Equities

The only thing Aussies love more than sport ... is a punt on the sport. Or just punting in general for that matter. Gambling is a very common Australian pastime and many profitable Australian businesses have emerged as a result. Just ask Aristocrat (ASX:ALL) or Ainsworth (ASX:AGI) with their slot machine empires. But as smartphone technology has evolved, the new generation of gamblers are moving online towards sports. 

While Australia is a developed market for online bookmakers, in the USA it has only recently been allowed (on a state by state basis) to legalise online sports betting. So assuming Americans will love gambling on sport as much as Australia, this is potentially a huge market opening up. 

While it's exciting to think about the growth and future size of online wagering in the US, it is a slow and legislative process. So as each state opens up online gambling, the competitors all begin jostling for a market-leading position and the punter's dollars. 

What makes a successful gambling business is those that have scale (i.e. a lot of customers). Wagering is effectively creating a market that allows the bookmaker to profit regardless of the outcome. In theory, the number of wagers each side of a market should balance (in practice this doesn't often happen). The bigger your customer base, the more predictable and profitable your bookmaking should be. Gambling is a highly scalable business which makes it a very competitive market that requires significant promotion and marketing to acquire and retain users. 

PointsBet (ASX:PBH), which has recently raised $75m at a valuation of $220m (EV of $150m and current market cap around $285m), is now entering this potentially lucrative market. PointsBet in the first half of FY2019 saw revenue of $12m for an after-tax loss of $8.5m. As indicated below, this was largely driven from a big increase in sales and marketing expense as they aggressively acquired users in this rapidly growing market. They estimate they now have around 18,000 users in New Jersey (around 4% of gambling turnover in that state).

However, PointsBet is not alone in chasing the newfound American punter. Flutter Entertainment (previously Paddy Power - Owners of Sportsbet in Australia) have also recently made a foray into the US market by acquiring FanDuel in 2018. 

FanDuel is a fantasy sports business that operates as a quasi-sports betting alternative. FanDuel acquired their customer base prior to the regulators legalising online sports betting through this innovative "fantasy sports" business model. Flutter bought this business at a valuation of US$465m to give it instant scale in the US sports betting market. FanDuel generated $285m in revenue (including "fantasy" sports) in 2018 and is estimated to have over 8.5m users. These users were acquired with over $400m in marketing spend in the last five years. 

New Jersey (NJ) which was an early adopter of legal sports wagering has become a test bed for sports betting growth and is on track to "dethrone Nevada as America's sports-betting capital". This market is growing rapidly and will likely continue to grow in the years ahead. 

The below image shows the revenue growth of FanDuel and market share (compared to the 4.1% share of the market for PointsBet). 

Another private Australian company called Virtual Gaming Worlds (VGW) is now also chasing the growing sports betting market in the US.  

VGW is an online gaming company that offers online casino games (slots, keno) and online poker to players in the US. The company is now also moving into sports betting as it further diversifies its product suite. The business is very unique in that they offer US players the ability to cash out their winnings through their unique "$weepstakes" model. This has been a huge success for VGW who have seen exponential growth of revenues and profits in the last few years without having a sports betting product.  

The benefit of scale and multi-product offering in the gambling industry is the ability to cross promote to an existing user base (cheaper acquisition of user cost). This is something Flutter is doing with FanDuel and its existing gaming and gambling operations. 

Since 2016 VGW has grown revenues from US$38m to US$113m in 2017, then US$379m in 2018. In the first half of FY19 they generated revenue of over US$173m for an after-tax profit of nearly US$20m. 

We estimate the business is on track to deliver around $450m in revenue and around $40m EBITDA for FY19. While the company is not currently listed on any stock exchange, shares currently transact on "primarymarkets.com" for around 30c each (currently around 550m shares on issue) giving VGW a market capitalisation of around $165m. With over $43m cash on the balance sheet as at Dec 18, the business has an EV of $120m. 

The problem with fast-growing markets and opportunities, is how do investors accurately value such businesses relative to the future revenue opportunity? As demonstrated, here are three different companies all operating and chasing a similar new market opportunity, yet with what seems like significant valuation differences and levels of maturity. 

The problem with gambling (like investing) is working out what horse (stock) to pick and at what odds (valuation) you should back them! 

Disclosure: This is not a recommendation or financial advice to buy shares in any of the mentioned companies. Investors should undertake their own research and discuss their financial position with a qualified advisor before purchasing shares in any company. 

All views and information provided should be considered general in nature and are the opinion of Fiftyone Capital and are not to be considered statements of fact. Our fund owns shares in Flutter Entertainment & VGW. As such any appreciation in the share price will result in financial gain for the fund and individual unitholders in the fund. 

Please undertake your own research and seek professional advice when considering if this information presented is relevant for your own situation. 



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