DraftKings’ surcharge move has made the headlines, but the group has also given itself plenty of wriggle room at the same time as painting a target on the industry’s back for regulators and industry critics.
The mix of unexpected U.S. jobs data showing unemployment numbers increasing and consumer sentiment leaning towards caution has been brutal on U.S. gambling stocks. As markets opened on Monday morning, Caesars Entertainment was down nearly 8%, Rush Street Interactive dropped close to 7% while Penn Entertainment shares were down 6%.
Still, with the gambling sector’s historic ability to withstand these upheavals, analysts at B. Riley Securities noted that “most casino/supplier valuations are already trading several turns below historical averages despite reaching new gaming records and a history of sector revenue resilience,” and the expectation is that the industry will weather this particular storm.
For all that, such concerns don’t seem to be impacting the thinking of senior DraftKings leaders. The group issued second quarter results last week, reporting that revenues were up 26% year-on-year to $1.1bn, while adjusted EBITDA rose 75%, but was below estimates at $128m. However, coverage was dominated by chief executive Jason Robins’ announcement that the group would be implementing a surcharge on winning bets in states with tax levels that are above 20% such as Illinois, New York and Pennsylvania.
DraftKings’ statement made it clear that the move was the company’s way of addressing the recent tax rise introduced in Illinois and, having decided on the policy for the Prairie State, it seemed to think that it might as well roll it out in New York and Pennsylvania. However, this didn’t seem to consider there being key differences in how those two states brought in their tax rates and how the latter is able to deduct promotional costs.
Caveat emptor
In any case, there are also caveats to DraftKings’ move, such as around timing. It plans to bring the surcharge into effect in January, just as the NFL season reaches its crescendo with play-offs and the Super Bowl. That timespan gives it a long enough window to assess how customers and other operators might respond to the measure and, if it sees its players leaving their accounts in droves, it can postpone or cancel the move, having “taken stock” of players’ feedback.
Even if DraftKings sees an exodus of players, it can still address this with increased bonuses for its highest spending (and losing) players and an acquisition drive. Discussing the issue on the group’s earnings call, Robins said industry observers should look at it through the “overperformance that we are seeing with customer acquisition, underlying trends and outperformance on the handle side” and “even if we don’t get any benefit from the fee, we will still see $900m-$1bn in adjusted EBITDA next year”.
When it comes to market share, it’s also worth noting that DraftKings and FanDuel seem so far ahead of their rivals that Robins and his colleagues might well have viewed the surcharge as easy (and tax free) revenue. A recent CDC Gaming Reports column picked up on the market share issue, with the graph below showing how both operators have increased share over the chasing pack in the past two years to April.
When it comes to market share, Jordan Bender, equity research analyst at Citizens JMP, says the key point is that “the best product wins” and “a surcharge does not change the fact that DraftKings and FanDuel have an advantage for providing the end user with the best entertainment”.
Dueling brands
However, he adds that Flutter Entertainment, FanDuel’s parent company, “will act as the deciding factor in the decision to move forward with a surcharge” as it “has data-based outcomes telling it if market share or long-term profitability is at risk with these actions”.
“There is clearly a financial benefit if companies can maintain share, but the uncertainty around if market share will be eroded is not in the DNA of Flutter. If Flutter balks at the idea, we believe it lowers the probability [of] DraftKings implement[ing] the change.”
More intriguing is whether DraftKings’ move might antagonize regulators in New York and Illinois should those two states decide to regulate the key online casino vertical. With “DraftKings clearly sending a message to states that its main focus is on profitability”, explains Bender, it’s worth keeping in mind that “the surcharge would be untaxed; therefore, DraftKings has found a way to extract more money out of residents in the states with no benefit (taxes), which is the reason these states legalized online sports betting in the first place”.
“We imagine regulators are not going to like the idea of DraftKings finding the loophole, and one day if New York or Illinois legalize igaming (icasino), regulators could keep these actions in mind when issuing licenses, adding in a risk in the story for DraftKings.”
Consumers paying the price
For the industry and its image, DraftKings’ move is not good, even if it has the merit of being upfront. Indeed, Robins has regularly commented that he does not want winning players, and the surcharge should be seen in that light. But the fact that he is openly passing on costs to players does little for the industry’s image.
As has been remarked on social media, operators in highly taxed European markets are still able to generate profits. Meanwhile, Rush Street Interactive chief executive Richard Schwartz had a good line about why his company would not introduce a surcharge: “As we put our customers first, it was an easy decision for us.”
For DraftKings, one impact of the move might be to drive some of its VIPs away; and since the average revenue split for operators tends to be 80/20 (or higher) towards VIPs, it could mean DraftKings’ player base becoming more recreational or its revenues taking a potentially significant hit.
“I think players betting multi-leg parlays and things like that are going to be less sensitive” to the move, Robins told analysts during the earnings call, although he also admitted that he “hadn’t really thought about how it might affect” VIPs. “We’ll have to see how that plays out (but) it would take quite a bit of top line deterioration to make it not worthwhile from a bottom-line perspective”.
As for how regulators might view the move, the final word goes to Steve Ruddock of the Straight To The Point newsletter. He told the iGaming Daily podcast that the industry is on a twin mission: to “cry poor and tell lawmakers how much money you don’t have.”
“And mission number two is to tell your big numbers to investors and anybody who’s thinking about purchasing stock. So, you have this double-edged sword that they’re trying to deal with, and lawmakers are picking up on that.”
There is little doubt that lawmakers will have made a note of this surcharge episode and will have a ready-made answer should the industry lobby against future tax hikes.
