|Barrons cover story |
Sports Gambling Will Be a Huge Opportunity. Bet on These Stocks.
By Andrew Bary
Jan. 24, 2020 8:22 pm ET
The Super Bowl is the premier event in U.S. sports. It’s also the biggest day of the year for sports gambling. What’s different this year is that an increasing share of the wagering on the Feb. 2 game between the San Francisco 49ers and the Kansas City Chiefs will be done legally.
Sports betting—and, in particular, online sports wagering from mobile phones—has quickly become the hottest trend in the U.S. gambling industry. The business has mushroomed since the Supreme Court in May 2018 struck down federal legislation that had banned sports wagering in all but a handful of states including Nevada.
Since then, there has been a rush to legalize sports wagering, with betting now allowed—but not necessarily live yet—in 20 states, including New Jersey, Pennsylvania, Illinois, and Michigan. Analysts think that another dozen or more states could approve sports betting in the coming years.
The market is potentially enormous: An estimated $150 billion is bet on sports illegally each year, according to the American Gaming Association. States, meanwhile, are eager for the tax revenues from legal wagering.
“This is the biggest growth opportunity for the U.S. gambling industry in the past 10 years,” says Thomas Allen, a gaming analyst with Morgan Stanley. He projects that sports betting revenue will rise to about $7 billion in 2025 from less than $1 billion in 2019, with about 80% of the 2025 total online. This compares with current annual U.S. casino revenue of $75 billion. The total size of the sports betting market—assuming broad legalization at the state level—is estimated at $15 billion.
These revenue projections greatly understate the amount of potential betting because revenue is the amount of money won by the gambling companies. The profit margin, or “hold,” on sports betting is about 7%, meaning that $7 billion of revenues would stem from $100 billion of bets.
The industry is focusing its expansion on mobile sports gambling, rather than the sports books patterned on those at Las Vegas casinos. Most bettors—millennials, in particular—prefer to wager on their phones.
“Online is the future,” says Jason Ader, the co-founder of SpringOwl Asset Management, which invests in the industry. “Millennials go to Las Vegas for the nightclubs, restaurants, and entertainment. They’re not the same casino gamblers as their parents. Millennials are more comfortable doing their gaming on mobile phones. This is the biggest challenge for the industry. It needs to figure out this demographic or miss out.”
“This is the biggest growth opportunity for the U.S. gambling industry in the past 10 years. ”
—Thomas Allen, Morgan Stanley analyst
Gambling companies have flocked to New Jersey, where 85% of the wagering last year was done online. With 15 operators, the state is now the epicenter of U.S. online sports wagering. Aggressive marketing includes free initial bets and partial matching of first deposits. Last year, there was $4.5 billion in sports betting in the state, generating $300 million of industry revenues.
It’s estimated that as much as 25% of New Jersey’s business comes from New Yorkers who are crossing the Hudson River by train or car to gamble. (New Jersey requires online bettors to be physically present in the state.) The leakage of bettors to New Jersey is putting pressure on New York to legalize online sports wagering. The state permits it only at four upstate casinos.
The industry’s prospects hinge on whether the four most populous states—California, Florida, Texas, and New York—with a combined one-third of the U.S. population, legalize online sports gambling. There is no legal sports wagering now in California, Texas, and Florida.
Wall Street is excited about the outlook for sports gambling despite uncertainty about the pace of legalization and the ultimate profitability. Allen doesn’t see the industry moving into the black until 2022, with ultimate profit margins of about 25% of revenues. There is a risk of a backlash if sports gambling becomes seen as a corrupting influence on sports and a contributor to the problem of gambling addiction.
The Street’s enthusiasm is most evident in the surging stock price of Diamond Eagle Acquisition (ticker: DEAC), a special purpose acquisition company, or SPAC, that reached a deal in late December to buy DraftKings, an early leader in online sports betting. Investors have gravitated toward Diamond Eagle, which will be renamed DraftKings when the deal closes in a few months.
California: Online unlikely anytime soon; possible on ground: tribes control casinos
Texas: Antigambling state: only two Indian casinos; no fantasy bets
Florida: Legalization unlikely in 2020: powerful Seminole Tribe key to outlook
New York: Legal in four upstate casinos: mobile approval possible, but governor not in favor
Pennsylvania: Legal at physical casinos, online; high state tax of 34%, vs. 14% in N.J.
