G2E: Improved financial condition of sportsbooks sparks M&A talk

October 21, 2023 3:55 PM
  • Buck Wargo, CDC Gaming Reports
October 21, 2023 3:55 PM
  • Buck Wargo, CDC Gaming Reports

The financial improvement of sports-betting and igaming operators has increased the chances of mergers and acquisitions and a greater willingness to invest in the gaming space, according to investors.

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That’s a trend to keep an eye on and the message from a Global Gaming Expo panel discussion, “The Future of Real-Money Gaming: What Investors Are Betting on.”

The panel featured Chris Lynch, who leads the gaming practice for Citizens Bank and oversees all merger-and-acquisitions capital-raising activities, and Lloyd Danzig, managing partner of Sharp Alpha Advisors, a New York-based venture-capital firm specializing in sports, gaming, and entertainment. It was moderated by Benjie Cherniak, an active investor and advisor to emerging sports-betting and igaming companies.

In 2022, Danzig said buyers and sellers couldn’t agree on prices. Buyers thought they could make acquisitions with much a lower cost of capital, while potential acquirees thought their businesses would be worth a lot more in the exit.

“You couldn’t get buyers and sellers to agree on prices and with inflation and the interest-rate shock, almost no one was at the negotiating table,” Danzig said. “This year, things are a lot different. It seems two things have happened. Both buyers and sellers have readjusted their expectations and they recognize the valuation environment we’re in. The number of exploratory M&A conversations this year at G2E must be ten times what it was last year.”

Lynch said the rebound in the stock market has helped, but there’s continued room for improvement. When he joined BetMGM in 2020, the debate was whether the company was worth $22 billion to $24 billion. Equity- research analysts today say it’s between $6 billion and $8 billion and as high as $10 billion.

“It’s not really a reflection today of the performance of BetMGM or any company for that matter,” Lynch said. “The market has come full circle since the fall of 2021 when the market peaked and we’ve fallen pretty far from that. You’ve seen it across the market, but sports gambling has been hit hard. Now, we’re starting to claw our way back. If you use DraftKings’s stock price as a barometer of the health of the industry, it’s ($27 to $30 a share over the last month), up from a low of $10. We’re still in uncertain times and volatile markets, but we’re well off the lows and the highs. We’re somewhere in the middle. Public and private markets and operators are looking for stability. That stops and starts with interest rates and until we all have some visibility of where w’are going from here, it’s going to be a bumpy road. But it feels better than it did 12 months ago.”

Cherniak said sports-betting and igaming operators are turning the corner and aiming to be cash-flow positive. As that dynamic continues to emerge and become the mainstream versus where it was a year ago, he suggested it plays into the mindset of the investment community in terms of what the industry can accomplish in the future.

Danzig cited the correlation between DraftKings’s share of marketing spend and its share of gross gaming revenue in the years following the U.S. Supreme Court repeal of PASPA that until very recently “were perfectly correlated.” If DraftKings’s share of marketing spend went up 1%, their share of revenue went up 1% and similarly to the downside, he noted.

“Then about three to four months ago, that relationship got completely decoupled,” Danzig said. “DraftKings’s marketing share plummeted, yet their share of revenue continued to tick upward. That’s a really great datapoint that shows we’re entering a new phase, where some of the market leaders have hit their stride and have begun to recognize economies of scale, while smaller operators have a harder time keeping up. We’re moving from the customer-acquisition gold-rush days into customer- retention and engagement phase.”

Prior to 2021, Lynch said investors didn’t look any further than the revenue line and just wanted to see growth. But overnight, people wanted to see cash flow and that prompted operators to look at how they could pivot and accelerate cash flows.

“A lot of operators will post positive cash flows in the second half of this year or already have,” Lynch said. “Virtually everyone will be cash-flow positive or breakeven next year. We’ve now entered the second phase. Now that it’s been proven that these companies are capable of producing cash flows while continuing to grow, we can start to revisit things like M&A and inorganic growth and new markets like Europe or South America. It took the past 18 months to prove to the market that these business models are viable and, in my opinion, have proven the market wrong. They’ve shown the market that they can do it and now they have a longer leash to pursue other initiatives.”

Cherniak said one of the current dynamics in the industry is operators feeling better about their ability to produce positive cash flow. Now that they’re looking at mergers and acquisitions, he questioned how much capital is available for investment.

Interest rates are the predominant determining factor, according to Danzig. People can put their money into an asset that yields 5.5% to 6% and is liquid and risk free, so they’ll demand a higher rate of return on any investment.

On the other hand, Danzig noted that the industry is more mainstream, evidenced by ESPN having its name on a sportsbook as ESPN Bet with Penn Entertainment. Thus, it has attracted interest from some of the larger players and private-equity groups.

“A larger set of institutional players that can write eight- and nine-figure checks are here (at G2E) taking meetings, while a year or two ago, some of them weren’t,” Danzig said. “It was still a bit of a niche category, because the market didn’t know how large it would grow and if these companies could reach profitability.” Danzig said there’s no question, however, that earlier- stage companies are having disproportionately more difficulty today. That comes down to appetite for risk.

