DKNG - Flutter: A Buy On The Dip Opportunity For This Sports Betting Global Giant

2023-11-13 09:29:52 ET

Summary

• PDYPY (Flutter) reported a 12% negative revenue impact in Q3 due to unlucky play in the US and poor results from Australian horse racing.
• The company's upcoming listing on the NYSE is expected to bring advantages in terms of visibility and attract retail investors.
• The battle between PDYPY and DKNG for market share dominance in the sports betting sector continues, with PDYPY already owning the biggest share in the US.

Above: The passion for sports extends into betting as a global phenomenon

• The shares of Flutter (PDYPY), US subsidiary of UK leader Flutter (LON:FLTR) ,

  have taken a 9.4% hit due to a hold percentage related revenue dip in 3Q23.

• The real big news of the earnings call however, was that parent Flutter, was fast approaching a NYSE listing by 1Q24. It's a biggie for visibility.

• Fundamentals of the stock are strong, hold percentages part of the normal fluctuations over time. But the house edge always wins.

  Premise : In our last SA post on October 25 ^th the shares of PDYPY (Flutter) parent of sector leader Fan Duel we, along with analyst consensus, guided a PT of $107. On Nov 8 ^th , the shares rose to $84.67 and were well on the way to moving toward the forecasted PT at 1Q24 of $117.

  What’s Changed?

On Nov.9 ^th , PDYPY reported 3Q results which indicated a 12% negative revenue impact from unlucky play in the US as well as poor results from Australian horse racing. Despite overall positive results from the UK and EU, Mr. Market responded to the top numbers taking the stock down 9.4% overnight. That presents a buy on the dip opportunity.

The sharp dip once more indicated a distinct lack of understanding among many investors of how the long range bookmaker’s odds work. The averaged long term hold is 7%. When the bookmaker runs lucky, a 9.5% hold can be attained. When the players turn lucky, hold can drop to as low at 4%, and in extreme cases, show a dead loss for the sports book.

Above: A quick education in sports betting odds fluctuations. As in all gambling, long term the house edge remains predictive.

Over the long term the 7% hold target for the sports books holds firm. The basic math of gambling odds always brings a house edge no matter a periodic run of player luck. In the business we call such periods a time “when the rats eat the cats”. Nobody panics, its expected, just as periods when the house plays lucky. The key point here is this: Sports betting is a low margin business without question. However the overall hold percentage built in against a smart, operation with good cost controls is a great business for those who can acquire market share on an efficient basis. In short, a quarterly earnings miss that is due to poor hold is no reason to sell the stock if it otherwise has strong attractions for appreciation.

Contrary wise, a big fat profit emanating from an unusually strong hold is no reason unto itself to buy the shares.

Having been in the business for 35 years I have seen this knee jerk proclivity in Mr. Market’s trading patterns of gambling stocks continuing. The only time to begin questioning the performance of a sports book regarding win percentages is if the unlucky play continues over several quarters. That breaks the basic irrevocable math.

And one might begin to question management effectiveness, or in extreme cases, widespread cheating. That is why security and compliance policies and regulators keep intense watch on patterns here.

The imminent NYSE Listing got buried by the revenue miss

After several years of delays, Flutter announced it had finally cleared the deck of obstacles and was rapidly moving to list its shares on the NYSE. Shares are now traded on the LSE and in Ireland with US depository receipts trading under the PDYPY ticker as we report it on SA.

The NYSE move brings countless advantages to investors that the company does not yet have in terms of visibility in the US. Upon the listing PDYPY will replace DraftKings (DKNG) as the biggest pure play in online gaming to be traded in New York. The company’s target is the retail sports book investor. Its current institutional ownership based in Ireland and the UK is 13%--that is also expected to expand due to the new listing.

