It can be maddening when other people don’t see the world the way we do. In the stock market, this kind of misalignment can be a source of great wealth.
I was thinking about that kind of contrarian approach recently while buying shares of Flutter Entertainment
a British-based company that’s the market leader in a new industry that investors adored a year ago and hate today. Flutter could be a great investment: Not only does it operate in an unloved sector, almost nobody in America has heard of the company.
Flutter dominates most of the online sports betting markets in which it does business: the U.K., Ireland, Australia and the U.S. The reason people have never heard of Flutter in the U.S. is that it operates here under the brand name FanDuel.
It’s the best way to play the rise of sports betting in this country, which should be both rapid and lucrative. While today only about one third of Americans can bet legally on sports, states are hungry for the tax revenue associated with legalized gambling. Within five years, that number should exceed two thirds.
Early race for bettors
In the early race for Americans’ share of mind and wallet, DraftKings
is a distant second to FanDuel, with 20% market share to FanDuel’s roughly 50%. Though well-known, DraftKings represents a poor investment as I see it, and the recent news about the company’s potential alliance with ESPN does nothing to change my view. More on that later.
All the other sports-betting apps, including ones from land-based casinos including Caesars
trail even further behind. Barstool, for example, is operated by Penn National
and has a huge brand name — but only a 3% market share. For investors who want to capitalize on the rise of legal sports betting in the U.S., FanDuel — or, more precisely, its publicly traded parent Flutter — is where the money is.
Before we get into the specifics as to why this is so, it’s worth reviewing the short and simple history of online sports betting in the U.S. It can be divided into four chapters:
1. In 2018, the Supreme Court overturned a law that made betting on sports illegal. Nine days after the decision, Flutter bought a controlling interest in FanDuel. (Nine days!) That was an early signal that Flutter knew, as the Brits like to say, what it was about.
At the time, FanDuel was nothing more than a leading fantasy sports site, but Flutter understood that FanDuel’s fantasy sports customers could be easily and cheaply converted into sports bettors. As states began to legalize gambling on games, FanDuel and DraftKings, which ran the other major fantasy sports platform, quickly captured millions of customers with almost no advertising. This low customer acquisition cost explains why FanDuel and DraftKings began as market leaders, which in turn positioned both companies to scale up both revenues and profits. Only FanDuel, however, has executed properly.
2. Two years ago, DraftKings came public through a Special Purpose Acquisition Company, or SPAC. Like Flutter’s purchase of FanDuel, DraftKings’ method of going public was an early tell as to how they would operate — but not in a good way.
Flutter is an amalgamation of legacy British and Irish subsidiaries, the oldest of which has been laying odds and taking bets for 127 years. As soon as it bought FanDuel, Flutter began translating that experience to America.
“We had the head start with fantasy sports,” Amy Howe’s, FanDuel’s CEO, recently told MarketWatch’s Best New Ideas in Money Festival, “but what we got from Flutter really accelerated our progress.”
DraftKings, however, had no such expertise to draw on. It was forced to buy a back-end tech platform to help it design bets and calculate odds. Rather than wait to fully integrate the platform, though, DraftKings rushed its IPO. As a result, it began life as a public company more or less making it up as it went along.
3. Nothing opens Wall Street’s wallets like the prospect of a huge and growing market, however, and with more states legalizing sports betting, investors overlooked DraftKings’ slapdash approach. Even though the company was losing money and was outsourcing much of its core betting operations, DraftKings’ stock price more than tripled from its April 2020 IPO.
4. Buoyed by DraftKings’ public-market success, every company in the industry besides FanDuel began to spend money like drunken sailors and run operating losses to try to gain market share. It was a classic land grab — and, like most land grabs, the grabbers’ expectations were unrealistic. The joke around the industry was that there were 20 companies collectively spending billions on advertising and promotion, with each one claiming it would get 10% market share.
About a year ago, in late 2021, investors realized that this math wouldn’t work, and what began as a market frenzy became a market rout. From its peak, DraftKings has lost nearly 80% of its market value, and some casino companies with big sports betting exposure have fallen by similar amounts. Somewhat insulated by its profitable non-U.S. business, Flutter has declined by roughly half as much.
That’s where the industry stands today — in a mess — and so the sports betting business represents a perfect place to employ our handy contrarian winnowing tool. A year ago, Wall Street loved these companies; now they hate them. Which attitude is correct?
On the one hand, Wall Street is right that most sports betting companies will fail to gain any real edge in the business. That’s the beauty of free-market capitalism: Companies in every sector, from sports betting to selfie sticks, bash each others’ brains out trying to win over the consumer. Often, the only real winners are the consumers themselves.
On the other hand, if a business in an industry has an edge — a competitive advantage, a secret sauce, a “moat,” to use Warren Buffett’s apt metaphor — they will win. If a company has special characteristics that allow it both to please the customer and earn more profits than the rest over time, this company will defy the normal, free-market “Hunger Games” dynamic. It will then qualify as that rarest of creatures in a capitalist ecosystem: a long-term profitable investment.
In its swing from manic to depressive, Wall Street has overlooked such franchise characteristics in FanDuel. While most sports betting companies are doomed to mediocre returns, FanDuel has two distinct edges — two moats.
First, FanDuel is the low-cost provider of sports bets. In a commodity business, whichever company can deliver the goods at the lowest price will be rewarded by an increasing proportion of the customer’s pocketbook.
FanDuel’s cost edge comes from two places: Its leading market share, which allows it to see the largest number of bets in America, giving it more insight into where the action is heading, and its parent’s century-long expertise in laying odds.
