in the LGA. 21

Payment Terms Clubs Australia recommends monthly in arrears payment terms commencing in 2022. The Victorian gaming market is in decline, faces significant regulatory risk with many community clubs already in a financially precarious position, some 17 per cent having to seek extensions to their entitlement payments to Government. 24 There is little capacity within the clubs sector to absorb significant upfront payments for entitlements. Even large, successful clubs which are performing well are fragile and highly susceptible to financial difficulty due to the structure of club businesses which must subsidise loss making offerings such as bowls from surpluses in other sections of the club. Therefore, Clubs Australia recommends that the Victorian Government introduce payment terms that coincide with actual usage of the entitlement rather than through payment in advance for community clubs. In addition to supporting club financial viability, monthly in arrears payments should also help maximise the financial return to the State. This is because in present valuing the future cash-flows clubs will need to apply a significantly higher discount rate than the State. The main reasons clubs need to use a higher discount rate than the State are as follows: - clubs have greater weighted average cost of capital, due to higher borrowing costs; and - clubs cannot control regulatory risk and need to factor this into the discount rate. Therefore the State can maximise value by receiving entitlement premium as periodic payments rather than an upfront amount. Transfer Market Clubs Australia submits that the existing transfer market provision should remain. The Government are proposing that there is currently no way for the State to capture and share in any of the increased value of entitlements during the course of an agreement. The Government appear to be arguing for access to any increase in value, but do not appear willing to share in the downside if the value of entitlements decline. The Auditor General details that hotel entitlements have transferred for twice the amount paid for them in some instances as justification for increasing the amount the State should charge for entitlements. 25 In contrast, many community clubs have lost significant value on the amount that they invested in good faith as part of the Gaming Machine Entitlement auction conducted by the Victorian Government in 2010. To our knowledge the Government has not sought to reimburse these clubs for the loss in value they have experienced. Under our preferred transaction structure, whereby entitlement premiums are based on actual monthly revenue per EGM, the state would share in benefits of more efficient allocations of entitlements through market transfers. In addition, the Government would also benefit from increased premium should market conditions improve and would bear some of the risk should market conditions deteriorate. 24 Clubs Australia analysis of VCGLR data 25 Victorian Auditor-General s Report, Allocation of Electronic Gaming Machine Entitlements, June 2011 22

Appendix 23

14 Jan 2016 Bendigo Advertiser, Bendigo VIC Author: ADAM HOLMES Section: General News Article type : News Item Classification : Regional Audience : 9,817 Page: 1 Printed Size: 368.00cm² Market: VIC Country: Australia ASR: AUD 1,283 Words: 445 Item ID: 525114599 Copyright Agency licensed copy (www.copyright.com.au) Page 1 of 1 back POKIE DEBT The Bendigo Club buckles under $800,000 debt to government BY ADAM HOLMES THE Bendigo Club has entered voluntary administration with an $800,000 debt owing to the state government for gaming machine entitlements. The Strathdale-based hospitality and gaming venue spent $2 million on entitlements for about 40 machines during the state government auction in 2010, but has been unable to pay back the debt. An exact figure on the amount owing to all creditors, as well as the number of creditors, is yet to be determined. Administrator PPB Advisory took control of the club on Wednesday and will launch an immediate review into the operations of the business, with normal services to continue until the review is complete. PPB Advisory partner Craig Crosbie said a number of options would be considered as part of the review. Our immediate priority is to conduct a review of the business, which will allow us to explore all possible options including a possible restructure, merger with another club or sale, he said. In the meantime, the club will continue to trade on a business as usual basis. An expression of interest process will be part of the review, in the hope of finding another club to either buy outthebendigoclub,ora private individual to purchase the land and manage the club or lease it out. The club does not have any significant assets beyond the business itself. Mr Crosbie said he was confident the club would remain open once the review was complete, and did not expect any job losses as a result. Continued Page 10 Bendigo Club in debt for pokies From Page 1 PPB Advisory partner Craig Crosbie said for a merger to work, another club would have to buy the business. We don t expect it will close, there are sitll a lot of avenues to explore, he said. The issue with The Bendigo Club stemmed back to the gaming entitlement auction process in 2010, when it didn t achieve anywhere near the pre-determined amount for the entitlements. There could be more of this happening to clubs in the future, who were locked in with similar pre-determined amounts. Club members have been invited to an information session at the club at 5.30pm on Thursday. The first meeting of creditors will be held at 10.30am on Friday, January 22. Based on Park Street, Strathdale, The Bendigo Club is a hospitality, entertainment and gaming venue. The club is described as one of the hidden gems of Bendigo on its website and has been in operation since the early 1900s, when it was basedinbullstreet. DEBT: The Bendigo Club will remain open while its books are analysed.