Sports betting stocks went up...then down. We asked two pro investors why, and can they bounce back?

For ASX sports betting stocks, the post-COVID rollercoaster has been steep in both directions.

There was the 2020 upslope, when money poured into anything connected to stay-at-home lifestyles (ecommerce, tech, sports betting).

Exuberance topped out towards the middle of last year. Then investors began demanding that the sky-high share prices of post-COVID darlings were backed up by consistently strong earnings metrics.

Sports betting stocks — some quick background

ASX betting stocks have operations in Australia, but the central investor narrative has always been geared around the US opportunity.

In 2018, US lawmakers legalised in-state betting (previously just the domain of Nevada).

That kick-started a state-by-state rollout across the country which is still ongoing.

The blue-sky opportunity is obvious; a massive consumer base, with 50 different states jurisdictions on offer for companies that can execute a first-mover advantage.

Coming from a mature gambling market, the pitch is that Aussie companies with established technology can grab a healthy slice of that.

But Stockhead spoke with two professional investors this week who said cracking the US market is much easier said than done. Here’s why:

Competition

Last July, ASX sports betting company PointsBet (ASX:PBH) announced a $400m capital raising.

Priced at $8-$10 a share, PBH said the raise would help consolidate its “strong position in the rapidly expanding US sports betting and iGaming market”.

The $400m was indicative of the enthusiasm among Australian institutional investors. And the new fund left PBH “cashed up to spend and acquire US customers”, said Nick Cummings, a Global Portfolio Manager at Oracle Investment Management.

But he added the opportunity – consisting of a strong tech stack, plenty of cash and a fast-growing addressable market – leaves out one key threat in the US betting landscape: there’s a number of big dogs already in the front yard.

Meet the big dogs

The US is dominated by three companies; FanDuel, DraftKings and BetMGM.

BetMGM and DraftKings are both ~U$20bn businesses with revenues north of $1bn.

Similarly, FanDuel is a subsidiary of UK giant Flutter Entertainment (which also owns Sportsbet in Australia).

Prior to broader legalisation, they established market share with services tied to fantasy sports (i.e. US-centric versions of AFL SuperCoach).

There’s no doubt the post-2018 market is still maturing. For example, state betting rules have yet to be implemented in Florida, Texas and California – three states comprising around 100m people.

But those footprints are notable because it means a lot of the early customers have been won, Cummings says.

“In states where US betting is legal, they’ve leveraged that base to corner around 60-70% of the market,” he said. In some states, it’s “more like 80-90%”.

“So there’s not that much share for smaller providers to go after, and they’re going up against massive marketing budgets.”

That’s where PointsBet’s $400m raise needs to be put in context, he added.

“They’re cashed up and spending to acquire customers. But they’re going up against competitors that have real cash flows of that amount, or more.”

“In isolation, their balance sheet still looks strong. But in terms of the competitive landscape it doesn’t look as strong. And if they keep burning at the current rate, they’ll have to come back to market at some point.”

Customer acquisition

The competitive landscape forms the framework for the next key challenge facing ASX sports betting stocks in America — building market share with profitable per-unit economics.

As with many companies and sectors, the devil can be in the detail.

In sports betting, there’s “a few areas you have to be careful with,” Cummings says.

Here are the core metrics investors assess:

Online turnover: the gross total of funds that are run through the betting platform;
Gross win: what the company takes after winning bets are paid out;
Net win: The gross figure, subtracted for costs such as free bets and management fees

For the December quarter, Pointsbet reported a net win of $71.9m (5.4%) on turnover of $1.326bn.

Bluebet (ASX:BBT) reported a net win of $13.6m (9.8%) on turnover of $138.6m.

To win market share in the US, Aussie entrants would be “giving away a lot of free bets,” Cummings says.

“Say a customer over there might get a $1,000 fee bet. If they bet it, the net handle goes up by $1,000. But they haven’t made money – it’s used to distort the numbers. So that’s a really important figure for their long-term customer acquisition costs (CACs).”

Those same CACs were a core focus among investors in the latest round of quarterly updates in the sports betting sector

For Heath Moss at HLM Investments, the data showed the while the US addressable market is one thing, getting a meaningful slice of it is another.