DraftKings, Caesars and the other American-based sports betting companies now have internal sports betting “engines,” the technological back office that sets odds and computes payouts, and this has blunted FanDuel’s low-cost edge somewhat. But FanDuel’s deeper betting pool and longer experience continue to make it the low-cost provider of odds to American sports bettors.
FanDuel’s second competitive advantage is both more profound and more obscure. When I began to study the industry, I thought that its low-cost proposition was FanDuel’s key competitive driver, and in this I was not alone. Most people who don’t take the time to study the industry think that sports betting sites are commodities. “They’re all the same,” Tom Rogers, a cable television pioneer, told CNBC recently. “The odds are the same, the interface is the same.” But it turns out that I, Rogers, and others are wrong.
Emphasis on ‘parlays’
Most of the money made in sports betting comes not from simple wagers like betting that the Giants will beat the Eagles, but on exotic “parlays,” multi-step bets that require you to get several things right to get paid. People love these complex wagers: Not only do they bet that the Giants will beat the Eagles, they bet that the Giants will win by more than 10 points, that their quarterback will throw for two or more touchdowns, and that their tailback will rush for more than 100 yards. Or, during basketball season, they’ll bet that the Knicks, the Hawks, the Celtics and the Warriors will all beat the spread on a single night. These are hard bets to win, which is great for the sports betting companies. The average “hold,” or win, rate, for a casino on a standard bet is 3%-4%, but a parlay can be multiples of that range.
Given its extensive experience in Ireland and England, Flutter excels in developing parlays that bettors want to bet on. American sports are different from sports across the pond, of course, but it wasn’t hard for Flutter to translate its experience in football, rugby, and cricket to baseball, basketball and (American) football.
FanDuel was the first American sports betting site to offer same-game parlays, and in the critical American football market, FanDuel clearly has the most engaging product. Last NFL season, the average FanDuel user spent nearly 3 ½ hours a month on the site. The average DraftKings user spent roughly half that amount of time.
“FanDuel really has its finger on the pulse of bettors,” says Jordan Bender, an analyst who covers the industry for JMP Securities.
Better odds, better bets, higher customer engagement, a dominant market share — all these factors create a flywheel for FanDuel. With roughly 50% more revenue than its nearest rival, FanDuel can plow those extra dollars back into making its odds lower and its products more engaging. Such efforts lead to increasing market share, which drives more sales dollars, which again gives FanDuel the means to deepen and widen its moats. The result is a virtuous circle that companies in all industries covet but few ever achieve.
Hamstrung by inferior product and inferior odds, FanDuel’s rivals continue to spend billions on marketing with little to show for it. DraftKings has shelled out roughly $1 billion soliciting new customers over the last year, yet its market share has shrunk. Caesars has spent $1.5 billion in the same period, but its market share remains well under 10%. Protected by its multiple moats, FanDuel can spend more reasonably on marketing and drive to profitability sooner than the competition. Unlike most, FanDuel projects it will be cashflow positive next year.
By 2025, I expect FanDuel’s operating margins to reach the mid-20s as more states legalize gambling and the company leverages its fixed technology costs over a larger customer base. If revenue growth continues as planned, FanDuel could earn between $800 million and $1.2 billion after tax by 2025, or 4 pounds and 5 pounds per share for its U.K. parent. Meanwhile, Flutter’s mature subsidiaries in the UK, Ireland, Italy and Australia should earn at least that much.
If you put Flutter’s U.S. and the international operations together, it’s reasonable to assume that Flutter could earn 10 pounds a share in 2025, yet the stock is trading for barely more than 100 pounds a share. The market is giving us an opportunity, in other words, to buy a dominant sports betting franchise for slightly more than 10 times Flutter’s earnings power three years out.
What about ESPN?
Of course, the nature of free-market capitalism is such that when other companies see an industry with good potential, they think about getting into the space as well. American sports betting is so far running ahead of even the most optimistic projections, so it’s no surprise to see news that Disney, through its ESPN sports television subsidiary, get into the game.
Also rumored to be getting ready to throw its hat in the ring is Fanatics, the privately held company founded by Michael Rubin. Fanatics has upended the market for sports merchandise and trading cards, and he’s hired FanDuel’s former CEO to build out a sportsbook.
These are two formidable names, but before we get overenthusiastic, let’s remind ourselves what wins in an industry: moats. ESPN has one — its great brand name — but it doesn’t follow that the brand translates into online sports betting success.
Capitalizing on its moat, ESPN is reportedly seeking $3 billion from any sports betting company in exchange for partnering with America’s most popular sports network. That’s great for ESPN, but is it great for DraftKings? The company is already spending $1 billion a year in marketing and bleeding red. By spending an extra $3 billion to ride ESPN’s coattails, is DraftKings somehow going to a.) catch FanDuel and b.) turn profitable?
For any company to catch FanDuel in sports betting, it will need to destroy FanDuel’s moats and then create moats of its own. This will require considerable effort, and even then it might not be enough. Anyone can spend billions in marketing and promotions to buy customers, but the real differentiator in the business is great gaming content.
Both ESPN and Fanatics have zero years of experience in creating it. Despite four years of trying, none of the existing players have yet matched FanDuel’s parlays. Why should DraftKings’ alliance with Disney change that dynamic?
While competitors try to catch up, FanDuel isn’t standing still, either. It continues to tweak its Americans sportsbook to provide ever more engaging bets. In so doing, it’s doing what Buffett says all great companies do: making its moat stronger by throwing sharks and alligators into it.
Adam Seessel owns shares of Flutter on behalf of clients. He is the founder and chief investment officer of Gravity Capital Management in New York and the author of “Where the Money Is: Value Investing in the Digital Age.”