Feeling bullish: Why SPACs are fueling the first wave of igaming IPOs

The term Special Purpose Acquisition Company (SPAC) appeared in the betting sector’s lexicon earlier this year as DraftKings announced its reverse merger with the blank-check company Diamond Eagle Acquisition Corporation (DEAC).

As DraftKings tied up the deal, which included its acquisition of Europe-based betting platform provider SBTech, a seismic shift in the investment space occurred as the operator’s share price soared to $42 at its peak, and its market cap swelled to an eye-watering $12bn.

And all this transpired during a time of significant market uncertainty as professional sports took a break during the Covid-19 lockdown earlier this year.

The operator’s resounding IPO success sparked immense interest from business and financial news outlets and, crucially, the wider institutional investor and SPAC owner space. It has also resulted in two similar SPAC deals spinning off the online businesses of two land-based casino competitors: Golden Nugget and Rush Street Interactive (RSI).

Exactly how did DraftKings make such a significant impression on investors and how are they now viewing the burgeoning betting and gaming sector in the US?

“The market’s interest in this space, to a large degree, really began in April of this year, based upon the success of the DraftKings transaction,” Sal Kamalodine, investment banker at B. Riley FBR investment bank in Los Angeles, tells EGR NA.

“Shortly after DraftKings, GAN went public the regular way and their stock also dramatically appreciated. Everyone looked at DraftKings and GAN’s trading multiples and that unleashed this thirst for other assets in the space and taking them public.”

The DraftKings effect

Many within the industry’s insular little bubble perceive the DraftKings valuation as a little steep; after all, the operator has yet to turn a profit. Its 2019 losses rose 87% year over year to $142.7m on increased technology costs and geographical expansion, with an additional $161m lost in Q1 of this year.

But to investors and analysts, the Boston-based operator is the “the undisputed leader of the B2C model in the US and a leader in going public,” says Kamalodine.

“US investors have a very different time horizon and risk appetite for underwriting losses for a period of time, and that is in stark contrast to European investors that are much more focused on near-term profitability.”

Having spent many years investing in European gaming start-ups, Velo Partners director Andrew Reader is sceptical of DraftKings’ $12bn valuation and the increasingly gung-ho approach to betting US investors are taking.

As a gambling fund, Velo Partners invests in Series A or early growth stage rounds and has stakes in independent gamification-focused operator Suprnation and long-standing online UK casino supplier Gaming Realms.

“Where I sit, I just see that the momentum is probably somewhat disconnected from the underlying fundamentals in the market,” Reader comments. “It’s difficult to justify the pace at which these valuations have come out. And I think it’s just a function of market fervor.

“We haven’t directly participated in any [US gaming IPOs], having looked at a couple of them and finding that the valuations have been so high compared to what we perceive to be the underlying market opportunity.”

Those of us close to it are all too familiar with the narrative of exponential revenue and widespread adoption once bigger states open up to betting and igaming, but according to the founder of industry advisory firm Sharp Alpha Advisors, Lloyd Danzig, the investment world is just opening its eyes to the industry.

“What I found before the DraftKings deal was a perception that there was a ton of money waiting to get into sports betting. But in the pitches for start-ups and M&A discussions, it seemed there was a lack of education,” Danzig says.

“There was a lack of ability on behalf of both retail and institutional investors to truly understand why the States represented such a compelling investment opportunity. Anecdotally, this was exemplified by the rush of US investors who, immediately post-PASPA, expressed interest in deploying capital and yet had never heard the term gross gaming revenue.”

It’s certainly not the case now, as a spotlight shines on gaming stocks and analysts and banks issue buy ratings for GAN and land-based casino operator Penn National Gaming, which is preparing to launch its highly anticipated Barstool Sportsbook in time for the NFL season.

But uncertainty over the wider regulatory landscape for betting and gaming, and with the industry still being in its infancy, makes it difficult for analysts to accurately predict what operators’ cashflows might look like in three to five years.

“If you’re an institutional portfolio manager or you’re an equity research analyst, there is more attention than ever being focused on price targets and market commentary,” says Danzig.

“Valuations are based on meticulous projections of discounted future cash flows, which, in turn rely on assessments of the size of the total addressable market. Uncertainty over the speed of legalization and nature of tax policies makes this a difficult undertaking.”

A sports hook

Pre-Covid-19, PwC estimated the sports market in North America would grow from $71.1bn in 2018 to $83.1bn in 2023, with betting forecasted to make up a small slice of the bigger pie. Danzig suggests that recent interest in betting firms has been stirred by huge investments into sports teams and sports technology start-ups.

Only a couple of weeks ago, former college football player and wrestler Dwayne Johnson made headlines when he teamed up with private investment fund RedBird Capital to acquire the formerly defunct XFL for $15m.

RedBird has elsewhere partnered with MLB EVP Billy Beane to establish a $500m SPAC looking to invest in sports media and data companies. Industry rumblings have speculated that Red- Ball Acquisition Corp. could be eyeing up data provider Sportradar, which has ramped up its US presence significantly in the last year or so.

“We’ve seen a rise in things like athlete venture capital, where you have athletes that bring money as well as influence to venture capital firms or family offices and try to deploy resources that way,” says Danzig.

