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“I have already made up my mind, don’t confuse me with the facts….” Philip A. Fisher, legendary investor
Since the 2018 SCOTUS decision, the sports betting sector has been churning like a tempest, blowing some boats to distant shores of paradise and others sitting in dead pools with few fair winds still on the way. Investors traded up some stocks to eyebrow raising valuations, leaving others to inch up or down a point here or there with no propulsion in sight. Some of the pom pom waving has been understandable. Month after month the stamp of approval of sports betting in one state legislator after another have sent retail investors chasing those stocks. Few pay attention to the realities of what was swiftly developing as an overcrowded sector and a raft of growing operating losses in a turbulent sea of giveaways.
No one disputes the bullish long-term prospects for what will be no more than a handful of companies thar will ultimately dominate the sector. We can certainly expect consolidation by acquisition or merger of the near 20 reasonably viable companies now engaged in chasing down new sports bettors with beggaring thy neighbor marketing.
Eventually we will have perhaps four or five operators gobbling up to 70% of the market or more, with all the others nipping at their heels with single digit crumbs. Flutter, now through its Fan Duel site and its other branded apps, will continue to lead the pack. A bet on Flutter (OTCPK:PDYPY) now is as close to a mortal lock as you can get as the game of US sports betting unfolds.
Until then it’s a dogfight. The question for investors now is what are the keys that should guide buy side decisions?
Data by YChartsLast month (Nov, 16) we made the general case for Flutter Entertainment PLC, the UK-based, largest global online betting group, and specifically, its US traded ADR, Flutter Entertainment plc (OTCPK:PDYPY). On the day of publication, the stock was trading at $86 a share. We readily acknowledged that it was priced considerably above two other sector leaders that day (Nov. 16):
Draft Kings (DKNG) at $42.64 that day and Penn National Gaming Inc. (PENN) $64.62 that day.
Since then, lively trading has continued on overall bullish sentiment in the sector:
Prices at this writing: Average daily volume
Flutter: $100.90 +$14 ~27,000
DKNG: $49.25 +$6.61 27,000,000
PENN: $70.77 +6.15 7,300,000
Flutter has a very thin institutional ownership with one hedge fund holding near 1m of the 1.7m institutional shares. Furthermore, there’s little retail following of the stock, for many reasons, which have nothing much to do with the prospects for the company. Yet it’s apparent that both DKNG and PENN have become retail darlings because of enthused millennials star struck by its presumed prospects. One analyst recently put an utterly absurd $100 PT on the stock based on a totally unrealistic premise that DKNG would command a future 20%-plus share of market.
The DKNG stock has a good future as a likely member of the top five or six apps in the space. But common sense tells us that if it moved to $100, then by extension, the much bigger and deeper pocketed Flutter would be trading at or around $200.
If the sector reaches 38 states by 2025 as expected by Morgan Stanley, we see it producing around $20b to $23b in annual revenues. At that number, DKNG would need to produce a $4b annual sales number at least to validate a double digit share in the 20s.
But reality bites: This year, Flutter will have already reached $4b in global revenue. That projects to at least $6b by 2025. But in US revenue only we can see it achieving $3.5b as against ~$1.7for DKNG and ~$1.4 for Penn.
The funny joker in this deck as we have noted on SA before is BetMGM, the JV between MGM Resorts International (MGM) and GVC of the UK, which is rapidly challenging for third place now. They may well overtake either DKNG or Penn by 2025 given its huge commitment to spend $450m on marketing just over the next two years. It’s pouring out marketing dollars head to head with DKNG.
The prospects for both DKNG and PENN are fine, as we have noted in SA before. Our problem is that we see a) DKNG as a pure-play attaining a trading level above its real world value as one of five leading competitors in the space. And b) That we see PENN riding the same wave created by its purchase last year of a huge chunk of the sports fan site Barstool, with its 60m plus avid millennial sports fan audience.
What we like best about PENN is not the sport betting thrust. Clearly, that’s what has propelled the stock. Instead we like its brick and mortar casino business much better as we enter what’s hoped to be the beginning of the endgame of the pandemic.
US regional casino operators like PENN already are in the early stages of revenue recovery, currently stopped dead by the second wave virus surge. But just beyond, perhaps eight weeks away, we will begin to see the first results of the miracle vaccines making their way into the arms of millions of Americans. And simultaneously, the rapid decline of new infection levels. The bull case for regional casinos is here.
By June, it’s widely believed, the citizenry will be well on the way to mass herd immunity that should produce a huge spurt in daily visitation to regional casinos. With 41 properties, Penn will see accelerating volumes. But it will run a vigorous second to Caesars (CZR) with its much larger property portfolio and considerably larger 55m customer database.
