Has Youbet.com Picked A Winner?

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Chuck Champion, CEO of Youbet.com, has a dream: He wants to revive off-track betting on horse racing as a thriving Net business. He's out to clean up the gaming industry's image, too. Unlike the many gaming and bookmaking Web sites that find homes overseas to avoid U.S. regulations, Woodland Hills (Calif.)-based Youbet (UBET) is publicly traded on the Nasdaq exchange.



It uses the same model as legit off-track betting establishments nationally, taking bets on horse racing only and wiring all wagers into the betting pools at the tracks, after taking a small percentage of the take. "We would like to be an agnostic, independent company that provides services to the entire industry" says Champion. "We believe the industry needs someone like us."



But for a business trying to put a new face on online gambling, Youbet made a curious move on Feb. 8, when it announced plans to acquire the International Racing Group (IRG), based in the Dutch Antilles. Three weeks before the acquisition announcement, federal prosecutors identified IRG as one of four betting shops used by a New York group connected to the Gambino organized-crime family to allegedly run a multimillion-dollar illegal gambling operation, according to a Jan. 13 indictment issued by the U.S. Attorney's Office of the Southern District of New York.



NOT A TARGET. The FBI and the New York state authorities are still investigating whether IRG and the other betting shops identified in the indictment may have been complicit in the alleged scheme, BusinesssWeek Online has learned. "If they were mentioned in [the indictment], they're definitely going to be looked at thoroughly," says Michael Coan, a spokesman for the New York Police Dept.



Law-enforcement sources emphasize that IRG hasn't been charged with any wrongdoing and isn't a criminal target of the ongoing probe. IRG President Louis Tavano denies that he or anyone working with the company "knew anything about our customers and a connection to organized crime." Champion says he believes his intended merger partner will ultimately be vindicated. The acquisition, which analysts estimate at $5 million to $10 million in a combination of cash and stock, is still contingent on approval from a Youbet review board and its board of directors.



Acquisition of IRG would mark Youbet's first entry into a controversial practice known as rebate betting, which pays a percentage of the total pot back to clients who make extremely large wagers, win or lose. While rebate betting is legal in most states, nearly all the gambling shops that handle it are located offshore or on Indian reservations within the U.S.



INDUSTRY IRRITANT. Headquartering offshore allows such establishments to avoid municipal and state gambling regulations. What's more, players can reinvest their winnings into new wagers without paying taxes on each winning bet. They need only fork over taxes on winnings when they wire them back to the U.S. Offshore hedge funds often employ a similar strategy.



Rebate betting is a burr under the saddle of the horse-racing industry, however, which charges that such incentives are luring high rollers away from their businesses. "It's hard to see somebody else who has little or no overhead" gain a competitive edge, complains Bill Nader, a top official with the New York Racing Assn., which hosts the annual Belmont Stakes, among other races.



Nader says NYRA would like to offer rebating but can't because New York state law prohibits it. Remi Bellocq, executive director of the National Horseman's Benevolent & Protection Assn., says "the offshore wagering hubs need to be a lot more open with who their clients are."



MAKING THE CASE INTERESTING? Offshore rebate outfits, operating out of remote locales with small client lists, have drawn attention recently for taking wagers from bettors who may have been laundering money or evading taxes. This is precisely what the U.S. Attorney's Office alleges happened with the New York-based Uvari Group, an operation that included brothers Gerald and Cesare Uvari and Gerald's son Anthony, who the Attorney's Office identifies as associates of the Gambino crime family.



The Uvaris, along with defendants identified by law enforcement as Marvin "Cookie" Meyerowitz, David "Pebbles" Appelbaum, and others, aggregated bets from anonymous bettors to take advantage of the rebates, according to the January indictment. As a result, the bettors avoided reporting any winnings to the Internal Revenue Service, while the Uvari group reported the losses as their own, the indictment charges. In 2003, that resulted in a tax refund for Anthony Uvari amounting to $156,794, according to the indictment.



