All aboard the DraftKings rocket ship

There is no bigger story at the moment than DraftKings. The US DFS operator turned online sports betting and casino power player has gone public and hit the jackpot with its share price rocketing on the back of votes of confidence from analysts and investors alike. After topping out at $43, the price has come down a little to $38 at the time of writing, but this still values an entity that made a Q1 loss of $74m from revenue of $114m at just under $12bn.

The only company worth more is the Goliath that is Flutter with its $22bn valuation and the weight of the PokerStars, Betfair, Sky Bet, Sportsbet, Paddy Power and FanDuel brands behind it. To put this into context, for roughly the same amount you could acquire GVC, Kindred Group, William Hill, 888, Kambi, Playtech, LeoVegas and Gamesys. That’s a group with combined revenue of over $10bn and a combined EBITDA of $2bn, four sports betting platforms, six gaming platforms and near total US market access.

On the face of it this looks absurd. DraftKings has to execute almost perfectly in a number of vastly complex areas while not undermining its core brand and acquisition funnel just to get to what is rapidly becoming the base case scenario for most investors. To do this, it needs to navigate the world of state licensing and partnerships, the vastly complex US media landscape, remain on top of the affiliate world, where further M&A and even operator take-outs should not be ruled out, the digital marketing space, product and retention.

The operational challenges don’t stop there for DraftKings either as this is not to mention managing an integration with SBTech. Making sure both SBTech and DraftKings technology remains market-leading or as near as matters during this period and beyond. For anyone with experience of the European space it seems a near herculean task. And that is assuming there is no radical shift to operating conditions or to the operator pool. But is this really the full story?

Overvalued or one of a kind?

There is a strong sense of ‘the way things are is the way things will always be’ about the US sports betting market, despite it being barely out of its infancy and the endemic brand leaders not even existing prior to the last decade. But if the online gambling industry has taught us anything it is to expect sudden and unexpected change regularly. For investors, however, they will be confident DraftKings can ride all of this out and has inherent brand, platform and marketing acquisition advantages that should keep it ahead of the pack in any scenario.

And there is no doubt that as one of very few pure-play US online gambling operators it is an extremely attractive investment opportunity. It allows US investors to take a stake in a US firm in what is potentially a huge growth market and will probably become the largest and most important online gambling market in the world. The assumption is DraftKings will take at least 20% market share of this and, while this should hardly be a given, it’s also hardly a deeply improbable outcome with the more restricted market access in the US market.

The more interesting question when looking at the delta in valuations is to what extent the European side is undervalued. If we take GVC, for example, then it’s had a fairly large fall from grace in the stock market since late 2018 and a peak of £1.12 a share compared to the £82p it sits at the time of writing. Kindred’s drop over a similar time frame has been even more precipitous, going from SEK130 to under SEK60, and both are after a fairly strong recovery so far this year. But it wasn’t always this way. There are plenty of examples from the European market of some very frothy valuations going all the way back to Betfair in 2010.

The exchange operator listed in late 2010 with revenue of around £300m a year and EBITDA of around £50m. Betfair had a market cap of £1.3bn and, initially, it soared to over £1.6bn. More recently, we’ve seen LeoVegas rising to a valuation close to €1bn at the start of 2018 after news of its acquisition of the IPS brands. This was despite revenue of €217m in 2017 and EBITDA below €30m. In 2018, it rose to €328m and €41m respectively, but the share price dropped to less than half during the course of the year as the regulatory outlook in the UK went from sunny with showers to take cover there is a storm coming.

Growth at what cost?

The only major European operator with a valuation above a single-digit multiple of 2019 EBITDA is Flutter, which has repeated the trick it has pulled twice so far of being the darling of the stock market. It consistently manages to tell convincing growth stories, while churning out cash, and this is a very attractive combination. It is arguably the best placed operator in the US, as well as the largest operator in the UK and with significant growth potential elsewhere due in the main to some very smart M&A, not least in the US.

So, is the story that DraftKings is overvalued or that the European sector is hugely undervalued? Well the truth is probably a little from column A and a little from column B. The attractiveness of US pure-play option inflates the price to an extent, but Europe is struggling to capture investor interest. It’s hard to be excited about the European online gambling sector at the moment and you sense the same from many of the executives within it. Their heart is no longer in the concept of high-growth, technology-led disruption; it’s about incremental gains and share through acquisition and cost barriers.

A senior executive at an operator recently told me: “I don’t believe in synergies – I believe in growth”. But the trouble is I’m not sure many other people do. There aren’t many convincing growth stories in the sector at the moment, and investors are having a hard time believing ones that do get told. The default position now is the retail-to-online crossover, and that the huge European land-based gaming, and to a lesser extent betting sector, will continue to migrate to the ‘better’ experience online just as has, sort of, happened elsewhere in the entertainment and leisure sector.

Disrupting the narrative

The land-based migration is a debate for another day and another column, but few disagree this is a slow-drip process and not one that will see players flooding through to online. And beyond this it starts to become very hard to show any step-change growth that doesn’t involve breaking out the chequebook. We’re still waiting for the Uber or Netflix of gambling. We’re still waiting for a big leap forward.

There are a lot of online gamers, sports consumers and casual gamers out there who don’t gamble and probably won’t ever gamble with the current product and presentation. You could argue it was a missed opportunity in lockdown, but the industry wasn’t ready for it and is not yet focused on where the next set of players and revenue growth comes from. It is broadly unprepared for the next phase, blindsided by regulation that was 10 years in the making.

The US remains the only true greenfield growth market left and it’s not going to be a market that is easy to break into for outsiders, nor one that favours a long tail of operators. It will be a market divided up between a handful of predominately US-led firms and everyone else can take the crumbs off the table. Will DraftKings be one of those? You have to think it might, but it does seem a very large bet on a very narrow range of outcomes from all those possible when looking at the potential players in that market.

But maybe that’s not what matters right now. DraftKings is telling a good story; whether you believe it or not is another matter. But the industry needs to recognise that it is in dire need of some good stories of its own.