The goal is set to when the shares become easier to understand in terms of same currencies and financial status, retail investors will flock to the stock. PDYPY is by far the global leader in revenues and footprint in global regions. And mostly, it already owns biggest share of market in the US under the Fan Duel brand. DKNG challenges this estimate saying it had moved into the #1 share position last month. It posted a gain in monthly players of 40% as the NFL season got underway.

Above: Dominance of DKNG and Fan Duel will continue due to deepest penetration of states and original fantasy sports databases.

Fan Duel shares are up 9% this year. DKNG shares were up a hefty 208% YTD. In reviewing the state by state metrics we concluded that shares were so close that even a claim’s validity depended on which metrics one chose. Suffice it to say the two leaders now own over 75% of the market.

As we have noted before, the sector now awaits the arrival of two deep pocketed entrants: Disney’s ESPN/Penn ( DIS ) and sports gear online retailer Fanatics. It is far too early to forecast any possible market share incursion either of these two new competitors could achieve. Neither is a pure play as both are relatively small parts of immensely larger companies.

There are two conflicting schools of marketing logic here to consider. First is that new entrants take share from the biggest operators simply because there is so much more to poach. Second is that the small, second and third tier operators are more vulnerable because they can easily be outspent by a new, richer competitor. Either way, my view and that of industry associates I have talked with see a long road ahead for both entries that will not materially impair the CAGR growth of both Fan Duel or DKNG in the near term.

DKNG results for 2023 at best could come near breakeven. Our calculations indicated that even 2024 our best case for the company would be another breakeven year with the strong possibility of finally turning profitable by 2025. Against that you have the debut of PDYPY on the NYSE and a much clearer apples to apples comparison. The UK firm is already profitable due to its global business. Fan Duel is already in the beginnings of positive profit territory.

There has been an element of pom pom twirling on the shares of DKNG reflecting both institutional conviction (It is 56% institutionally held vs. PDYPY 13%) and its large retail appeal tied to its brand visibility. I have not been a fan of DKNG in general because I have ongoing concerns about their commitment longer term to reduce promotional spend. I also see their return on equity stands at –(89.44) vs. PDYPY at –(0.63). So this indicates to us that DKNG has huge numbers of retail holders as well as institutional fans primarily as a sales growth play. The conviction here is that the stock is steady on the road to profitability within the next two years. However I see pot holes ahead. I believe much of the run up from its January low at $14 has been based on its sales growth numbers as well as some progress in reducing promotional costs. At writing DKNG traded at $35. All this to the good but investors will have to live with a zero profit operator for the next two years at least.

By 1Q24, US retail investors will have a NYSE stock—a much bigger pure play—already in profit to choose from in PDYPY

Above: DKNG has slight edge in brand awareness but Fan Duel visibility will rise exponentially after the NYSE listing and news flow begins.

It is not yet clear at what price PDYPY will debut at when it begins US trading. There are many guesses, mostly clustered around a conversion of its UK valuation at $148.23 USD. It now appears the company listing will include the global business not just the US which has revenues ~$9b US vs. an estimated $3.7b for DKNG. Once listed the shares will begin to go head to head in terms of visibility and comparatives for investors.

Here is the case for the NYSE buy scenario

The US traded stock under the Fan Duel banner gains immense visibility as the revenue leader globally. The battle between DKNG and Fan Duel for #1 market share is a see saw. But until now, Fan Duel, for all its market share dominance in the sector, has been a bit harder to understand than DKNG for the retail investor. We also believe there will be much institutional interest in the US shares because besides its pure play status in the US, it offers exposure to its global reach. The wide disparity in share prices between the two companies makes for tough comparisons for value. Fan Duel’s US revenues will run near $4b this year, and hit profit. We believe the US traded equity will find its way into retail portfolios quickly as the clarity of the market share race sharpens ahead.

Conclusion

Overall we see the potential in the US debut of the NYSE traded stock as a huge positive for valuation in both the near and long term. We see the dip triggered by the unlucky play 3Q23 results as a buying opportunity before the US trading begins and acquires both institutional and retail enthusiasm.

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