Scott Olson/Getty Pictures Information
With its inventory now buying and selling down 70% over the previous 12 months, DraftKings (NASDAQ:DKNG) is now out of the “no manner would I ever” territory and not less than approaching a stage the place I might contemplate shopping for in. As a part of my due diligence, I felt the necessity to replace some analysis I did final 12 months on on-line sports activities betting and its potential addressable market and revenue. After doing so, I’ve concluded that my preliminary estimate of DraftKings addressable market most likely was far too low…however I nonetheless have too many issues to purchase in.
Prior Analysis
My sports activities betting analysis was initially achieved with regard to fuboTV (FUBO) however it applies equally effectively to DraftKings. By the identical token, at this time’s DraftKings analysis is equally helpful to those that are contemplating a fubo funding or certainly an funding in any main sports activities tv inventory, reminiscent of Comcast (CMCSA) or AT&T (T) at this time. Disney (DIS) is reportedly reconsidering its prior resolution to maintain ESPN away from sports activities betting as effectively.
However the query of the day is DraftKings. As all the time, we’re extra keen on revenue than we’re income, besides as income pertains to revenue. However what makes evaluation of sports activities betting a bit of difficult is that income, in flip, is merely a subset of “deal with.”
For these new to the topic, the deal with of a sportsbook is the gross amount of cash wager on its platform, whereas the precise income is the “take” of the platform of that income, with the remainder of deal with paid out to bettors as winnings. For sure, the largest outlay of deal with by far is cost to winners, with income for a sportsbook coming in effectively below 10% of deal with.
Prior Estimate
In my analysis final 12 months, I postulated that the US sports activities deal with would come to about $150 billion, with roughly a 5% take price, ie., for each $20 two individuals wager with one another, the operator would hold $1 for itself. This penciled out to $7.5 billion in precise income for operators, which I believed could be extra like $1.8 billion in ultimate revenue for the operators after paying not solely state and federal taxes, but additionally charges to the sports activities leagues who make these wagers doable – who’ve made it very clear they intend to be minimize in on the ensuing spoils.
At that stage, DraftKings’ 70% decline over the previous 12 months nonetheless isn’t sufficient to make it a very good purchase. With a roughly 25% market share within the US, DraftKings would generate about $450 million in revenue, whereas buying and selling with a close to $8 billion market cap. At a 19 P/E, with rate of interest hikes most likely about to lastly finish the times of the 25 P/E S&P, that wouldn’t depart a lot room for additional upside.
However there are rising indications that my numbers might have been too conservative.
A Rising Pie
One of many single largest and most vital variables within the calculation is solely the dimensions of the general market. Goldman Sachs now initiatives a $39 billion mature market income run price in 2033, a quintupling of my projections that completely blow my numbers out of the water. Different projections are usually not coming in at fairly that stage, however there’s a rising consensus throughout the sphere that the ultimate quantity goes to be effectively in extra of what I postulated.
I’m slowly coming spherical to this conclusion as effectively: I most likely did undershoot the income quantity. However my revenue projections, which once more are what buyers ought to actually care about, may not want practically as a lot adjusting.
The sports activities betting {industry}, which is undoubtedly presently present process one thing that qualifies for the phrase “revolution,” suffers from three main weaknesses which impair its capability to extract extra revenue from extra income.
First, Competitors
The primary is solely competitors, or extra exactly low boundaries to entry. Because the income pie grows, different firms who need in on the motion discover it straightforward to carve out a bit of the pie for themselves.
Disney is already transferring ESPN in direction of playing, maybe with a accomplice, and Yahoo will most likely do the identical. Fubo, after all, is already laborious at work getting its personal sportsbook up and working.
This competitors implies that margins will possible be pressed additional as income grows, shrinking market share and maybe leaving DraftKings with a smaller margin on a smaller share of this bigger pie.
Second, Asymmetry
That isn’t the one downside. For now, let’s assume that by some means, the {industry} does get to a $39 billion income run price – a frankly mind-boggling quantity. Do not forget that it isn’t simply our minds being boggled; sports activities leagues and state legislature tax committees see that gold mine as effectively.
This brings me to the second large weak point that I see in betting firms – they’ve an especially giant dependency on exterior events to provide their worth. And the connection between these exterior events and the betting firms is asymmetrical, with DraftKings and its friends virtually all the time within the weaker place. When earnings do get boosted greater, DraftKings companions can see that and improve their very own takes in response.
DraftKings has solely restricted energy to cease this due to the asymmetrical nature of the connection. There are a number of digital sports activities betting firms, and a pair dozen extra firms who want to get into the enterprise. However there is just one NFL, NBA, March Insanity, and so on. So when it comes all the way down to a showdown over revenue, it’s a lot simpler for the NFL to get a brand new accomplice than for DraftKings to get a brand new sport.
Sports activities Leagues
In my prior analysis, I estimated league take at 1% of deal with, equating to roughly 20% of income. For now, I’m going to imagine the share stays fixed, which means the leagues get their share of that greater income base however don’t actively attempt to improve their share. If something, that’s most likely a bit of too optimistic, however let’s depart it there as a result of DraftKings’ different exterior accomplice is already gunning for it.
State Taxation
The entire key to this new {industry} is the legalization of sports activities betting. The Supreme Courtroom ruling that kicked this all off didn’t say that states needed to legalize playing – simply that they might in the event that they needed to. That implies that DraftKings stays depending on state legislatures to really make their authorized betting enterprise – enticing to customers solely as a result of it’s extra handy than unlawful betting – doable. And state legislatures comprehend it.
