How DraftKings Stayed Competitive in a World Without Sports
Here’s why investors are bullish on a fantasy sports betting company that went public when sports and casinos were shut down
It was a little over a month after the NBA season and NCAA tournament had been canceled due to the coronavirus pandemic. Spring training had been delayed, and the entire 2020 Major League Baseball season was in jeopardy. Despite all this, fantasy sports giant DraftKings went public in late April in a deal valued at $2.7 billion. The Boston-based company, founded in 2012, is part of a growing list of companies that have eschewed the traditional IPO and gone public via a reverse merger with a special purpose acquisition company (or SPAC), which is essentially a blank check shell company.
Since then, the company has managed to hang on. In the second quarter, DraftKings’ revenue rose to $70.9 million, compared to $57.4 million the prior year (although revenue was down 9.6% year over year if you don’t include its acquisitions, including the SPAC merger). Meanwhile, the stock price has risen more than 80% since the company went public in April, from $19 to $35 (as of market close on August 21). How did DraftKings survive in a world without sports? The answer has to do with gambling laws, day traders, and a bit of ingenuity.
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Shifts in gambling laws
With over 8 million registered users, DraftKings focuses on daily fantasy sports, a supercharged version of traditional fantasy sports: Instead of picking a team and tracking them over the course of a season, consumers make daily bets on individual players and teams’ performance and can cash out on an immediate basis. This is a hyperactive, hyper-addictive form of fantasy sports, much closer to gambling than to traditional fantasy sports, where payouts only occur at the end of the season.
DraftKings took a legal activity, made it as similar as possible to a very popular illegal one, and built an entire business off of it.
While betting on sports had been illegal, the Unlawful Internet Gambling Enforcement Act of 2006 specifically carved out fantasy sports as a legal option for sports bettors. DraftKings, in other words, took a legal activity, made it as similar as possible to a very popular illegal one, and built an entire business off of it.
It’s a bit like the way wine companies reacted to Prohibition: They couldn’t sell wine, so they sold “wine bricks” made from concentrated grape juice. The bricks were legal, and just to be helpful, they came with a label warning the buyer not to dissolve the brick in water and leave it in a cool dark place for three weeks, lest it turn into wine.
Then, in 2018, DraftKings got an assist from the Supreme Court, which invalidated a federal ban on online sports betting in 2018. As states legalized sports betting — 19 at last count, with four more passing bills that allow betting and nine more considering them — DraftKings could scale and extend its business into new operations.
The pandemic-fueled growth of esports
DraftKings, like so many of us, had its 2020 plans ruined by Covid-19. In its case, sports basically shut down around the world, leaving players with nothing much to bet on. In that situation, many companies would have been tempted to retrench, but DraftKings, taking a page out of its own playbook, took a gamble and went public anyway.
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DraftKings also got creative. Its “iGaming” product, a traditional online casino currently operating in three states, did well during the pandemic as more casino players were stuck at home but still had an itch to play slots. But the company also jumped onto another gaming trend: esports. The esports market is growing, though the economic model isn’t fully baked. The best gamers can score pro-athlete-level salaries (esports star Tyler “Ninja” Blevins has millions of fans and was reportedly paid between $20 million –30 million to join Microsoft’s Mixer esports service). However, the platforms haven’t been able to monetize that popularity (Mixer shut down this July, less than a year after Blevins joined). But esports gave DraftKings a new venue for gambling — with everyone stuck at home, sports that can be played from a self-quarantined home were at a premium. DraftKings inserted itself between the new supply of gamers and the new supply of eyeballs, and found a way to monetize them.
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The company also introduced other new things to bet on: For example, it has allowed bettors to enter free-to-play popularity pools for Netflix’s Tiger King back when that was a thing. It also let players place wagers on political debates, weather forecasts, and reality shows like Shark Tank, Survivor, and Top Chef.
That made DraftKings’ last quarter better than it could have been, all things considered (though earnings still fell short of expectations). The company anticipates 22% to 37% revenue growth in the second half of the year per the Wall Street Journal. DraftKings isn’t hurting for cash, either, with $1.2 billion on hand and no debt.
The surge of interest from amateur day traders
DraftKings’ rising share price doesn’t just reflect its deft shift into different kinds of gambling. The stock has also been popular with day traders on apps like Robinhood. According to data from Robintrack.net (which Robinhood shut down last week), DraftKings is the 62nd most popular stock on the site, just ahead of the S&P 500 index fund. The S&P has a market capitalization of $300 billion. DraftKings’ is $12 billion.
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Clearly, individual investors are bullish on DraftKings. And why wouldn’t they be? Every investor worries — accurately — that hedge funds with multimillion-dollar data budgets and vast teams of analysts will spot changes in the business before they do. So the safest stocks for individual investors are, paradoxically, the ones where analyzing the business consists entirely of guesswork. With the pandemic still posing a threat to professional sports, buyers might be right, or they might be wrong, but they’re playing a fair game. Buying a stock when the company’s results are uncertain is a bit like owning a lottery ticket — both in the sense that it’s a bet that has a good chance of turning out poorly and a small chance of making money. Plus, it offers the buyer the chance to imagine, for a while, what they’d do if this turned out to be the decision that made them rich (for a recent example of this mindset, see the rally around Hertz’s essentially worthless stock).
And Robinhood’s user interface clearly borrows from gambling and other forms of addictive gamification — there’s a peppy, high-energy design, gobs of social proof (a form of mob mentality, where people copy one another as a form of influence), giveaways for heavy players, almost every trick perfected in Macau and Las Vegas has been redeployed on the app (aside from comping traders’ drinks). All told, there is a simple explanation for DraftKings’ stock performance: In the before times when live sports was still kicking, gamblers placed their bets on DraftKings. Now, many of them have transferred that pent-up demand for betting by gambling via Robinhood — but rather than gambling with DraftKings, they can gamble on it instead.