Illinois: Legal but no betting yet; physical operators have head start vs. online-only
Ohio: Legislation pending: legalization possible in 2020
Georgia: No momentum for legalization: constitutional amendment may be needed
North Carolina: Legal at casinos but not online; commission studying situation
Michigan: Both physical, online betting legalized in late 2019: not operational yet
The currently unprofitable DraftKings will emerge as the only pure play in online U.S. sports gambling and a potential takeover candidate for industry leaders like MGM Resorts International (MGM); Eldorado Resorts (ERI), which is buying Caesars Entertainment (CZR); Wynn Resorts (WYNN); and Las Vegas Sands (LVS). DraftKings looks appealing, based on its scarcity value and profit potential, but the stock is richly valued after its recent run-up.
The other chief play on U.S. sports gambling is Flutter Entertainment (FLTR.UK), the top United Kingdom betting company that controls FanDuel, the main online U.S. sports wagering rival for DraftKings.
Flutter, which also has U.S.-listed shares traded under the ticker PDYPY, is a more diluted play. It is diversified globally and plans to merge with the Stars Group (TSG), the owner of PokerStars and the leader in online poker globally, to form a $16 billion market value company.
Two other U.K. sports wagering companies, William Hill (WMH.UK) and GVC Holdings (GVC.UK), have staked out claims in the U.S., which is seen by the industry as one of the largest global opportunities. Other diluted plays include regional U.S. casino operators Boyd Gaming (BYD) and Penn National Gaming (PENN), which have partnerships with online sports betting companies and stand to benefit from increased traffic at their casinos from sports wagering.
Diamond Eagle shares have rallied to $14 from $11 when the deal was announced last month, valuing the company at $4.8 billion, based on the projected postdeal shares outstanding. SPACs are blind pools that raise money from investors and then look for a business opportunity, as Barron’sdetailed last week.
The Diamond Eagle deal offered DraftKings an alternative to an initial public offering as a way to go public. The transaction got the endorsement of big institutional investors such as Capital Group and Wellington Management, which invested a total of $304 million in the deal at $10 a share.
Pure-Play Sports Betting
Company Recent Price 52-Week Change Market Value (bil) 2020E EPS 2020E P/E
Diamond Eagle Acquisition / DEAC $14.44 44.4%* 4.8** NA NA
U.K. Sports Betting Operators
Company Recent Price 52-Week Change Market Value (bil) 2020E EPS 2020E P/E
Flutter Entertainment / PDYPY $58.73 47.2% $9.2 $2.02 29.1
GVC Holdings / GVC.UK 888.00pence 33.1 6.8 77.71pence 11.4
William Hill / WIMHY $9.30 0.7 2.0 $0.65 14.3
U.S. Casino Companies
Company Recent Price 52-Week Change Market Value (bil) 2020E EPS 2020E P/E
MGM Resorts International / MGM $32.32 16.2 $16.6 $1.38 23.5
Eldorado Resorts / ERI 60.64 40.0 4.7 2.00 30.4
Penn National Gaming / PENN 25.90 8.5 3.0 2.09 12.4
Notes: *Since 2019 IPO; **After DraftKings merger closes; E=Estimate; NA=Not applicable
“The opportunity is tremendously large,” says Jason Robins, the DraftKings CEO. “People love sports in the U.S. and love to bet on them.” He notes that sports betting is already well established in the U.K. and Australia.
There is no analyst coverage now of Diamond Eagle, but Jefferies U.K. analyst Becky Lane, who covers Flutter, wrote last month that the DraftKings listing “will drive increased investor interest in a fast-growing sector.”
In a presentation that accompanied its deal with Diamond Eagle, DraftKings outlined a path to $1 billion in annual earnings before interest, taxes, depreciation, and amortization, or Ebitda. The $1 billion of profits assumes $3.7 billion in annual revenue, up from an estimated $415 million in 2019, and is probably at least five years away. This scenario assumes that sports gambling is legalized in states with 65% of the U.S. population—up from about 35% now—and that DraftKings gets a 25% market share. More immediately, it sees $700 million of 2021 revenue.