CZR’s nimble management could well have a spinoff of its ongoing deal to acquire UK based William Hill (OTCPK:WIMHY) sometime late this year or early 2022. So that Hill and as we note later here, Fan Duel, also will join the ranks of pure play sports betting stocks, a status in the US now owned primarily by DKNG. That’s part of the allure to retail investors.
But on the sports betting side of life, both DKNG and PENN will do fine, but neither cannot begin to match the existing scale, capital base and scope of the Flutter. So for the bull case we made last month and now based on new developments, we guide overweight on Flutter. We continue to believe that DKNG and Penn are both fully valued, if not somewhat overvalued given the forward prospects of their sports betting footprints head to head against Flutter.
What’s new and reinforcing to our Flutter bull case
Above: With its massive portfolio, the world leader in online gaming has the resource base that deepens prospects for its fast track growth. Source: Flutter archives).
Last week, Flutter announced it was acquiring another 37% of the Fan Duel outstanding, bringing its ownership to 95%. The remaining 5% will be held by US regional casino operator, Boyd Gaming (BYD). The company will pay $4.2b for the stock with $2.1b from cash and the balance from an issuance of new shares. The dilution hasn’t hurt the stock, which as noted above, spiked on news of the buy.
The transaction means that Fox Sports will have its option to acquire 18.5% of Fan Duel at what’s characterized as a fair market price in July of 2021. Our sources believe Fox will exercise that option. All this creates an implied valuation of Fan Duel at $11.2b, which represents a fat discount from DKNG, which at writing had a market cap of $19.2b.
Consider this US only comparison: DKNG’s management has estimated 2020 revenue reaching $540 to $560m, nice upside. But Flutter’s Fan Duel unit is looking for its 2020 haul to come in around $850m, which puts it $290m ahead of DKNG’s best case number. Fan Duel has 9.5m customers, or put better, a 43% share of market in the currently legal 13 states. On a state by state basis, it’s a dog fight as noted, with DKNG either a strong second, or No. 1 as is the case in Indiana. But what should be understood is this: Every state is a battleground, and will continue to be one going forward as more are added. We expect one more coming on board in 2021.
The recipe that makes this Flutter development a tasty dish for investors now
(Below: Flutter daily per capita revenue is on the rise as we near the endgame phase of the pandemic. Source: Flutter archives.)
There’s little question in our view that Flutter, by its adding to the FD control, has its eye on this prize: A spinoff at some point in 2021, or at the latest, early 2022 of FD. The clear objective: To make Fan Duel a pure play in the US equity market going head to head with DKNG to attract both institutions and retail investors. Not far behind will be the spinoff of William Hill once it officially becomes part of CZR. So what we will have in effect, will be three pure plays to entice investors to whom that status represents a more propulsive ramping of fat returns.
(Below: Overall market leader in the US likely to be spun off. Source: Fan Duel archives.)
Flutter also owns The Stars Group, the Toronto-based operators of the globe’s most popular real money poker site and FoxBet, linked to that sports network. These and other ancillary sites under their control in the US bring a well- diversified product line to online bettors, plus of course, its existing DFS business.
Add to the mix, the beginning surging 5G technology. It’s adaptation going forward between 2021 and the out years to 2025 means that the speed of sports betting transactions will go hyper. Bettors will be able to vastly increase their wagers on in game events as is the case in the UK where in game betting dominates with 70% of the total mobile action. Furthermore, it will enable mobile users to simultaneously stream games and make bets as the action unfolds.
The head start guys in this early stage will be BetMGM which already has a deal with Yahoo sports, owned by Verizon. Also AT&T’s (T) Warner Media unit has already partnered with Monumental Sports and Entertainment, the DC based owners of the Capital One Arena, NBA Wizards, NHL Caps.
As 5G unfolds, the free for all will launch and all market participants at one point or another, will join the party. But Fan Duel, assuming by then that it could well be a spun off company, has the deep know how gained over time at its UK sites where in game betting savvy translates to revenue.
The takeaway: We remain high conviction believers that investors in the sector should be long any of the top, or even second tier players in the space. But when it comes to weighting there is no question that Flutter deserves the pole position not only because it already leads in existing revenue but is most rapidly scalable as more states legalize.
Fan Duel will maintain its market share lead and perhaps increase it going forward. While key competitors do have the cash positions to continue financing heavy losses due to fevered marketing deals in new customer acquisition programs in new states, they are not as well positioned going forward as is Fan Duel. Either as part of giant Flutter, or later on as a spun off pure play we like the opportunity we see. We believe it’s that prospect that generated the spike in Flutter on the virtual total stake it has acquired in Fan Duel. You look at the valuations and see Flutter as the most attractive buy among many contenders going forward. It will become the first US sports and i-gaming operator to attain $1b in annual revenue.
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