See below for this month’s Waterhouse VC newsletter. We specialise in global publicly listed and private businesses related to wagering and gaming.

Since inception in August 2019, Waterhouse VC has achieved a gross total return of 1,849% as at 31 January 2022, assuming the reinvestment of all distributions.

US regulation and taxation pushing away volume

On a recent trip to the US, we spoke with many US bettors who are incredibly frustrated with both the US online wagering experience and the US taxation system (regarding the treatment of winnings). Due to KYC/AML requirements, it is very cumbersome to set up and fund an online betting account. We do not envision this changing any time soon - if anything, this initial barrier to entry is likely to become more challenging for consumers.

Furthermore, according to the IRS’ website, wagering winnings are fully taxable and a bettor must report winnings as income on their tax return. Gambling spans lotteries, raffles, horse races, online sports betting and iGaming, and land-based sports betting and casinos.

An operator is required to issue bettors with a ‘Form W-2G, Certain Gambling Winnings’ if they receive certain gambling winnings. Whilst gambling losses may be deducted from income for tax purposes, the losses are only deductible off gambling winnings. This taxation system means that every US gambler is effectively forced to track their betting wins and losses to avoid being taxed on winnings. For example, if a bettor wins $1,000 and then loses $600, they must track this series of bets in order to only pay tax on the $400 of net winnings. If a bettor places 10 bets per week, an Excel with over 500 rows would likely be required to track the net result.

In addition, if more than $5,000 is won on a wager and the payout is at least 300x the amount wagered, the IRS requires the operator to withhold 24% of winnings for income taxes. Unique withholding rules apply to slot machines, keno, poker tournaments and bingo winnings.

These hurdles are pushing volume to unregulated operators, such as those operating in Costa Rica. There is not any specific online wagering legislation in Costa Rica so there are no barriers to establishing an operator in the country. Unregulated wagering websites are restricted from marketing directly to residents in heavily regulated countries, such as the UK and Australia. We have heard stories of US bettors regularly placing US$50,000+ wagers through Costa Rican bookmakers.

According to Costa Rican law, the physical location of an online wagering operator’s server is not where gambling actually takes place. Consequently, it’s legal for Costa Rican operators to offer online wagering services from Costa Rica so long as they do not offer them to residents of the region.

Undoubtedly, the US will try to clamp down on Americans betting through unregulated operators in Costa Rica and other jurisdictions. However, this will be no easy feat for US regulators, who already have to deal with the circa 40 domestic US operators.

Regulated operators (such as FanDuel, owned by Flutter) are able to develop strong brand awareness in the US through marketing channels unavailable to unregulated operators. FanDuel has market-leading brand awareness and user engagement. The company’s third quarter results illustrated their market leadership, with 18% market share of gross gaming revenue for iGaming and 42% share of online sports betting.

Unregulated operators carry a significant investment risk as they could lose a large portion of their customer base at any moment, whilst it is also increasingly challenging to effectively market them. Tax-paying regulated operators can help to form the general direction of regulation and lobby regulators. For example, we see many unregulated operators negotiating promotional/affiliate deals with celebrities (such as UFC fighters, rappers, ex-football players, etc.). FanDuel and other US operators could lobby regulators and state governments to ban celebrities from accepting such deals. If this occurs, unregulated operators would lose a crucial customer acquisition channel.

Regulated operators like FanDuel are well-positioned to compete with unregulated operators because they have larger marketing budgets, decades of experience and many customer acquisition channels, amongst several other key advantages. One of these advantages is the relatively easy access to capital from public markets.

Fluttering with a US listing

We have discussed Flutter in several prior newsletters (See November 2022, September 2021, January 2021). It has been a core portfolio holding since September 2019.

Flutter has long been listed in the UK and is the 27th largest company by market capitalisation. The company’s logic behind a US dual listing is three-pronged:

The US is now the firm’s largest revenue contributor.
A US listing improves access to US capital pools and makes it easier to offer share incentives to American employees.
US equities have long been valued at a premium P/E ratio compared to other global equity markets. Flutter’s shareholders would benefit from this uplift in P/E ratio, while the company could take advantage of a premium valuation to raise further capital.

The table below shows the P/E ratios of the largest global markets, calculated using the benchmark equity index of each stock market.

As shown in the table, many global markets trade at a >20% discount to the US market, whilst the UK (most relevant to Flutter) trades at a 25% discount. Over the last three years, as interest rates have risen globally, P/E ratios have compressed an average of 27%. In comparison, the P/E ratio of the US market has compressed just 15%.

Flutter is certainly making marketing waves in the US, with a US$7m Super Bowl commercial offering US$10m of free bets. A vote on the US listing would require a 75% approval rate at Flutter’s April annual meeting. We view Flutter’s US listing aspirations as another example of their genuine commitment to remaining the market leader in US wagering. As at 20 February, Flutter is up +20% this calendar year to date.

Media

I will be speaking at iGaming NEXT New York on March 7-9th about 'Trends Driving M&A Activity in US Sports Betting + iGaming'. Register here.

For wholesale investors interested in following wagering and gaming industry news and trends, please follow our updates on Twitter (@waterhousevc) or through our website at WaterhouseVC.com.

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Please note the above information in relation to Flutter is based on publicly available information in relation to the company and should not be considered nor construed as financial product advice. Waterhouse VC has a position in Flutter. The information provided in this document is general information only and does not constitute investment or other advice. Readers should consult and rely on professional investment advice specific to their individual circumstances.

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