Survival of the fittest: Can the stuttering DFS industry sustain both FanDuel and DraftKings?

On Thursday September 7, the New England Patriots lock horns with the Kansas City Chiefs in Foxborough, Massachusetts, in what is the NFL’s much-anticipated curtain raiser to the new season. Football’s opening weekend is always a highlight of the calendar for sports fans, but this year it fires the starting pistol for what could be the most defining period in the race for supremacy in the DFS space.

In fact, the next four-and-a-bit months could prove to be a make-or-break period for DraftKings and FanDuel following the abandoned merger between these two runaway market leaders. The archrivals announced their intentions to join forces last November, yet they called off the proposed union in July after the Federal Trade Commission (FTC) moved to block the deal on antitrust grounds.

The FTC said the combined business would have an unfair advantage over the competition and a “near-monopoly” for paid DFS contests by occupying more than 90% of the US market. Both had argued that they are part of the much larger fantasy sports industry rather than being dominant players in the DFS niche. That claim probably didn’t cut much ice with the FTC. “For any business, achieving a monopoly is the Holy Grail,” says Marc Edelman, a law professor and attorney who has practiced antitrust law. “In terms of market share, this would have been the equivalent of allowing Coca-Cola and PepsiCo to merge.”

A merger seemed a logical and sensible move when management teams from FanDuel and DraftKings – established in 2009 and 2012 respectively – held informal talks about a potential deal in the second half of 2015. Both start-ups were burning through astronomical sums trying to KO each other with ultra-aggressive user acquisition drives. And since then they have racked up huge lawyer bills fighting for regulation in individual states and against players’ class-action law suits. And according to an anonymous source with a legal background quoted in a recent ESPN article, both companies could have spent another $12-15m fighting the FTC in court, where victory was an improbable long shot.

Still, the pair are in a “precarious place” as it stands, according to Daniel Barbarisi, a former Wall Street Journal reporter and author of acclaimed DFS industry book Dueling With Kings. “The two giants have done a great deal legally to ensure their survival, but they’re still fledgling companies in an uncertain industry, and neither one has been able to show a profit yet. They’re weighed down by regulatory, legal, marketing and partnership costs, and now that the merger is off, the only way they can cut those liabilities down and raise revenue is to grow, likely at the expense of the other company.”

Cash flow

A leaked investor note recently obtained by financial news outlet Axios revealed that both companies accumulated combined losses of $151m in the first three quarters of 2016. DraftKings lost $92m on revenues of $160m between January and September, while FanDuel recorded an EBITDA loss of $59m for January to October. These losses and ongoing legal issues mean there is the real prospect of their once overflowing wells of venture capital funding running dry. Although DraftKings did close a $100m Series E1 funding round in March, taking total investment to an estimated $900m, FanDuel was recently forced to hand large chunks of equity to existing investors in exchange for a fresh injection of much-needed cash. The operator had $30m cash on hand at the end of 2016, according to Axios.

FanDuel CEO and co-founder Nigel Eccles is believed to have reduced his stake in the business to less than 10%, while the relocation of the 150-strong workforce in Edinburgh to a 58,500 sq ft office in the Scottish capital was canned in April. FanDuel also shuttered its UK-facing soccer product in July, less than a year after launch. Instead, the main priority is to focus all energy and resources on the NFL. Estimates suggest that as much as 50% of both companies’ revenue for the year will come from NFL contests. Once the football season concludes in early February, that’s when we are more likely to know who is best placed to come out on top. “I think FanDuel will make it through the NFL season and then look to be acquired by a major media company,” suggests Michael Rathburn, a writer for DFS news and advice site RotoWire.com.

In FTC court filings, FanDuel admitted that DraftKings is the bigger of the two, which would appear to settle debates as to which operator truly is the market leader. Prior to May 2015, FanDuel claimed on its website to hold 80% of the market. That was until DraftKings laid down the gauntlet and mounted a serious challenge, to the point where both described their proposed union as a “merger of equals” despite FanDuel’s claims. More recently, DraftKings has a major edge in the size of its early NFL GPPs. However, the salient question now is whether the DFS market is large enough to continue to accommodate these two protagonists. “There’s room enough in the DFS world for one big healthy company,” says Barbarisi, “but I don’t think the market has shown that it can sustain two. That makes this coming NFL season a crucial time for both companies.

“The loser might not be here at this time next year. I think DraftKings has the edge and the momentum for now, but definitely don’t count FanDuel out, especially if they can raise money soon.” Ifrah Law’s Rachel Hirsch is also skeptical that this powerful duopoly can remain intact. “They are both not going to survive, and one of them is going to be in serious hot water financially. It remains to be seen who will come out of this, although DraftKings looks more likely to survive.” She continues: “FanDuel was always considered number one and DraftKings was kind of like the new kid on the block, but they have both had a lot of expenses over the last couple of years. There is speculation that DraftKings will make it and maybe FanDuel will not, but it’s still anyone’s game at this point.”

Shrinking budgets

Like last football season, marketing spend will be a far cry from the fall of 2015 and the mammoth TV ad blitz when DraftKings and FanDuel commercials were omnipresent with DraftKings averaging one commercial every 90 seconds. Indeed, TV ad tracking firm iSpot.tv said that both companies splashed out $31m on 9,000 TV spots over that season’s opening weekend alone. They were outspending the likes of Coca-Cola and AT&T on football TV advertising, while their combined advertising spend across all platforms was $750m for the year. Winning players posing with massive checks were everywhere, much to the chagrin of many armchair NFL fans.

