DraftKings Inc Warrants (DKNG)

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DraftKings IPO: Investors Get Great Opportunity_For_Sports_Betting _Pure_Play

Link:
https://seekingalpha.com/article/4319270-draftkings-ipo-investors-get-great-opportunity-for-sports-betting-pure-play

Jan. 27, 2020 12:26 PM ET|25 comments | About: Diamond Eagle Acquisition Corp. ( $DEAC ), Includes: DEACU, TSG

Summary
DraftKings is merging with SBTech, a leader in providing sports betting technology.

DraftKings is going public via SPAC instead of conventional IPO.

DraftKings will be pure-play way for investors to invest in growing sports betting market in United States.

Strong growth and market share in New Jersey demonstrate DraftKings' success and potential.

One of the most well-known sports betting companies is going public in 2020. DraftKings (DRAFT) is taking the unconventional route of going public through an existing special purpose acquisition company. DraftKings announced it would merge with SBTech, a gambling technology company, and go public through the SPAC Diamond Eagle (DEAC). DraftKings will be valued at over $3.3 billion. Diamond Eagle will change its name and symbol to reflect the DraftKings name. The company highlights that it will be the "first pure online betting play available for the public to buy an interest in."

DraftKings lists this as their vision (presentation):

"To build the best, most trusted, and most customer-centric destination for skin-in-the-game fans, to develop the most innovative and entertaining real money gaming products and offers, and to forever transform the manner in which people experience sports."

Here are the Key Investment Highlights from the prospectus:

Massive Global Online Gaming Opportunity: $70 billion global sports betting market
The Premier Brand in Digital Sports Entertainment: #1 rated DFS and Sportsbook, 60% DFS market share
Acquiring SBTech, a Leader and Innovator in Sports Betting Technology: 47% CAGR 2017 to 2020, 1 of 2 scaled turnkey providers
Proven Leader in New Jersey with Rapid Growth Trajectory: 31% CAGR 2017 to 2021 (estimate), 35% online sports betting market share in New Jersey
Pure-Play, Online Gaming Company Well Capitalized for Future
Jason Robins, one of the co-founders and current CEO of DraftKings, will stay with the company and guide it through an exciting time of growth. Robins highlights the state-by-state rollout of legalized gambling. Robins had this to say,

"I look forward to building significantly upon our goals of continuing our state-by-state rollout and creating the most entertaining and engaging customer experiences for sports fans globally."

Along with keeping Robins as the CEO, co-founders Paul Liberman and Matt Kalish will also stay on board with the new company.

DraftKings has successfully transformed from a company offering daily fantasy sports for money to a real contender to be a leader in the online sports betting market that is rapidly growing in the United States. DraftKings was the first to launch a mobile sports betting option in New Jersey, which has become the second largest sports gambling state in the United States. In New Jersey, DraftKings holds a number two position and around a 30% market share of online sports betting. DraftKings launched online sports betting in New Hampshire on December 30th, marking the fifth state it has launched mobile betting in. DraftKings has retail operations in New Jersey, New York, Mississippi, and Iowa.

The global gaming market in 2018 was split as the following:

Casino: 35%
Lotteries: 26%
Gaming Machines/Slots: 21%
Sports Betting: 16%
Bingo: 2%
The percentage of online sports betting continues to rise as more states adapt to this growing trend and allow state residents to place bets from their phones or computer in legal territories. In 2015, online made up 9.5% of the total. In 2018, this percentage rose to 11.3%.


New Jersey serves as an excellent example of the growth potential of online sports betting for DraftKings and the market overall. From September 2018 to September 2019, DraftKings had an online market share of 37%, good for $75 million. Rival FanDuel had a 40% market share with $81 million in revenue. For the nine months ending September 2019, DraftKings has seen 8x revenue growth increase year over year.


DraftKings has demonstrated with New Jersey that it can achieve state level profitability by Year 2 as marketing spend rationalizes. Going forward, as more states launch, DraftKings will benefit from the ability to shift to national marketing spending. New Jersey will achieve a 29% contribution margin from 39% gross profit margins by Year 5 under current forecast models.

The DraftKings deal prospectus gives us some looks at some financial forecasts. The figures are based on the assumption of iGaming live in New Jersey and Pennsylvania, SBTech continuing to grow, maintaining a market leading position in DFS, and additional states launching online sports betting in 2020 and 2021.