“PointsBet’s net win came in at $71.9m, but they spent ~$65m just on sales and marketing in the quarter, so to get that net win rate was extraordinarily expensive,” Moss said.

In total for the quarter, PBH reported net operating cash outflows of $51.75m, while BlueBet had net outflows of $1.29m.

“I think the easy money has been made and competition is so fierce already,” Moss says.

He said per-unit CAC estimates in the US amount to upwards of $US1,500.

“If they’re only betting US$20 or US$50 at a time, you can see the churn there and how expensive it is to bring on customers,” he adds.

Cummings said the while the US market is more nascent, it’s actually “a lot better than other market in terms of publicly available data.”

Trading data is usually released within six weeks of month-end, and “a lot of sports betting stocks globally trade off that,” he said.

As an example, he noted that in the December 2020 quarter, data showed PointsBet had a 13% share of the New Jersey betting market. In the December 2021 update, that had fallen to 3%.

“So it sort of shows you how competitive the market is. Right now, the money they’re spending on sales and marketing isn’t turning into long-term sustainable customers.”

Skin in the game

Another central part of the news flow for ASX sports betting stocks relates to licences.

As each new US state opens its market, bookmaking licences are issued successful applicants.

Over the past month, Pointsbet flagged licence wins in the US state of Pennsylvania as well as Ontario, Canada, and took its first bet in the New York market where it won approval last November.

Bluebet flagged a ‘skin’ agreement in Colorado, where it will partner with an existing operator in that state to run a B2C online sportsbook.

However, Cummings said he’s still looking for evidence that those licence wins can convert into scalable per-unit economics.

“The frank point is that a lot of licences – it’s not that they give them out to anyone but there’s often nine or 10, sometimes up to 12 approved operators in a given state,” he said.

“So having a licence is great but it doesn’t mean a whole lot to be honest, in terms of whether you’re winning long-term customers and what cost you’re winning them at.”

B2B – investor thoughts

Rounding out the trio of ASX sports betting stocks is BetMakers (ASX:BET), which operates a platform model providing the back-end technology for bookmakers (primarily in horse racing).

In May last year when the market was running hot, BET made a bush into the wagering business with an offer to buy Tabcorp for $4bn.

The deal was structured with ~$1bn in debt-financed cash and ~$3bn in BET shares, which at that time were trading near $1.50.

To complete the deal, Betmakers would have had to issue around double the shares it had outstanding on the market.

In Moss’s view, that indicative proposal – subsequently rejected by Tabcorp — probably marked “the top of the market.”

While it operates an adjacent B2B model, BET hasn’t escaped the sports betting selloff.

Substantial shareholders in the business include racing identity Tom Waterhouse, who holds an ~8% after inking a deal with BET in early 2020 to use its live pricing and backend technology.

In Cummings view, that B2B model will be more sustainable going forward.

“That’s a more sustainable industry. It’s contract-by-contact and you’ve got to keep your customers, so there’s some contract risk,” he said.

“But it’s more attractive as a business we think. Even though there is competition, there’s less competition than the direct gambling space.”

Consolidation

Summing up the market, Cummings said that while the blue-sky opportunities are compelling, the reality on the ground is that like other tech sectors such as cloud services, digital scale is the key – and that battle has largely been won.

Even in Australia, he said local competitors will struggle to compete with Flutter subsidiary Sportsbet, just by virtue of its global backing and the fact it already has a ~50% share of the domestic market.

“It’s winner-takes-all the economics,” Cummings said.

“And if you’re trying to get market share through promotions and free bets, companies like DraftKings and FanDuel can do that 10x over and for 10x as long.”

For now, Moss is allocating his client money elsewhere.

“I’d like to see better numbers and financials. If they’re going to continue to burn cash it means they’ll have to come back to the market to raise capital. At the moment, it’s not a space that’s conducive to more growth in earnings per share,” he said.

“I think what we’ll see is consolidation, because in this sector you have to go out and buy a client base,” Moss said.

“Now that share prices have fallen, it might be cheaper to bolt on that client base through acquisition rather than spend the money to attract those customers.”