DraftKings is also banking on legalization of internet gambling, or casino games like blackjack and roulette, in states with 30% of the population. The combined company lost $117 million in the first nine months of 2019. DraftKings argues that it can ultimately generate 38% margins in sports betting as the market grows, and it can leverage its marketing spending in more states. In New Jersey, its most important market, DraftKings sees a profit of $49 million in 2021, compared with an estimated loss of $11 million in 2019.
Who dominates the growing market for online sports betting in New Jersey.
Company Market Share*
FanDuel (Flutter) 43%
William Hill 13%
Others (12 Cos.) 13%
*First 11 months of 2019
One of the surprises of sports betting in New Jersey is that DraftKings and FanDuel dominate the online business with an estimated combined 75% share, rather than any of the established land-based companies.
One reason for their success is an ability to leverage their dominant position in fantasy sports. Participants in fantasy football, the best-known fantasy sport, put money into weekly pools during the pro football season run by DraftKings and FanDuel.
They draft “teams” from players throughout the National Football League and compete to win cash based on how their players perform versus others in the pool each week. The two operators take a roughly 10% cut of the amount bet. DraftKings and FanDuel both have converted many fantasy players to sports betting customers.
“The online companies have a significant competitive advantage,” says Ader of SpringOwl Asset Management. ‘They’re built more like technology companies and are better at the two key aspects of the business: customer acquisition and retention.”
FanDuel and DraftKings, though, have had to partner with land-based casinos in New Jersey. DraftKings has teamed up with Resorts Casino, while FanDuel operates a sports book at the Meadowlands racetrack that is the largest in the world. Its handle, or total bets, last year was about $400 million.
Ader is partial to Flutter, which will emerge as the No. 1 global sports betting company following its coming merger with the Stars Group. “Flutter will be a powerhouse,” he says. “It will own some of the leading brands in the world.”
A Growing Pot
Morgan Stanley projects thatsports betting revenue in theU.S. will climb to about $7billion in 2025, with most ofthat coming from online bets.
Source: Morgan Stanley
Flutter was formed from the merger of Irish and British betting companies Paddy Power and Betfair. Flutter bought a 61% interest in FanDuel in 2018 and has an option to increase its stake to 80% in 2021, and 100% in 2023, by buying out stakes held by a group of investors including KKR (KKR) and CapitalG, formerly Google Capital, an investment arm of Alphabet (GOOGL).
Jefferies’ Lane wrote last month that Flutter should benefit from greater attention on the U.S. sports betting market. FanDuel has a leading position in the states it has entered, but still appears to be unprofitable. Flutter has projected a loss in 2019 of about $60 million for its U.S. operations.
Lane has a price target of 9,500 pence on the U.K. shares, up 7% from the recent 8,900 pence, with potential upside to more than 11,000 pence. Flutter is valued at about 13 times 2020 projected Ebitda when reflecting the Stars Group merger, a premium to peers William Hill and GVC.
Second to the Super Bowl in sports wagering is probably the NCAA Men’s Basketball tournament, especially the first Thursday of March Madness, when first-round games are played. Other popular contests are the college football championship game, the baseball World Series, and the National Basketball Association finals.
Technology promises to transform sports betting by allowing more in-game wagers. Reflecting this, the Diamond Eagle/DraftKings deal also includes the purchase of SBTech, a privately held company that uses historical data and algorithms to calculate game odds for sports betting companies and manage risk. Sports betting companies, for instance, want odds set to avoid lopsided wagering on popular teams like the New England Patriots.
“We talk about infinite betting,” says FanDuel CEO Matt King. “If somebody wants to make a bet, we want to offer it. For an average NFL game, the typical Las Vegas sports book offers 50 different bets. We offer 250.”
These include fantasy-style bets on how many yards will be tallied by individual running backs, receivers, and quarterbacks. FanDuel also specializes in parlay bets based on several events occurring in the same game or multiple events. Such a bet might involve New England quarterback Tom Brady passing for 300 yards in a game and throwing for three or more touchdowns and the Patriots winning by more than 15 points.
In the U.K., where sports fans are crazy about soccer in general and the English Premier League, in particular, more than half of all betting occurs during games.
FanDuel is focused on in-game betting and gets 40% to 50% of its wagers during games. Bettors, for example, could have taken advantage of this during the recent football playoff game between the San Francisco 49ers and Green Bay Packers. After the 49ers went up by 27 points at halftime, bettors who wanted to take the Packers to win were offered odds of roughly 30 to one.
