FanDuel and DraftKings – Taking a Gamble on Valuation

Spoiler alert!  Fantasy sports are big.  According to IBISWorld, the U.S. fantasy sports market is a $1.5 billion market and is expected to grow at nearly 7% a year through 2020.  When you think about it, it’s a classic venture capital market.  $1 + billion in market size + and high growth.  Fantasy sports are a technology-enabled industry, and thus the business scales well.  This wasn’t always the case.  In my first rotisserie baseball league back in 1991, the commissioner would input the daily box scores into a spreadsheet, and then would mail weekly statistics and standings to us.  Our transactions were made by phone, for the most part.  (It may not overly-surprise you to learn that our commissioner’s day job was in academic administration – and I’ll just leave it there.)  

Two companies have emerged as unicorns in the fantasy space – FanDuel and DraftKings – whose model is to entice players to play one-day fantasy games (Daily Fantasy Sports, or “DFS”).  You pay an “entry fee” to play in a league that takes place in one day, and your league is won or lost based on how your players perform that day.  If you win, you are paid that day.  If you lose, you can come back to play tomorrow.  You don’t have to suffer through an awful season where you drafted badly, or 1-2 key players are badly injured early in the season (if Sartre had written about fantasy sports, he would have written about a team whose best players came down with the Plague…) Numbers of participants in DFS leagues are hard to come by, but Fanduel appears to have around 1 million users. DraftKings, being Fanduel’s closest competitor, and arch nemesis likely has a similar number, though firm numbers for either company are hard to come by.  If nothing else, kudos to DraftKings and FanDuel for keeping much of their financial information secret.  The U.S. Government should be so effective…

FanDuel and DraftKings are both unicorns as of the latest data available from CB Insights.  While one might imagine that DFS’s legal challenges would have taken a meat axe to their respective values (DraftKings = $1.3 billion, FanDuel = $1.0 billion) this is the data we’ve got, and I’ll bet the values are still “close enough” for our purposes.  Like so many companies of their ilk, they’ve got revenues and users, but no profit, and no particular visibility to profit.  Making matters more complex, the competitive blood between them is such that they fight like they are two of the last three monkeys getting on the ramp to the Ark, and brother, it’s starting to rain.  This means lots of money spent on advertising in an arms race that makes Kennedy-Krushchev look like a West Side Story dance-off, and all the more difficulty to achieve profitability – and a low likelihood that they will set aside their differences and merge, as Sirius Satellite Radio and XMRadio did back in 2008.  However, I think their addressable market is larger and their competitive environment is far more favorable than for SiriusXM, and thus the urgency that some commentators place on such a merger may be overblown.

To perform a meaningful valuation analysis, we have to understand what these companies are.  They aren’t e-commerce sites and they aren’t online communities.  After many months of legal wrangling, state governments have determined, and the DFS companies have all but admitted that they are, in effect, gambling sites.  I agree with this characterization for not just DFS but conventional fantasy games also where money is paid to play.  While there is skill involved, the involvement of skill is not the same as, say, in a game of chess, or golf, or even Call of Duty.  I won’t go into the background of DFS and its struggle for legitimacy – ESPN recently published a terrific article on the DFS industry here. Suffice it to say that the DFS industry is becoming increasingly regulated as if it were a gambling business.   The legal infrastructure is catching up to ensure that players are treated fairly, and that no one competitor gains an unfair advantage.  While it’s hard to imagine Frank Sinatra and The Rat Pack hanging out and playing DFS games (and certainly the coolness factor isn’t there), times change, and so does the gambling biz.  You don’t even need muscle to collect on lost bets – all the money is paid upfront on a credit card.  Gambling does lose a little of the heart when broken thumbs are off the table.

The primary gambling-related industries that are the closest analogues to the DFS industry are non-hotel casinos, lotteries, gaming machines (video poker, slot machines, etc.) and horse racing tracks.  We’ll leave out the church bingo and festival raffle sectors.

Market

Size

Growth Rate

Fantasy Sports $1.5 billion

7%

Non-hotel Casinos $18.8 billion

1.2%

Lotteries $69.7 billion

2.4%

Gaming Machines $4.5 billion

2.4%

Horse Racing Tracks $2.9 billion

-1.2%

Source:  IBISWorld

In terms of market size, fantasy sports has some catching up to do and DFS is a subset of the fantasy sports market.  The DFS market size right now is likely less than $1 billion and I’d be surprised if it’s over $500 million at this stage.  If the combined valuations of FantasyKings and FanDuel of $2.3 billion are accurate, than those companies are being valued at 4.6x market size.