Year

DraftKings

SBTech

Combined

2019

$305 million

$110 million

$415 million

2020

$400 million

$140 million

$540 million

2021

$550 million

$150 million

$700 million

DraftKings also provides the following comparison between peers, which shows the company could be undervalued based on the $3.5 billion market capitalization:

DraftKings/SBTech

High Growth Consumer Internet Companies

Interactive Gaming Companies

Europe Sportsbooks

Enterprise Value/2021 estimated revenue

3.9x

5.6x

4.4x

2.4x

2019 to 2021 estimated revenue CAGR

30%

26%

9%

5%

Enterprise Value/2021 estimate revenue growth adjusted

0.13x

0.25x

0.57x

0.51x

Enterprise Value/2020 EBITDA estimate

9.9x

26.7x

16.6x

10.1x

(tables by author, constructed from data in presentation)

One of DraftKings biggest strengths is its existing user base from daily fantasy sports. The company has over four million DFS players in 43 states. These customers have already placed money on a type of sporting event and can easily be cross-promoted to as states legalize online sports betting. In New Jersey, many of DraftKings sports betting users were cross-sold from other DraftKings products. The DFS is also a profitable business and is expected to produce $213 million in revenue for fiscal 2019.

The merger with SBTech opens up DraftKings for a new source of revenue, although time will tell how this deal will ultimately work out. DraftKings currently uses SBTech's rival Kambi (OTCPK:KMBIF), but is expected to use SBTech in the future to power its sports betting app. SBTech is a world leader in online gaming technology and is present in over 20 regulated markets/jurisdictions. Fiscal 2019 revenue is estimated to be $110 million for SBTech. The company splits its revenue between Asia (54%), Europe/UK (42%), and United States (5%). The current revenue estimate was listed as $140 million for SBTech in fiscal 2020. The company had recent wins for Svenska Spel (Sweden's gaming market), and the Oregon Lottery. Once DraftKings uses SBTech to power its platform, it believes it will be able to introduce more unique pregame, in-game, and parlay bets. No announcement has been made yet of DraftKings ending its existing relationship with Kambi.


(picture from presentation)

Each year, it is expected that more states will legalize sports betting, and some existing states will add online/mobile betting options. This gives DraftKings built-in growth every year just by rolling out its product on a state-to-state basis.

Twenty states have legalized some form of sports betting. Many of these states have not taken bets yet, but are in the process of finishing up regulations. Sports betting revenue was only $249 million in 2017. That figure grew to more than $800 million in 2019. Estimates for the total size of the U.S. market are all over the place, but this CNBC article provides several estimates. Morgan Stanley analyst Thomas Allen estimates $7 billion in U.S. sports betting by 2025. Jefferies analyst James Wheatcroft estimates the U.S. sports betting market will hit $13 billion by 2023.

Action Network provides a great look at where states stand on legalized sports betting. Here is a look at where the 20 states and Washington D.C. that have approved sports betting stand:

Arkansas: physical sports betting allowed
Colorado: no bets yet, mobile betting expected by May 2020
Delaware: physical sports betting allowed
Illinois: no bets yet, 2020 expected, gives brick and mortar operators an 18-month head start ahead of mobile
Indiana: physical and mobile launched in September and October, respectively
Iowa: physical and mobile allowed, weird rule that makes users register in person before they can bet on phone until 2021
Michigan: no bets yet, expected mobile and physical by March 2020
Mississippi: physical and mobile betting, can only place mobile bets while in a casino
Montana: no bets yet, state lottery will oversee
Nevada: physical and mobile sports betting
New Hampshire: just launched 12/30 with DraftKings, only mobile bets currently
New Jersey: physical and mobile sports betting
New Mexico: physical sports betting allowed
New York: mobile sports betting legislation continues to fail
North Carolina: no bets yet, physical approved, mobile being explored
Oregon: physical and mobile sports betting, mobile run by Oregon lottery (SBTech)
Pennsylvania: physical and mobile sports betting
Rhode Island: physical and mobile sports betting
Tennessee: no bets yet, have no casinos in state, will launch online wagering in 2020
Washington D.C.: no bets yet, expected 2020
West Virginia: physical and mobile sports betting allowed
Action Network expects nine additional states to pass legislation allowing sports betting in 2020. Those states are Kansas, Kentucky, Louisiana, Maine, Massachusetts, Missouri, North Dakota, Ohio, and Virginia. The site sees an additional eight states passing legislation in 2021. That would bring the total to 37 states and Washington D.C. by the end of 2021.