In professional baseball, bettors can wager on the number of runs in each inning of a game, with the odds determined largely by the batting order and pitchers.
Morgan Stanley’s Allen expects FanDuel and DraftKings to maintain leading market shares as more states roll out online sports wagering, but below their current positions in New Jersey. He sees FanDuel at 20%; DraftKings at 15%; William Hill, FOX Bet, and Bet365 at 10% each; and others making up the rest.
Part of William Hill’s U.S. strategy has been to convert the customers at its sports books—it is the leader in Nevada—into those online.
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In New Jersey, William Hill has built what is probably the most attractive sports book in Atlantic City at the Ocean Resort, an independent hotel and casino formerly known as Revel. The William Hill sports book features three sky boxes that can be rented for the day. The cost: a minimum of $1,000 in food and beverage purchases. The boxes were filled for a recent Saturday night fight involving Ultimate Fighting Championship star Conor McGregor.
The major U.S. land-based casinos should benefit from sports gambling, Morgan Stanley’s Allen estimates. He favors Penn National because it should get the most bang relative to its size, thanks to sports gambling as well as added business at its casino table games and from food and beverage sales. Allen says the regional gaming companies, which trade cheaply relative to the industry giants, don’t reflect much benefit from sports gambling.
Fox (FOXA), which airs NFL games and is taking on ESPN in sports programming, has gone all-in on sports betting through a 50/50 U.S. partnership with the Stars Group called FOX Bet. With the Flutter/Stars Group merger, Fox will get the right to buy 18.5% of FanDuel. CBS, which shares Sunday afternoon pro football rights with Fox and has rights to the NCAA men’s basketball championships, hasn’t yet outlined a sports betting strategy. (Fox has common ownership with Barron’s parent company, News Corp. )
For football broadcasters like CBS and Fox, the growth in sports gambling could boost the audience for games, keep viewers more engaged, and bolster advertising revenue. CBS is already seeing higher sports gambling ad revenue in markets surrounding New Jersey during NFL broadcasts.
Walt Disney’s (DIS) ESPN unit is walking a fine line. Reflecting viewer interest, it has expanded its betting-related programming, including a show called the Daily Wager that airs on ESPN2, but the family-focused company has stopped short of gambling ventures.
“I don’t see the Walt Disney Com pany, certainly in the near term, getting involved in the business of gambling, in effect, by facilitating gambling in any way,” Disney CEO Bob Iger said last February.
DraftKings’ Robins says that discussions with investors used to focus on whether his company could compete with land-based casinos. “Now that they’ve seen we can compete, we hear, ‘How big will this market be, and how many states will legalize?’ ’’
The online companies see the opportunity to take share from illegal betting, which, contrary to the popular image, often involves overseas sports books rather than bookies. While online companies don’t provide credit the way bookies do, they offer the security that bookies and offshore sports books don’t.
There is still a stigma attached to sports betting and online gambling, however. For one thing, it isn’t easy to fund online sports gambling accounts. Customers often need to rely on cumbersome bank wire transfers, since JPMorgan Chase, Bank of America, and other credit-card companies block transactions to online gambling sites. FanDuel and others are trying to simplify the process.
The state legalization outlook is tough to predict. Morgan Stanley’s Allen sees sports gambling legalization, including online wagering, by 2022 in Florida and New York, with wagering at physical sites only in California in the coming years and nowhere in Texas.
The political calculus is complex in each state. Native American tribes who operate land-based casinos have a powerful role in California and Florida and are wary about anything new that could divert business from them. Texas is one of the most gambling-unfriendly states in the country and is among the few that don’t permit fantasy football pools.
In New York, sports gambling has yet to gain the support of Gov. Andrew Cuomo, who has suggested that an amendment to the state constitution may be needed.
It is also tough to estimate the future profitability of sports gambling because of the uncertainty about the number of states that will legalize it, as well as state taxes and marketing expenses. State taxes have generally been set at about 15%, but Pennsylvania went to 34%, and that hasn’t deterred online operators from setting up shop in the state.
Despite these issues, sports gambling probably will become more pervasive in coming years. Investors can get exposure through Diamond Eagle, Flutter, William Hill, or Penn Gaming.
This is one trend investors probably shouldn’t bet against.
Write to Andrew Bary at firstname.lastname@example.org