“And on the fan side, they want to have these more intimate relationships with the teams they follow. An investment is an interesting way to express your sports fandom and enhance engagement in ways that weren’t possible before.”

The link between betting on sports and trading stocks is a well-established one, as start-ups like BallStreet Trading have encouraged sports fans to trade athletes and teams during live sports events.

Let’s not forget Barstool Sports founder Dave Portnoy’s lockdown alter-ego Davey Day Trader, as he pivoted over to trading stocks while live sports were on hiatus.

But while sports and sports betting SPACs are a novel concept in the investment space, Danzig says SPACs have been around for a few years, having previously targeted energy companies. “It’s only because oil prices really tanked so much last year and this year that we see the depletion of those.

“But otherwise it might have been the case that the energy sector was where SPACs really took off,” he comments.

(Photo by Ulrich Baumgarten via Getty Images)

What’s inside a SPAC?

The principal appeal of SPACs, particularly in the gaming world, is the certainty of financing. There is a common misconception that SPAC IPOs are quicker to market than traditional IPOs, but B. Riley’s Kamalodine dismisses the notion, insisting the deal takes up to six months from signing a letter of intent to merge with the determined entity to shareholders voting and closing in on it.

Once the initial SPAC investors are replaced with fundamental investors, there is roughly an 80% chance the agreement will be finalized within six months.

“The SPAC sponsor goes on the road to raise a PIPE [private investment in public equity] financing,” Kamalodine highlights. “That is done confidentially in what is called testing the waters. And coming out of that process, they get commitments from institutional investors to fund the merger.”

For those seeking to go public, a SPAC acts as a shell company that provides protection from any history of less-than-desirable activity that could put off institutional investors when funding operators directly.

In DraftKings’ case, that may well have been its B2B arm SBTech’s murky history in gray markets like Turkey.

Also appealing in these types of deals is the SPAC founders’ lack of involvement in the day-to-day running of the business. Today’s DraftKings C-suite looks almost identical to its former exec team, bar the inclusion of a handful of SBTech executives who continue to manage the B2B side of the business.

In Golden Nugget’s case, its CEO and founder Tilman Fertitta is also a sponsor of the SPAC that will acquire the online gaming business. Kamalodine says this type of “inside deal” is very unusual.

Fertitta partnered with independent investment bank Jeffries and will maintain a 52% stake in the new group. Upon announcing their respective SPAC deals, DraftKings, Golden Nugget and RSI have all provided investors with a public comps (companies) analysis, comparing their total enterprise value (TEV) to their peers.

RSI’s hook in its investor deck was how cheaply it was valued considering its forecasted 2021 revenue of $320m, and its already positive cashflow. Compared to Golden Nugget, RSI was valued at 5.4x its 2021 revenue, while Golden Nugget and DraftKings’ TEVs were much higher at 8.9x and 17.5x respectively.

“The whole thing is about buying these guys at a big discount to the public comps, and so when they eventually consummate this transaction, they’re going to get a huge gain when it trades up relative to the comps,” Kamalodine notes.

“When the venture capitalists are upset to see an IPO trade up 30%-40% on day one, what they don’t understand is that when a company goes public through a SPAC they’re under-pricing their equity in the merger to facilitate that transaction,” he adds.

This approach certainly seemed to work for RSI, which secured $60m more in PIPE than it had anticipated following its announcement in June. The firm later revealed that Fidelity was among its latest investors. Overall, the SPAC raised $160m in PIPE.

Who’s next?

Kamalodine, Danzig and Reader all agree that more gaming and betting SPACs are likely to be on the cards as operators appeal for more capital in the US.

And as firms like RSI and Golden Nugget spin off their online businesses, and suppliers like GAN migrate their listing to a US exchange, many have been questioning whether the likes of Flutter, 888 or William Hill might do either to help gain a better footing in the States.

Kamalodine doesn’t expect so, though. “What has happened since DraftKings’ and GAN’s success in the public markets in the US is that sophisticated institutional investors in the US have no problem buying equities [shares with no fixed interest] abroad,” he says.

“And so, what you’ve seen is to a large degree there has also been a meaningful rerating of revenue multiples in Europe. And I can mention a handful of companies that already have pretty good multiples in their home countries. Better Collective trades with a nice healthy multiple, [as does Kambi]. They’re five, 10 or 12x revenue.”

While Reader doesn’t anticipate any business migrating its listing to the US, he does believe a European firm might spin-off and IPO its US business. In recent months, the UK and Sweden’s gaming stocks have endured extreme volatility in the face of the global pandemic, tightening regulations, and the Swedish Gambling Authority’s questionable approach to sanctioning operators.

And with DraftKings, GAN and Penn National Gaming’s share prices all on a veritable uptick, the time to make such a move is now.

When considering the world’s wider financial footing at present, US and UK unemployment is rising at record rates and both countries have plunged into deep recessions. Yet, in times of market instability, Sharp Alpha’s Danzig says SPACs are extremely attractive.

“Capital is accessible and cheap and we are in a low interest rate environment with an accommodative monetary policy right now, not to mention that there seems to be a lot of capital that has been waiting on the sidelines and ready to jump into something new,” he concludes with a glimmer in his eye.