Backing Draft: What next for Paddy Power Betfair and its newly-acquired DFS operator?

In January 2016, Jeremy Levine, co-founder of Draft, had to sit his investors down and tell them there was a 50% chance the company wouldn’t make it in the real-money DFS world.

Despite having raised $3.5m in Series A funding less than a year before, New York State Attorney General Eric Schneiderman had declared DFS to be a form of illegal gambling and banned in the state.

“It rocked our world,” Levine told Inc. at the time. The sector as a whole was uncertain whether other states would follow New York’s lead, so the decision at Draft was taken to bunker down and try to ride the storm out.

Levine put a halt to all marketing spend and let its two marketing employees go. “The decision was made to get lean,” Levine said. The next nine months were “painful” for the firm, but in August 2016, New York legalised DFS and Draft was back in business. And just nine months later, the start-up would be worth $19m in upfront cash to one of the largest gambling operators in the world, with another $29m due over the next four years based on performance.

A new approach

So what is Draft, and why is Paddy Power Betfair willing to shell out so much cash for a company that, despite its return to New York, is currently loss-making?

The company was founded by Levine and Nicolo Giorgi, just months after they sold their first DFS start-up StarStreet to DraftKings for an undisclosed sum in August 2014. The StarStreet platform was essentially a FanDuel/DraftKings copycat, where players pick a team for the day based on salaries and the salary cap.

That has been the dominant DFS model since its inception, but following the sale, Levine recognised an opportunity for an alternative; specifically a model that combined the best parts of DFS, with its 5.5 million active players, and season-long fantasy, which is played by somewhere in the region of 60 million Americans.

“After we sold StarStreet, we saw two pieces of opportunity,” Levine says. “One was around the fact that nobody had ever built a mobile game for fantasy before. And two was around the fact that all existing fantasy games are pretty hardcore and time-consuming experiences.”

The solution was live ‘snake drafts’ for daily fantasy contests. Users essentially log into the app and pick how many opponents they would like to play against, up to 10. Then as soon as the contest is filled, the draft begins, with each pick given a tight time limit, so drafts are over in less than five minutes.

“FanDuel and DraftKings are in utter disarray and chaos right now” – Stephen Murphy, Boom Fantasy

The effect on a recreational player’s chances of winning is dramatic. Pros cannot enter thousands of contests, scripts are banned (and essentially useless) while bum hunting and the like is also banned.

The result, as Levine proudly boasts, is that recreational players are three times more likely to win money on Draft than on the big two sites.

As he explains, on FanDuel, over 40% of the NFL winnings goes to just 1% of the players — and that’s in their single entry tournaments. In the multi-entry tournaments, the top 1% of players win over 50% of the money.

According to a report published by McKinsey, in the second half of the last MLB season, over 91% of the money was won by just 1.3% of the players on DraftKings.

As a result of this sharks and minnows ecology – the same type of paradigm the poker industry is trying so hard to dismantle – recreational customers are leaving the big two operators in their droves.

“FanDuel and DraftKings are in utter disarray and chaos right now,” says Stephen Murphy, the CEO of Boom Fantasy, another start-up trying to make DFS more fun.

“They have really struggled to retain their casual users because the product is so intense, unwinnable, and off-putting to most sports fans. Even as a merged entity, the new company will be in considerable debt and working with a severely flawed product.”

By contrast, on Draft, the winnings are much more evenly distributed. In the NFL last season, the top 1% of players won just 19% of the money. It was that recreational lean, combined with the mobile-first approach and an impressive management team, that made Draft such an attractive proposition to PPB, according to EGR Intel sources.

A helping hand

But the London-listed gaming giant is under no illusion as to the size of the challenge ahead. FanDuel and DraftKings, for all their flaws, still control around 95% of the DFS market, and ironically the purchase of Draft could help the firms get their merger approved by competition regulators, with officials taking it as a sign there are still new companies willing to enter the market.

As a result, PPB has pledged to lend its full technological and marketing resources to Draft, while also keeping Levine and co-CEO Jordan Fliegel on to run the company. Exact details of the support PPB will lend were not revealed, but the quickest wins will surely come from marketing. PPB CEO Breon Corcoran told investors to expect a $20m EBITDA hit thanks to “substantial marketing investment in the business in the next few years,” in order to “maximise the growth opportunity”.

Meanwhile Levine told ESPN his marketing budget would increase“100-fold”, with the firm lining up “a bunch of massive partnerships” ahead of the next NFL season. The impact could be immediate, particularly with regards to liquidity. Levine estimates the average wait time for people joining a draft will fall from six minutes during last football season to under a minute this year.