Just about everyone seems to be planning on upping their take, however undoubtedly probably the most aggressive on this regard to date has been New York State. Beneath the legalization invoice that went energetic January 8th, the state extracts a whopping 51% of complete income – not revenue, income – in addition to an preliminary flat price. Regardless of protests from the {industry}, New York feels comfy doing this as a result of with wagers within the state already at an $8 billion annual deal with run price, it’s the third-largest market within the nation, is aware of it, and doesn’t suppose operators can afford to disregard it.
They’re most likely proper. Whereas it’s definitely not inconceivable that the tax price may go down, it will possible solely accomplish that if Goldman’s income projections proved too optimistic, which might simply imply operators have been hurting otherwise. Assuming that we actually are about to quintuple the prevailing market measurement, New York has left greater than sufficient for operators to show an enough revenue, and doubtless received’t really feel a lot stress to loosen up. If something, different states who see a New York market rising regardless of such charges will change into extra inclined to emulate them.
If I plug in Goldman’s income projection, but additionally improve my prior estimate of state taxes and costs from 12% to 51%, the elevated tax price accounts for a whopping 60% of the income improve, leaving solely $11.3 billion of income for the operators after paying the leagues and the states. This income pool should cowl not solely funds to buyers, but additionally funds to workers, distributors and different working prices.
Working Prices
In my authentic analysis, I had working bills at $3 billion per 12 months industry-wide, however that was on a a lot decrease gross sales determine. Granted, playing will likely be digital, and that ought to cut back prices in comparison with taking money and promoting tickets in an old style on line casino. However between bank card charges, customer support, the odd blown-call gamble forgiveness, and sustaining the apps and web sites, this quantity most likely nonetheless must develop fairly significantly.
For now, I’m going to imagine that prices develop solely half as quick as revenues off of the unique base. That’s, if income quintuples, I’ll assume that prices “solely” triple, to roughly $9 billion.
Closing Revenue Quantity
This leaves a ultimate industry-wide revenue variety of $2.3 billion per 12 months – in comparison with roughly $1.8 billion in my prior estimate a 12 months in the past. For this further $30 billion in income, DraftKings and its {industry} friends reap one other $500 million in revenue.
Anticipating Objections
I acknowledge that these calculations are essentially estimates and hypotheses. And likely, they may strike some as far too conservative. However contemplate which prong you suppose must be in the reduction of to go away extra for the operators.
Is it the states? Keep in mind that even these numbers present that operators are most likely going to make more cash than was anticipated just some years in the past, and states know that legalization is taking part in an important function on this course of.
So why precisely would they really feel compelled to yield to requires a decrease tax price? Any risk from DraftKings or others – “decrease the speed or we’re strolling out” – simply doesn’t appear to be that credible, contemplating that everybody is aware of {that a} smaller share of one thing is preferable to a bigger share of nothing. Any operator who does stroll out of New York or anyplace else for that matter will most likely shortly discover themselves changed by a competitor.
A lot the identical logic applies to the leagues, who know that every one this playing largesse is just doable due to their product. The truth is, whereas the argument may maybe be made that the state’s take is simply too giant in my calculations, the argument is also made that the leagues take is simply too low, contemplating that I didn’t improve their share in any respect.
This leaves prices, which I believe might be probably the most questionable piece of my numbers. With out prior historical past to information us, we merely don’t understand how digital playing prices will shake out within the long-term in comparison with extra conventional in-person opponents. If prices solely doubled as an alternative of tripled as income quintupled, earnings industrywide would shoot above $5 billion.
In opposition to that have to be set the chance that the elevated competitors I spoke about may merely depart much less for everybody. That’s, maybe income received’t quintuple, however will exceed my prior projection by some lesser quantity. As Jeff Bezos likes to say, “your margin is my alternative,” and presumably the identical digital nature that makes on-line betting cheaper to implement additionally makes it cheaper for imitators to repeat.
Why Purchase When You Can Construct?
The one different potential path to revenue for DraftKings buyers could be that age-old standby, acquisition. Because the second-largest market operator within the nation, DraftKings represents a fast entry to the highest of the {industry} for anybody who desires to get in fast.
However whereas I don’t rule out that chance, I don’t suppose that the record of acquirers spans fairly as extensive as some suppose. And this brings me finally to the third gap within the enterprise mannequin, as I see it: I more and more query whether or not it is sensible for sports activities betting and sports activities streaming to be in separate firms in any respect.
Fubo administration has made it clear from the start that they see gamification and streaming as going hand in hand on the identical platform, and the variety of dissenting voices is getting slimmer and slimmer. It’s now virtually a common consensus that gamification boosts engagement. Even DraftKings itself has change into the accomplice of DISH Community’s Sling TV, and its competitor FanDuel is already partially owned by Fox Company (FOX) (FOXA).
Which means any acquirer is more likely to come from the ranks of media firms. And but, most of them appear to agree with fuboTV that it’s cheaper and higher to repeat DraftKings than to purchase it. Not simply fuboTV however Disney’s ESPN and just about everyone seems to be seeking to construct a sportsbook, not purchase one.
Funding Abstract
It’s getting tougher and tougher to defend my $7.5 billion income projection, and I’ve tried to not waste time right here by doing so. However I’m not so positive revenue within the {industry} goes to shoot up practically as quick as income. Whereas I agree DraftKings has a big addressable market in entrance of it, the asymmetrical nature of its relationship with its key companions makes me query whether or not it could extract sufficient revenue to be thought of undervalued, even at this a lot lower cost.
I’ve determined to carry off on any purchases for now.