All the defendants have pled not guilty to the charges. "The prosecutors are trying to tie in organized crime because they want to make a boring case interesting," says Tony Fusco, an attorney for Meyerowitz. "Just because there's gambling here doesn't mean it was illegal gambling." Attorney Russel Gioella, who is presenting Appelbaum, declined to comment. The other defendants' attorneys didn't return calls seeking comment.



ROOM TO RUN. Youbet's desire to acquire IRG is all the more interesting because the former has emerged as a leader in online wagering on horse races, a $1.7 billion industry that's estimated to grow by 15% to 20% this year. The company reported profits of $4.6 million on revenue of $65.2 million last year. And it appears poised for strong organic growth.



The outfit has made a remarkable turnaround since Champion, a former circulation director at The Chicago Sun-Times, became CEO in 2002. It posted its first profit two quarters ago and offers the best technology in the field. In addition to hosting video feeds from more tracks than any other site, it lets users watch multiple video feeds at once and research horses by viewing old races.



Because of the massive expenditures on technology early on (which almost sank the company when the dot-com bubble burst in the early part of the decade), Youbet has plenty of room to grow. It operates at only 25% of its servers' total capacity. And almost 90% of its costs are fixed, according to the company. Its shares have posted steady gains, up from being a penny stock in 2002 to close at $6.13 as of Apr. 21. Analysts expect the sum of bets placed on Youbet to rise by 25% when it releases its quarterly earnings at the end of April.



STABLE CLEANING. So why head into the shadowy world of rebate betting? It's a huge business, Champion says. Although the yields are low, rebate betting offers tremendous volume. IRG, a midsize rebate shop with 120 to 130 customers, collected $210 million in wagers last year -- an average of nearly $1.6 million per customer, both companies say. Comparatively, Youbet has 140,000 customers and took in roughly $315 million in bets, making the IRG acquisition particularly attractive.



While Champion is reluctant to talk about IRG being named in the indictment, he allows that, as a public company, Youbet is well positioned to bring legitimacy to rebate shops, one of the fastest-growing segments in horse racing.



"We need to know who owns these places with greater certainty...who their customers are," he tells BusinessWeek Online. "We've stepped in to try to assist the industry in doing that." He adds, "It's sticky, and there's risk associated...[but] if not us, who?"



DEFYING PREJUDICES. Analysts agree. "There's a need to have the offshore participants become more ethical participants in this industry," says Jeff Martin, who covers the stock for Roth Capital. "If anything, I think Youbet will help bring that with their acquisition. I have to believe that such activity wouldn't be tolerated by the Youbet management." Neither Martin nor his family owns the stock, and Roth Capital hasn't done any banking with Youbet, according to Martin.



Yet none of the analysts who cover Youbet was aware of the indictment naming IRG until contacted by BW Online. Champion maintains that he selected IRG as an acquisition target after a two-year search because he believes it defied many of the prejudices associated with the offshore rebate shops. "They're very professional guys, very upfront, and they were knowledgeable [and] concerned about the industry," Champion says.



Youbet has appointed a six-member "due diligence" committee to examine IRG before completing the acquisition, Champion notes, including former members of the Secret Service and the Nevada Gaming Control Board. He says the review should be finished by mid-June.



DECLINING TO TALK. While Youbet's chief says he knew about the initial indictment when his company issued its intent to acquire IRG, he insists he wasn't aware of any ongoing investigation involving the offshore outfit. "If we should find out that IRG is the target of a state or federal prosecution, is that going to cause us to rethink our acquisition? Of course" says Champion.



IRG's Tavano says four of the men now under indictment -- the three Uvaris and Meyerowitz -- had accounts with his company "for a couple of months in 2004." Tavano says he first met them while they were staying as high-rolling VIPs in a hotel and casino in Las Vegas, the city where he resides and runs Curacao-based IRG. He declined to talk about his relationship with the four beyond that, adding, "I wouldn't want to talk about any particular customers, really."



With so much riding on its selection, Youbet can only hope it has backed the right horse.