“In 2021, people were seeing the valuations that startups had grown to and founders could leverage FOMO and competitive pressure to get deals done. It’s less the case today. The way you value future cash flows is to count them back to today’s rates. That exponentially impacts those companies whose cash flows are further in the future compared to those companies nearer in the future.”

The healthiest part of the ecosystem at this time is content, Lynch said. While slot games are a healthy piece of the content puzzle, he pointed to the sports side as well and cited microbetting and the Angstrom Sports deal (the U.S. data-analytics company) that gave BetMGM more exposure to the same-game parlay.

“Content and how to make it different from other people’s platforms is driving demand for deals right now,” Lynch said. “The interesting thing is in the U.S., we have this dynamic that maybe a half-dozen operators really matter at the moment. They’re all trying to figure out how they differentiate themselves. How is FanDuel different from DraftKings and how is BetMGM different from Caesars? They all need to figure that out. They all came to the same idea to differentiate themselves with content for games.”

Lynch said the best example is the DraftKings Rocket game that doesn’t exist on other platforms. The game is played with a rising rocket in which players must cash out by exiting the rocket before it stops rising. It’s the first game DraftKings released using ExitBet, a technology that explores entertainment-based gaming.

Operators want exclusive games designed for the U.S. consumer, Lynch said. There aren’t a lot of game studios in the U.S., but there are in Europe.

“You have the suppliers chasing the same limited pool of content providers,” Lynch said. “A small number of companies have focused exclusively on creating content for the U.S. consumer and you have demand from both sides of the B2C and B2B space going after them.”

Operators are not only trying to differentiate themselves. They’re also looking for more engagement with the recreational, entertainment-seeking, non-price-sensitive customer, Danzig said. That entails working with game studios — in particular those with games where there’s no skill component, but the user intervenes and influences the outcome.

“They speak to the younger generation that’s accustomed to a high degree of interactivity, but also on the sports- betting side, it offers more recreational products and suppliers having more sophisticated data science and trading teams on the back end,” Danzig said. “Same-game betting and microbetting are almost exclusively recreational products, but require vast improvements in the data science and modeling capabilities in order to price effectively. Every single operator (at G2E was) having these M&A discussions with small- and medium-sized-pricing companies and that’s on top of mind for all of them.”

Investors expect the sports-betting companies to unveil a lot of cross-sale opportunities over the next five to 10 years. Fanatics CEO Michael Rubin has talked about combining sports betting, e-commerce, ticketing, and merchandise.

Others might have sports betting, poker, icasino, lottery, crypto trading, and Robinhood stock-trading options. There could also be playing and betting on video games, which Danzig said are psychologically similar behaviors that could be converged into a singular experience.

“Right now, operators are thinking that they paid so much per customer and how to maximize the lifetime value of the customer and harness more of the types of things these people like to do all under one roof,” Danzig said. “In order for that to happen, a lot of technological innovation has to take place to provide the connective tissue that allows a one-stop shop to exist in the first place. That’s over the medium term and one of the most interesting things to think about. What will the product offering include, besides what it includes today, for the market leaders five to 10 years from now?”

Lynch said they’re already seeing some of that. For example, DraftKings launched an NFT platform as part of the market forcing companies to show profitability.

“We’re at a point where you’re going to start to see a reemergence of differentiation of platforms,” Lynch said. “People have the ability to go and invest in ancillary product lines.”

Danzig, over the NFL season, is tracking Fanatics’s mechanism that for every dollar wagered, bettors get 1% back in fan cash, or 5% if it’s a parlay. That money can be used to buy jerseys and other products Fanatics sells.

“I could see someone say, if I’m going to place a bet anyway, why not get a free jersey out of it? Others will say, I don’t need a jersey for betting. Only time will tell which of those is the case. I’m interested to see how it is at driving retention.”

The growth of igaming, which has been slow to expand in the U.S. so far, will continue to shape the industry. States aren’t expected to approve the expansion of igaming until they face budget deficits in the future.

The financial difference between sports betting and igaming is huge. In 2022, sports betting posted $7.5 billion in gross gaming revenue in 33 states, and almost as much for igaming in six states, Danzig said.

“We’ve seen a surge in the interest in companies that offer casino or casino-like products without having to go through the same licensing processes,” he said. “The other trend is how to make sports-betting-unit economics look more like online-casino economics. Casinos are more profitable. A slot machine bet takes seven seconds to resolve and you can play 24 hours a day. NFL games take 3½ hours and mostly on Sundays.”

As for the NFL, Lynch said he’ll be keeping an eye on ESPN Bet that will launch in November. If it captures 15% to 20% market share right away, there will be a renewed focus on content to real-money player convergence. “If that deal is unsuccessful, that might be the end of the focus on that area,” Lynch said.