DraftKings Reports Mounting Losses, SBTech Takeover Makes Co. 1st ‘Vertically Integrated’ U.S. Gaming Operator

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DraftKings announced just prior to Christmas that the company would go public in ‘H1 2020 via a merger with SBTech and the publicly traded special purpose acquisition company, Diamond Eagle Acquisition Corp (DEAC). As noted back in November, the DFS turned gaming operator’s “need for cash” was the driving force behind the transaction (the deal gives DK $500 million in working capital). Earlier this week (Jan. 7), DraftKings filed a detailed financial disclosure with the SEC for the first time confirming those suspicions. Financial losses “accelerated over the first nine months of 2019” (lost $114 million, up from $75 million in 2018) as the company aggressively invested capital in "new products and technologies, [in] acquiring and retaining new users and [on] expanding its product offering into new jurisdictions.”

Howie Long-Short: DraftKings intends to go public with a market value of “around $3.3 billion.” But at least one sports betting consultant suggested that number is “a bit long in the tooth.” DraftKings and FanDuel are similarly positioned as “the top two [sports betting] operators in the U.S.” and it’s not unreasonable to believe FanDuel is “beating DraftKings on marketshare. Flutter Entertainment's current market cap is $9.6 billion. If it was $8 billion before PASPA was overturned and the company has since added FanDuel, agreed to buy The Stars Group and suffered through re-regulation abroad, how can DraftKings be worth [more than] $3 billion?” 

DraftKings has indisputably proven capable of converting DFS players into sports bettors which gives them a tremendous leg up on the legacy operators, but industry insiders are projecting that the sportsbook operator will to continue to “burn cash left and right” on customer acquisition over the next two to three years. That is important to note with the company "reliant on the investment community.” While it shouldn’t be a problem in the short-term - “people are drinking the Kool-Aid [on the promise of a sports betting gold rush]” (see: DEAC +9% on Thursday 1.9) - it’s feasible that at some point “investors sold on the idea they would be making money, begin to shy away.” If that happens and the share price begins to tumble, don’t be surprised if “someone with deep pockets steps in and buys DraftKings [perhaps as their entry point to the U.S. market].

The takeover of SBTech is part of DraftKings vertical integration strategy. The company, which had been outsourcing risk management and much of the “sports-betting back-end” to Kambi, will now “control their own technology - largely the trading function." Taking ownership of SBTech’s software solutions will also allow DraftKings to do away with a significant expense - the 10% to 15% of gross gain revenues it was paying out to the sports betting experience provider.

Another industry adviser we talked to strongly believes that bringing functions like trading and risk management in-house should help the large operators (like DraftKings) in the long-run. But he/she was far less convinced that SBTech offers an effective solution - in its current form - for the US market. Rumblings indicate that both operators and customers have had "poor experiences with their technology." That’s not to say that DraftKings can’t or won’t improve the software to suit the needs of its American clients, but it paid “a pretty penny” for a company that has often disappointed with "poor service." 

While SBTech technology may not be best in class (at least for the needs of a U.S. operator), our source acknowledges that the addition is more likely to help DraftKings’ efforts to raise money than hurt them. “The narrative that DraftKings is the first vertically integrated American sportsbook operator makes for a pretty headline that will appeal to investors. Time will tell if they are able to enhance the platform and execute. The customer experience will eventually tell us if they get there."

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