Welcome to the September 2021 newsletter for the Waterhouse VC Fund.
The Fund specialises in global publicly listed and private businesses related to wagering and gaming. The Waterhouse family has been involved in these industries for over 100 years, and the family’s experience, contacts, and capital provide opportunities that most funds would neither appreciate nor have access to.
Since inception in August 2019, the Waterhouse VC Fund has achieved a total return of 2172% (assuming the reinvestment of all distributions). The unit price is $22.71, as at 31 August 2021. See our long-term performance table at the end of this newsletter.
Returns to scale
Similar to the past consolidation of mature betting markets in other countries, we envision a US online betting market where a handful of firms earn the lion’s share of revenues and profits. In our January newsletter titled ‘Land Grab in the Land of Opportunity’, we explained our thesis that the large scale operators like FanDuel, DraftKings and BetMGM would enjoy increasing market share concentration.
Early entrants to the US online betting market can spread marketing and technology costs over millions of users, which increases barriers to entry. Since 2018, the market share of the three largest operators has increased from less than 33% to 75% currently.
FanDuel’s market share in key early states:
Source: Flutter Entertainment’s Interim Results 2021 Presentation
Flutter estimates that FanDuel’s 2021 revenue will be between US$1.8 - US$2.0 billion, with an EBITDA loss of US$315 - US$385 million. FanDuel has more than 13 million registered customers across America, attracted by its core fantasy sports and more recent online sports betting offering. The firm has strengthened its market share to around 50% in New Jersey, Pennsylvania and Indiana, three states where online sports betting was legalised early.
FanDuel also has market-leading brand awareness and user engagement, which we believe will continue to accelerate throughout this year’s NFL season, which commenced on September 9th.
Source: Flutter Entertainment’s Interim Results 2021 Presentation
Momentum step change
Flutter’s non-US operations are highly cash generative, effectively funding the growth of the FanDuel business. The non-US operations generated an adjusted operating profit of US$880 million in the first half of 2021. This profit could fund FanDuel’s entire cost of sales (COGS) and marketing costs over the six month period. Such favourable operating dynamics allow FanDuel to match DraftKings’ US$400 million half year marketing spend without matching their US$651.9 million net loss (DraftKings’ Q2 2021 Earnings Presentation).
Furthermore, Flutter’s global operational expertise, coupled with the high quality of its US assets and cross-sell opportunities, have resulted in FanDuel generating one of the highest ratios of revenue to marketing cost in the industry. A direct comparison with DraftKings is shown below.
Sportsbet (Flutter’s Australian business) has experienced a significant increase in scale and profitability, with 192% 2-year EBITDA growth, far outstripping the 86% 2-year revenue growth recorded. Over the past year, Sportsbet’s profit margin increased by 630 basis points, reflecting stable marketing expenditure, cost efficiencies and higher than expected customer retention. The company now enjoys around 50% market share of Australian online wagering.
Sportsbet’s 2-year key operating metrics:
Source: Flutter Entertainment’s Interim Results 2021 Presentation
Despite the step change in Sportsbet’s profitability, increases in taxation for Australian sports betting operators has continually impacted the profitability of all Australian operators. Smaller operators have been particularly impacted, decreasing their available marketing budgets, which ultimately contributes to Sportsbet’s increased market share.
For example, in 2012, Sportsbet’s COGS was 23.7% of revenue. Taxes effectively increase COGS. By 2020, COGS had more than doubled to 48.4%. Leaving all other 2020 costs unchanged, if Sportsbet’s 2020 COGS was 23.7% (i.e. the same cost of sales proportion as in 2012), Sportsbet would have generated EBITDA of US$807 million in 2020 rather than US$440 million. Unlike smaller operators, Sportsbet can spread marketing and operational costs across close to one million average monthly players.
Similarly to Australia, we believe that there is a high risk of tax increases on US sports betting operators, which will ultimately increase pressure on smaller operators and the market shares of larger ones. Flutter’s management has previously been skilful in navigating global regulatory changes and understands that operating at scale is key to maintaining attractive profitability.
A premium valuation for the premier operator
When assessing Flutter’s valuation relative to listed peers, one may initially be disappointed to note that the business is valued at a circa 50% higher EBITDA multiple than the industry average (24.2X compared to 15.8X). However, most industry peers are capital intensive hotel (or other forms of primarily in-person) operators, including Caesars Entertainment and Wynn Resorts. These businesses are playing catch-up to the online operators, such as Flutter and DraftKings. The online operators are best prepared to cater to the digital wagering preferences of the next generation of bettors. The larger ‘scale’ operators have multiple product offerings and huge audiences to cross-sell and monetise.
We believe that 24.2X EBITDA is an attractive price to pay for the clear market leader in US online sports betting and that FanDuel’s ‘flywheel’ (enhanced customer proposition > higher revenue growth > greater operating leverage > increased scale and flexibility > enhanced customer proposition etc.) is significantly underappreciated.
In December 2020, Flutter increased its stake in FanDuel to 95%, at an implied enterprise value of $11.2bn. We covered the purchase in our January newsletter. If we strip out the FanDuel business (which generated US$1,480 million in revenue and negative US$329 million in EBITDA over the 12 months up to 30 June 2021), the remaining business would be valued at a significant discount to the industry average. If it is stripped out at the same sales multiple as DraftKings (i.e. 21.5X EV/Sales), this would value FanDuel at US$31.8 billion and the remaining business at just US$6.5 billion. This is equivalent to 3.4X EBITDA / 1.0X Sales for the remaining business - such a valuation for Flutter’s high quality global brands would be astounding.
Such a scenario is far more likely than most would think, with Flutter likely to float FanDuel in the near future.
We tend to focus on B2B businesses, given the team's operating experience in the industry and the general lack of broker coverage. Flutter is one of our less common B2C investments, where we focus on the dominant scale operators in regulated markets. We believe Flutter is the highest quality global wagering operator, with a compelling valuation and long runway for international growth, particularly in the nascent US sports betting industry.
Media: The Australian
The Australian newspaper interviewed Tom about the success of Waterhouse VC’s investment in BetMakers, a core holding of the fund. In the article, Tom reiterates his focus on B2B opportunities, which are well-positioned to take advantage of the continued growth of US online sports wagering. Check out the article here.
For wholesale investors that want to follow gaming’s global growth, please follow us for updates on Twitter @waterhousevc.
Please note the above information in relation to Flutter Entertainment and DraftKings is based on publicly available information in relation to Flutter and DraftKings and should not be considered nor construed as financial product advice. The Fund currently has a position in Flutter Entertainment. 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.
Waterhouse VC Fund gross performance as at 31 August 2021