In researching this piece, the market capitalizations of gambling companies turned out to be smaller than I would have guessed ($billions):

Company Market Cap ($billions)
MGM Resorts International 13.4
Caesars License Company 1.6
Penn National Gaming 1.2
Caesars Entertainment 1.1
Red Rock Resorts 0.8
Isle Of Capri Casinos 0.7
Scientific Games 0.7
Pinnacle Entertainment 0.7
Eldorado Resorts 0.7
Tropicana Entertainment 0.5
Empire Resorts 0.3

Which means that FanDuel’s and DraftKings’ combined values are greater than every other publicly traded casino company except for MGM Resorts, though you could perhaps make the case the two Caesar’s properties should be combined for a $2.7 billion valuation, which would push the DFS companies down to #3.  This next analysis blew me away.  Real estate is a significant part of the casino business.  Luxurious resorts, places for James Bond to play Baccarat, comped buffets and the straightforward requirements to house physical assets, such as roulette wheels and slot machines, and integral to the gambling business.  No casinos, no business.  Nowhere for Pete Rose to hang out.  No tense locations for James Bond to size up his nemesis at the card table. The DFS sites, of course, have no such requirements.  Look what happens to these market capitalizations when we adjust out the real estate ($billions):

Company Market Cap Net Fixed Assets Net Business Value
MGM Resorts International 13.4 16.1 -2.7
Caesars License Company 1.6 0 1.6
Penn National Gaming 1.2 2.9 -1.7
Caesars Entertainment 1.1 7.5 -6.4
Red Rock Resorts 0.8 2.1 -1.3
Isle Of Capri Casinos 0.7 0.9 -0.2
Scientific Games 0.7 0.7 0.0
Pinnacle Entertainment 0.7 2.8 -2.1
Eldorado Resorts 0.7 0.6 0.1
Tropicana Entertainment 0.5 0.8 -0.3
Empire Resorts 0.3 0.025 0.275

Almost every single company has a negative equity value if you take the casinos away.  In other words, the gambling business (for these publicly-held companies, anyway) is worthless.  It’s not just the gambling addicts who are losing.  The value of a given casino lies mainly in the real estate.  The DFS companies have greater net “business value” – value that is not tied to real estate or some other tangible asset, then every other company on this list and it’s not even close.  DFS blows everyone away from a business value perspective like Simone Biles at The Olympics.  The reason?  DFS sites take a “rake” of 10-15% on every contest and they have no real estate to maintain, and their model is infinitely scalable.  Lower costs, guaranteed revenue on every bet, and infinite scalability = good business.  The gap would be even more striking if I had removed cash and equivalents to present a more comparable pre-money valuation analysis, but the point is proven.  I will concede one caveat here – GAAP accounting is awkward with real estate.  GAAP makes it much easier to write assets down than to write them up.  The real estate owned by these companies may well be worth more than book value.  Insiders may have a more representative view of the values of their respective companies’ real estate holdings.  However, this is all we have to go on and all that a non-insider would have to go on (we’ll let the SEC sort out whether insiders are trading based on inside real estate value information.)

How are investors justifying the DFS’ valuations?  They are likely banking on demographics to rapidly expand the addressable market.  Americans (and visitors to the U.S.) still like to gamble, but they are less likely to want to have to plan a trip to Las Vegas, or Atlantic City, or some Native American reservation or riverboat to do it.  While older people still enjoy the excitement and romance of the casino towns, the younger crowd is increasingly happy to get that thrill on a computer screen or smart phone.  What happens at home, stays at home.  We also tend not to think of fantasy sports as gambling.  There’s no bookie named “Mac” that we are calling to place a bet.  No tickets to cash in if our horse/dog wins the race.  No dice to blow on.  And there is a subtle business model story here.  Whereas a real casino has to put up its own “house” money to operate its games, the DFS companies generally don’t (though they did early on to attract players and ensure that leagues would fill up).  That business model surely has value.  No fixed assets and we don’t have to ante up our own cash?  Ok now that’s a business model that makes sense from a VC perspective.

Still, just to get to a 1:1 ratio of revenue to value, the market has to expand over 400%, and we aren’t even factoring in time value of money.  Getting a VC-type of return is hard to see here, especially with the two competitors at each other’s throats.  I’m not sure Kenny Rogers would get in this game.

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4 Comments

  1. Fascinating analysis, Mike! It certainly should give VC’s more concern about the proliferation of unicorns.

    Two thoughts/questions:

    –Perhaps part of the justification for the high valuations is the view of the market that ultimately one of the two DFS companies will fold or sell out to the other, leaving the survivor with near-monopoly market position – any thoughts about that?

    –Geeky accounting question: when you adjusted out real estate of the bricks-and-mortar casinos, was that based on land and buildings? And assuming so, was the building number cost or net of depreciation?

  2. Thanks Carl

    There’s a lot of commentary out there to suggest that the two firms ought to merge, but the relationship between the two is so toxic, it’s hard for them to have the conversation because each still believes they should be the surviving firm of the merger.

    And, to answer your accounting question, it was land and buildings, and net of depreciation. Of course, the fly in the ointment in the analysis is that book value may or may not reflect market value, especially because GAAP makes it hard to write up real estate to market conditions.

    • They are. Nice to see common sense prevail over personal rivalry. They don’t need to be dividing that market.

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