Back then, both companies had valuations of $1.2bn and were awash with venture capital funding. It seemed the sky was the limit for these unicorns as DraftKings kicked off the opening NFL weekend with its headline guaranteed prize pool (GPP) contest boasting a head-turning $10m purse ($2m for first place). Colossal prize pools and wall-to-wall advertising meant DraftKing’s real-money active players surged from 500,000 to 2.5 million in 2015. And yet Axios said the leaked note showed that the Boston-based outfit still lost a staggering $500m that year. “Their advertising was everywhere,” says Hirsch, “but little did you know that these companies were just pouring money into marketing to create this smoke-and-mirrors image of being bigger than they were. They are going to have to get those marketing costs down by a lot this year.”

After the aborted merger, DraftKings CEO Jason Robins announced in a statement that revenue was growing at 30% year-on-year and that the company had a customer base of eight million. Of course, there’s a big difference between customer base and active players. So as part of an effort to acquire and retain more active players, particularly low-staking casual users, DraftKings has been putting more focus on single and three-max entry contests, as well as games reserved exclusively for beginners and recreational customers. Meanwhile, all GPPs at $5 or lower are now capped at 20 entries per player. Some of these games previously allowed up to 150 entries.

In addition, players with over $1m in lifetime entry fees are now barred from entering contests with both a buy-in of under $5 and a prize pool smaller than $25,000. There is also an integrity and ethics team dedicated to pinpointing suspicious activity, such as those sharing lineups or trying to circumvent the multi-entry caps by having multiple accounts. Bosses hope these steps will go a long way to protecting casual players from the ‘sharks’ and result in a “healthier and more enjoyable environment.”
DraftKings has also launched a Pick ‘Em game, while FanDuel expanded its season-long formats.

Market forces

Even though DraftKings and FanDuel have cornered 90% of the market, there are a number of companies nipping at their ankles. The likes of FantasyDraft and season-long fantasy sports giant Yahoo will be looking to gain market share this football season, while start-ups FastPick and Boom Fantasy (see box) are clearly targeting the aforementioned casual players with their simpler, fast-paced games. This is partly why DraftKings introduced Arcade Mode for baseball this season, whereby users roster few players but the scoring is higher than a regular game. Yet you could argue that with DraftKings and FanDuel busy battling legal fires and focused on the merger, they may have taken their eye off the ball.

“In some ways, the real gains have been made by some of these other companies while FanDuel and DraftKings have been focused on litigation and other things,” suggests John Holden, a sports law professor at Florida State University. “These other companies have found their own niche within the market. In a lot of ways, DraftKings and FanDuel did everyone else a huge favor. They have poured the money into lobbying and fighting on a state-by-state basis to get DFS legalized. All these smaller companies have stayed off to the side and all the paving of the road has been done by FanDuel and DraftKings.”

Then, of course, there is the prospect of sports betting being legalized, which is potentially far more damaging to DraftKings and FanDuel’s businesses than any plucky DFS start-up. All eyes are on the US Supreme Court, which has agreed to hear New Jersey’s case in its bid to legalize sports betting. If the Garden State is successful it could lead to a domino effect as other states give sports wagering the green light. NBA commissioner Adam Silver has been vocal in his support of legalizing and regulating sports betting, while the NFL’s Oakland Raiders are relocating to Las Vegas. The land-based gambling hub is also getting a NHL team this year, the Golden Knights.

Truth be told, DFS probably only boomed because sports betting is outlawed in 46 states under the Professional and Amateur Sports Protection Act (PASPA) of 1992. Legal betting probably wouldn’t sound the death knell for DFS (the competitive, peer-to-peer nature of DFS differentiates it from sports wagering), but it would be a less than ideal development for the industry. Holden says: “That period when sports betting is inevitably legalized in the US will be a really important time for the fantasy companies because they are going to need to differentiate themselves from a product they have not had to worry about competing against – at least in a legal form.” Of course, regulated sports betting could mean DraftKings and/or FanDuel leverage their brands and player databases to branch out into the sector themselves.

For now, though, they are concentrating on the present. Eccles said in statement after the failed merger that there is still “enormous, untapped market opportunity” for FanDuel. He also told Recode that he believes FanDuel can break even next year. Meanwhile, Robins stressed during a recent Facebook Live Q&A with customers that the company had “no other plans for acquisitions or merger deals” and was focused on the upcoming football season. He also hailed the importance of international expansion, stating that his business plans to be up and running in dozens of countries in a couple of years. The operator has entered the UK, Germany and Malta in the past 18 months and has designs on other European markets including Ireland.

But regardless of which firm comes out on top, having two separate companies going at it hammer and tongs for market supremacy – at least for now – has to be good for consumers. A duopoly is surely better than a monopoly.

“There was a strong chance that ‘rake’ would increase with no competition, despite what both DraftKings and FanDuel stated publicly,” says Rathburn. Likewise, Edelman agrees that a failed merger is good for keeping the costs down and fostering innovation.
“If the merger had consummated there would have been one giant company with almost 100% market share and great barriers to entry. Thus, the combined company would likely have been able to increase costs of their services and would have little incentive to innovate beyond the current product classifications.”

Indeed, Edelman underscores his point when he says: “Monopolies are bad for consumers and vibrant competition is good.” So, once again, let battle re-commence this football season.