Bulls, Bears, and Horses: The Kentucky Racing Industry

One of our core principles at Baird is a commitment to community development and betterment. Our firm has a long tradition of investing in the areas where our associates live and work, from the over $5 million in nonprofit contributions in 2022 to the many partnerships with local organizations across the country. Quite simply, we believe that we cannot thrive without the communities we serve thriving, as well. This means good jobs, capital investment, and strong community spirit. And here in Kentucky, while the bourbon world might have our taste buds, it’s the horse industry that has our heart.

Where We Are Today

It has been a unique and challenging few years in the U.S. economy – from pandemic lockdowns to reopening boom to higher interest rates and inflation. The horse racing industry has not been spared from this volatility, and in many ways, it has amplified the sector’s longer-term challenges. Dr. Thomas Lambert of the University of Louisville’s Equine Industry Program sums up the state of the industry thusly: “In the aggregate, and when adjusted for inflation, gambling on horse racing is in decline, and the number of races each year continues to decline, as well.”

Covid-19 proved particularly challenging for horse racing, as it was for most sports, entertainment, and tourism-related industries. Dr. Jill Stowe of the University of Kentucky’s Agricultural Economics program concluded that, “in addition to direct job loss, the widespread cancellation of local, national and international competitions had a ripple effect on regional economies.” The massive disruption to the industry was perhaps best exemplified by the 2020 Kentucky Derby, which was rescheduled from its traditional May slot for the first time since World War II.

Luckily, the bounce back in the ensuing years has been sharp. As the economy reopened, the U.S. consumer expressed a pent-up demand for leisure, travel, and experiences, and horse racing proved a beneficiary. As an example, Dr. Lambert’s research around the 2022 Breeder’s Cup in Lexington, Ky concluded that “the 2022 World Championships produced the second-highest economic impact recorded in Breeders' Cup history. The 2022 event's economic punch was 25.8% higher than the 2015 event at Keeneland, which had an economic impact estimated at $65 million.” Lambert also notes that while horse racing may be in decline, “on a per race or per horse basis, profitability is still good. The industry has adjusted to an overall decline in demand…(and) thanks to the emergence of the “racino” model of business (a facility in which a racetrack and casino operate together in one location), horse racing has prevented further declines in gambling revenues and has been able to keep purse amounts at adequate levels.” Things may be challenging, but the industry is proving adaptable and resilient in the post-Covid era.

Where We're Headed

While the last few years have been volatile, the road forward (unfortunately) looks similarly rocky. Our partners at Strategas forecast a higher interest rate and stickier inflation environment going forward, as well as elevated odds of a near-term recession. That will dramatically change the tenor of the U.S. economy vs. the last decade, and could put additional pressure on the consumer heading forward. The recent shocks to the financial system should only serve to further cool economic activity. Lambert agrees, noting, “Higher interest rates, inflation, and a possible recession will harm racing and gambling in general. All of this is because of stagnating disposable personal income growth, and bad economic times will harm this growth further. Gambling is a luxury good, and so when incomes are squeezed, it is one of the first things to be dropped or curtailed by many consumers. It’s the same for tourism and traveling.”

On the brighter side, the U.S. labor market remains tight, with historic worker shortages driving near-record unemployment and strong wage growth. This has kept consumer spending steady despite high inflation pressuring budgets. Further, the post-pandemic economy has seen a radical shift in wallet share from goods (e.g., electronics, home furnishings) to services (e.g., travel and leisure). And despite the first Covid-19 vaccine being introduced well over two years ago, this trend continues to have legs. In fact, Churchill Downs’ CEO recently confirmed this sentiment on the company’s 4Q22 earnings call, noting the company doesn’t see any canary in the coal mine around consumer spending. Despite a challenging economic backdrop, the U.S. consumer has been resilient, and it’s a boon for the Kentucky horse racing industry.

What Else to Watch

As with any heavily regulated industry, the horse racing / casino / sports gambling complex faces potentially big changes in the coming years. The rise of sports gambling over the last decade has been prolific, with a majority of states having already legalized the activity. This represents a potential turning point for the racing industry, with Lambert noting that, “sports gambling will probably draw gambling revenues away from horse racing just as lotteries and casinos have cut into horse racing revenues over the last 30 to 40 years. The demand of any form of gambling is fairly elastic, and the landscape is very competitive.”

As of this writing, Kentucky looks set to legalize sports gambling after House Bill 551 unexpectedly passed through the State Senate just hours before the legislature adjourned. Per the Courier Journal, “Under the bill, the Kentucky Speedway and horse racing tracks could pay a fee to operate as sports betting facilities, with bets allowed there and on licensed websites and phone apps.” This represents a potentially huge source of tax revenue, and should provide a counterbalance to a challenged legacy horse racing industry. Senate Majority Floor Leader Damon Thayer said the bill would bring in an estimated $23 million in annual tax revenue directed to the state's public pension system, adding that Tennessee's sports betting law brought in $68 million of revenue last year.

Another win for the horse racing world came when the Kentucky General Assembly recently banned so-called “gray machines,” a slot machine-like form of video gambling that represents a key source of competition to one of the racing industry’s key growth drivers: historical racing machines (HRMs). These quasi-slot machines allow players to wager on the outcome of past horse races, and, per Lambert, accounted for nearly $7 billion in revenue for the 2021-22 fiscal year. Along with racinos, these alternative sources of revenue have helped keep purse levels competitive in the near-term, particularly against competition in nearby states where sports gambling had already been legalized, such as Indiana and Tennessee. Going forward, these avenues represent tremendous growth opportunities for the industry and the local economies it supports.

Impact on the State

It goes without saying that this industry is critical to Kentucky’s finances and future growth. Per the Kentucky Thoroughbred Association, the equine industry generates roughly $6.5 billion in total economic impact, supports over 60,000 jobs, and brings in over $100 million in tax revenue for the state. The hub around which the industry is built is the Kentucky Derby, the oldest continuously held major sporting event in the United States. Per the KTA, the 2019 Kentucky Derby and Oaks had an economic impact of more than $356 million. As Lambert concludes: “Demand for horse racing creates derived demands for horse breeding farms, racing equipment, hotels, and tourism throughout the state. It has a profound impact.”

But, as with bourbon or any other industry that is tied so closely to a region’s background, the impact is greater than just financial. Perhaps Breeders' Cup President and CEO Drew Fleming summed it best in a recent interview with Thoroughbred Daily News: “The moment you get off the plane in Lexington, Kentucky, horse racing is in the air. You go to a restaurant, a bar, a coffee shop, people are talking about breeding, training, and owning race horses.”

In our state, the industry is both an economic driver and a cultural touchpoint, directly or indirectly affecting the lives of almost every single Kentuckian. As Fleming succinctly concluded, “It's a way of life.”

At Baird, we want to help this proud tradition continue. We are a fully-fledged financial services firm with a focus on integrity, transparency, and keeping clients first. Across our range of business units, the potential for partnership and support is endless. Baird Trust – headquartered in Kentucky – provides asset management, trust administration and estate settlement services. Baird Capital makes venture capital, growth equity and private equity investments in targeted sectors, both locally and globally. Baird Business Owner Solutions advises lower middle-market and emerging growth companies and their owners on business transition, valuation and M&A transactions. And that’s just the tip of the iceberg. In the end, a healthy and growing horse industry means a healthy and growing Kentucky, and we’re thrilled to be a part of the journey.