DraftKings has to secure the rights to launch mobile betting in each state. As mentioned above, it currently operates online sports betting in five states. The five states are New Jersey, West Virginia, Indiana, Pennsylvania, and New Hampshire. The company has also partnered with some regional casinos to operate physical sportsbooks. I wrote recently about Penn National Gaming (NASDAQ:PENN), the largest regional casino owner, signing several rights deals with sports betting companies. DraftKings was one of those companies that partnered with Penn National, signing deals for Florida, Indiana, Missouri, Ohio, Pennsylvania, Texas, and West Virginia. This was an important deal as Indiana, Pennsylvania, and West Virginia have already legalized online sports betting. Florida, Missouri, Ohio, and Texas all don't allow sports betting at the current time.

One of my favorite plays on the sports betting growth market was The Stars Group (TSG), but that company is getting bought out by DraftKings rival and FanDuel owner Flutter Entertainment (OTC:PDYPF). Flutter owns BetFair, Paddy Power, FanDuel, Sportsbet, and Poker Stars. Flutter has 12 million customers and will trade shares on the London Stock Exchange and Euronext Dublin, offering limited exposure to most U.S. investors. The Stars Group saw shares rise nearly 40% after the deal, and the company now has a market capitalization of $7.3 billion and an enterprise value of $12.1 billion.

Investors can buy stocks of casino stocks with exposure to sports betting or some of the overseas players, but with The Stars Group going the way of buyout, DraftKings will truly be the best pure-play way to invest in sports betting growth in the United States.

Diamond Eagle went public last year and had seen shares trade between $9.76 and $11.04 prior to the DraftKings announcement. A spike from $10 to $11 happened on the heels of the announced deal, and shares had been settling in a trading range of between $10.50 and $11.00. A new report that DraftKings is eyeing a physical sportsbook in Las Vegas has sent shares north of $14.

Diamond Eagle was founded by Jeff Sagansky, a former president of CBS Entertainment, and Harry Sloan, a former CEO of MGM. The purpose of the acquisition company was to invest in media and digital entertainment companies. This marked the fifth public acquisition vehicle by Sagansky and Sloan. SPACs are quickly becoming a good option for private companies that want quick access to capital or want to go public as quickly as possible. The move can save months to a year compared to a regular IPO.

The big risk right now is investing in the SPAC prior to the deal going through. Virgin Galactic (NYSE:SPCE) went this route, and the company it merged with saw its shares fall when the deal went through. The bigger overall risk is the sports betting market. Each state has to legalize sports betting on its own terms. States have the ability to only allow physical sports betting, or only offer some companies the right to offer mobile betting. These are large risks to DraftKings, which does not have a large physical presence and relies heavily on users to place wagers online or through mobile apps. The sports betting market is also highly fragmented and is expected to grow, with many casinos realizing the potential of launching their own online betting systems or partnering with others. While DraftKings has had success in several territories, there is no guarantee that it can duplicate that model.

Investors can wait until the DraftKings and SBTech merger goes through to acquire shares or can begin buying shares of Diamond Eagle. Diamond Eagle also trades as DEACU (DEACU) that includes one share of common stock and one-third of a warrant to purchase a share of DEAC at $11.50. A recent special purpose acquisition company deal saw Virgin Galactic go public. In that move, shares of the SPAC fell from around $11 to less than $8, before again rising to $11 once the deal had finalized, and the ticker had changed. I would expect a similar move here and think investors may do well waiting for everything to take place before acquiring shares of DraftKings. Bullish investors may consider buying the warrants or combination common stock and warrants.

The $3.5 billion valuation given to this company seemed high at first glance, but when comparing it to peers, seeing the valuation of The Stars Group, and the size of the potential U.S. sports betting market, it doesn't seem that high. The overall U.S. sports betting market will likely grow to $10 billion, and DraftKings will be a major player in the market. I expect to buy shares of DraftKings when this deal goes through.