Elsewhere, Levine told ESPN the company will immediately double its workforce from 10 to 20 and will apply for fantasy sports licences in Colorado, Missouri, Indiana and Virginia – four of the 11 states to have legalised fantasy sports in recent years. Draft currently operates in 39 states but was forced out of certain states where DFS was legal thanks to hefty licence fees.

Mutually beneficial

So the future looks bright for Draft, but what sort of return can PPB expect to see in the short term?

Possibly not much, according to US gaming analyst Eilers & Krejcik Gaming. The firm said in a recent note: “In our opinion, this deal was not done based on any traditional valuation metrics or near-term financial upside.

“Our checks indicate Draft was not profitable and we estimate TTM revenues were likely in the $1-$2 million range, implying a deal valuation (upfront component only) of 10-19x revenues.

“With respect to a potential market shake-up, we don’t believe this will happen overnight and a likely best case scenario would be 10-20% market share over the next one to three years.  That being said, we do believe Draft’s more casual and mobile-focused product approach combined with Paddy Power Betfair’s substantial financial backing could help drive some much-needed demographic diversification and attract a greater share of traditional season-long fantasy sports players.”

Of course, a 20% share of a market that was worth $300m in 2016 is not to be sniffed at.

“In terms of further partnerships between DFS and gaming companies, we are likely still in the early innings” – Adam Krejcik, Eilers & Krejcik Gaming

Murphy adds that the beleaguered state of the current incumbents also represents a major opportunity. “I do think Paddy Power Betfair and new operators who really understand the DFS space will come in with guns blazing and have a very good chance of taking out a weakened and cash-poor FanDuel/DraftKings,” Murphy says.

“I know some people might think PPB should’ve just built a platform itself, but when you’re trying to win a market, you don’t sacrifice on product and team just to save a couple of dollars. “You look for a great team that knows the market inside and out and you find a way to partner with them – or in this case acquire them.”

Draft has also already built strong links within the DFS community that PPB would arguably never be able to replicate, in the form of promotional partnerships with leading content sites like Rotogrinders.

And while Draft brings those links to the table, PPB has some US infrastructure of its own that can help put Draft in front of new eyes. PPB already operates TVG, its horseracing betting and TV network, as well its New Jersey online casino and horseracing exchange. TVG, for instance, was covering the sale almost immediately across its TV channels, while users of the Exchange are overwhelmingly likely to be young, tech-savvy males with a penchant for gambling – the perfect target audience for DFS in other words.

“In our view, there will be numerous cross-sell opportunities,” agrees Gavin Kelleher from Goodbody. “There are a number of ways this business will be able to complement PPB’s existing US businesses.”

Final frontier

Of course what went unsaid in the post-deal press from both PPB and Draft was the looming spectre of US sports betting. PPB is known to have an interest in the US regulated sports betting market through its pursuit of Nevada sportsbook CGT, and the Draft acquisition puts it in a position to start building a national database of highly-engaged sports fans, who are willing to lay down some money on a game. And while even the most bullish experts suggest legalised sports betting is at least two years away that also gives PPB time to lay down some roots.

“This is a sign that very smart people believe US sports betting will happen at some point in the not-so-distant future,” suggests Murphy.

Indeed, Chris Grove, the North America analyst for Eilers & Krejcik, says that such is the power of the PPB brand that this deal could have wide ranging ramifications for sports betting. “I believe the acquisition could help to accelerate the pace of sports betting liberalisation,” he says.

Elsewhere, his colleague Adam Krejcik says he is “cautiously optimistic” that PPB’s purchase “will help spur additional M&A and investments in the DFS sector”.

“In terms of further partnerships between DFS and gaming companies, we are likely still in the early innings. Specifically, we believe as the legislative environment becomes clearer in the US (and mostly positive for DFS companies), other real-money gaming companies will begin to look much more closely at this market.”

Krejcik lists William Hill, 888, bet365, GVC, and Unibet as potential candidates to enter the market, because the opportunities that PPB has highlighted are clear –  a major market, where the incumbents are clearly flawed and ripe for disruption, plus the opportunity to put down roots for the real prize – the expansion of legalised sports betting.

But these real-money gaming sharks looking to go a similar route to PPB had better move fast. The brutal nature of DFS regulation over the past few years means there are very few minnows left swimming in the pool and the quick route into the market is fast disappearing.