RP iGaming Index: A new force awakens

December’s big news was the DraftKings-SBTech merger, and Regulus Partners’ Paul Leyland examines how this will impact the performance of the Index going forward.

The RP iGaming Index ended the month, year and the decade up respectably (+4.5% MoM) but still lagging the benchmark slightly (NASDAQ +5.0%). This has rather been the story of the index since inception: as gambling companies have (on the whole) struggled to beat forecasts, struggled to persuade the market of the strategic US sports betting opportunity (very cautious on market share and profitability whatever the buy-in to the top-line opportunity) and typically faced more regulatory headwinds and tailwinds.

Equally, as M&A has tended to be within the index, the gains of one company have tended to be cancelled out by the losses of another. The igaming sector ends the decade still needing to persuade the market that it can achieve broad-based sustainable growth and that M&A adds up to something more than short-term cost cutting benefits. Perhaps the 2020s will be the decade to show that, but in a much lower growth environment for mature markets and no let up in regulatory risk, the jury is still very much out…

In a relatively broadly based rally (19 stocks up, six of which were double digit), there was one stand-out performance: Kambi was down 25% MoM (31% in intraday trading before being suspended) due to the announcement of the new big beast in listed igaming: DraftKings + SBTech (Kambi currently provides DraftKings’ sportsbook content).

By the end of H1 2020 – all going to plan – the index will have a new US$3.3bn market cap constituent, all in igaming (for that is how we treat DFS), and therefore a business which immediately becomes 8% of the total index and one of its leading constituents (dwarfed only by the proposed Stars – Flutter combination). Rather than a stock in focus, we therefore explore this deal – almost certainly the biggest event for the performance index in 2020 whatever happens at the macro level (or at least we hope so!)

DraftKings announced the acquisition of SBTech and a proposed public listing on NASDAQ (via investor Diamond Eagle Acquisition Corp) to create a US$3.3bn market cap entity, including a US$500m net cash position. Details on profitability are scant but a significant ramp-up in profitability is expected with US rollout as well as capitalising on wider market growth and penetration: a key hope and a key risk…

DraftKings is one of the two US-focused DFS companies of scale and has proven its capability to convert DFS customers to online sportsbook (along with Flutter’s FanDuel) to take .c 37% market share in NJ (with a 40% conversion of its all-time NJ DFS database to sports betting). Group wide, it has reached US$213m of DFS revenue (in-house 2019E forecasts) and is profitable on a standalone basis, with c. 4m customers and c. 60% market share; live in 43 US states.

Significantly, DraftKings now expects to be profitable in NJ next year, currently achieving an estimated US$2,400 lifetime ARPU (on a 5 year LTV  + 30% TV discount assumption) and a US$250m blended CPA (51k customers cross-sold; 95k customers acquired at US$385 – although this cost does not appear to include the considerable marketing spend in NYC and the forecast rationalising marketing spend to profitability also potentially assumes that an aggressive second wave of NJ licensees does not disrupt market economics).

The NJ dynamics revealed perhaps help to explain DraftKings’ and FanDuel’s clear market leading position: CPA less cross sold customers and NY investment is roughly implied annual ARPU – very hard for operators without a head start to effectively monetise and likely structural for c. 2-3 years, in our view (i.e. that advantage may run out in NJ without the ability of DraftKings to stay at the forefront of product development…).

Overall, DraftKings is on track to achieve 2019E revenue of US$305m, demonstrating the power of sports cross-sell to customer spend metrics on relatively soft DFS growth (less the NJ sports betting contribution, 2019E growth would be 7.8%, with NJ sports betting alone accounting for 28% of group NGR pre-SBTech – again caveat there is likely to be a lot of NY-based customer revenue in this figure).

SBTech is the leading B2B-turnkey sports provider, with US$110m of revenue (in-house 2019E; to be 34% of the combined entity) derived from Asia (54%), Europe (42%) and US (5%), achieving 47% revenue CAGR (post divestiture of its dot.com business); the group is present in over 15 domestically regulated markets and has offices in 8 countries: significantly more meaningfully diversified than DraftKings.

Critically, SBTech combines a platform and trading/risk management capability in a modern technology stack: something competitors have struggled to develop or effectively assemble. This has enabled strong growth and impressive client wins (e.g. Sky B&G for Germany, Svenska Spel, Oregon Lottery) in a B2B sports betting market that appears crowded but is often bereft effective choice (unless a client effectively wants to build its own capability or has its own platform).

The combination talks up the potential for global growth (led by but by no means confined to US sports betting) and a pathway to US$1bn in EBITDA (requiring US$3.7bn in revenue; 2021E combined forecast is US$700m, suggesting 30% CAGR from 2019E). However, while this top-down view is certainly attractive if the world develops according to plan, we see the making of the deal as much more bottom-up. Both businesses gain a level of scale and control over their own destiny that changes them from relative upstarts to a credible leadership role.

For DraftKings, this means it has closed a critical area of supply-chain risk and dependence (Kambi) and also gained a product set which is relevant ex US (where DFS penetration has been patchy at best). For SBTech, this means a podium entry position into every US state that regulates as well as a transformative level of development firepower, which will be key to maintaining growth as B2B competitors catch up or emerge.

For us the risks are similarly operational (there is always enough gambling market to grow in macro terms, the key is positioning). First of all, to make full use of its acquisition DraftKings will need to migrate away from Kambi and manage its tech needs as an in-house customer without over-reaching its development ambitions or crowding out other licensees (no mean feat, in our view).

Second, the world of sportsbook is a big and complicated place, as SBTech’s geographic profile demonstrates – the extent to which (all) US regulators understand and are prepared to tolerate this, and the extent to which the US tail will now need to wag the global dog remains to be seen.

However, this last risk is one most global leaders in sports betting now need to accept and manage at least to some extent (eg Flutter, Stars, bet365, GVC, William Hill, Kindred – all US licensed, all with at least some level of dot.com risk exposure: US infrastructure providers notably absent), meaning that their number has just been joined by a new force to be reckoned with…

Disclaimer: the narrative provided represents the opinions of the authors. Any assessment of trends or change is necessarily subjective. The information and opinions provided are not intended to provide legal, accounting, investment or policy advice, nor should they be used as a forecast. Regulus Partners may act, or has acted, for any of the companies and other stakeholders mentioned in this article.