Kingmaker: how DraftKings' SBTech acquisition will shake up the sector

The world of online gambling has certainly been no stranger to blockbuster M&A deals over the past few years as consolidation has swept the industry at a ferocious rate. And just before the curtain came down on the past decade, this rarely stagnant sector snuck in one last huge deal when it was announced publicly listed special purpose acquisition company (SPAC) Diamond Eagle Acquisition Corporation was to acquire DFS giant DraftKings and omnichannel sportsbook provider SBTech in a three-way merger.

The combined entity, which will list on the Nasdaq and have an anticipated market cap of $3.3bn, is set to become a “vertically integrated powerhouse”, DraftKings CEO Jason Robins told investors just before Christmas. As part of what is essentially a reverse merger, expected to close in H1 2020, the new company – DraftKings Inc. – is receiving an investment of $304m from institutional investors and will get its hands on over $500m in unrestricted cash following the transaction.

The proposed deal, which comes 30 months after DraftKings and DFS rival FanDuel (now majority-owned by Flutter Entertainment) were forced to abort a planned merger on antitrust grounds, values the combined DraftKings and SBTech at $2.7bn. This is roughly four times their estimated revenue combined for 2021. As well as eventually achieving cost synergies of $100m-plus, the new business anticipates generating net revenue of $540m in 2020, with $140m coming from SBTech, before growing to forecasted net revenue of $700m in 2021 ($150m from SBTech). Through scale, DraftKings and SBTech believe they can eventually achieve over $1bn in EBITDA from $3.7bn of revenue in the US alone.

Besides offering DFS in 43 states and eight international markets, DraftKings has rolled out online sports betting, and in some cases also egaming, to five US states. In New Jersey, West Virginia and Indiana, the company has market shares of 31%, 65% and 67% respectively, according to the SEC filing. Yet it was almost inevitable the Boston-based business would at some point seek to access funding from the equity markets via a float (though more likely via a traditional IPO rather than a SPAC) to fuel expansion into new US states as online gambling expands.

As one industry source put it to EGR Intel, “they are running on fumes”. Of course, the race to launch and to grab and maintain market share in all these states doesn’t come cheap, as the SEC filing in early January underlined. While revenue rose $59m, or 44.3%, to $192m in the first nine months of 2019, DraftKings racked up losses of $114.1m, which was a 52% increase on its $75.2m in losses for the first nine months of 2018.

Taking full control

Besides DraftKings becoming a far more diversified business, geographically and in terms of SBTech’s B2B revenues, owning its own technology is a key step in the company’s evolution. Ever since inking a deal in June 2018, Kambi has provided back-end services and technology to power DraftKings’ sports-betting offering. Interestingly, the duo put pen to paper in August on an extension to their contract to cover eight additional US states. But by acquiring SBTech, DraftKings has “closed a critical area of supply chain risk and dependence”, Regulus Partners noted.

Addressing an investor conference in Orlando on 13 January, Robins underlined the potential cost savings by divulging how the revenue-share deal on every bet with Kambi would cost DraftKings “north of $100m annually” once US sports betting fully scales. Furthermore, having SBTech on board means DraftKings will have full ownership of its destiny from a sports-betting platform and tech stack perspective, which is clearly a big competitive advantage. Propus Partners’ Marc Thomas says: “They will now have complete control of their own roadmap and how they want to differentiate themselves and close any perceived gaps between them and their major competitors.”

On the longer-term benefits of this tie-up, Thomas says: “We don’t know what the aspirations are for DraftKings going forward, but if the business is looking to grow now as an enlarged unit to be sold or to be merged into a larger IPO, then obviously owning your own technology and platform probably means the multiples you can actually get out to the marketplace are even larger. So, the combined business will be worth more in three years’ time because you have your own technology.”

Opposites attract

Around 18 months ago, when DraftKings was the first mobile sportsbook to go live in New Jersey, you would have gotten long odds on a subsequent marriage with SBTech – or ménage à trois if you include Diamond Eagle. Indeed, SBTech would not have jumped out as an obvious target for one of the leading US brands. This merger illustrates just how fast the market, with its patchwork of state-level regulation, is evolving and how M&A is being used to accelerate growth, market share and access.

The deal pretty much guarantees SBTech a podium position in every US sports-betting state. SBTech has pursued an aggressive strategy in the US and currently has partnerships with leading brands Golden Nugget, Resorts Casino and Churchill Downs to provide sports betting, and is now also powering Oregon Lottery’s new Scoreboard betting app. As a multi-vertical B2B business, SBTech boasts over 50 licensees in more than 20 regulated jurisdictions around the world, while its European clients include the likes of Cherry, MoPlay and Bethard. A four-year deal with Sweden’s Svenska Spel was inked in September.

A particularly interesting slide displayed during Diamond Eagle’s presentation to announce the combination showed how 42% of SBTech’s revenue was derived from Europe, while the US accounted for just 5%. However, the largest share (54%) was attributed to Asia – a region where regulated online gambling is, of course, conspicuous by its absence. On the financial front, according to the SEC filing, SBTech achieved revenue of €68.3m ($76.2m) for the first nine months of 2019, slightly down on the €69.6m generated in the same period in 2018. Net income fell by two-thirds from €18.9m in the first nine months of 2018 to €6.2m in 2019.

Christmas sale

When news of the deal broke on 23 December 2019, investors wasted little time offloading Kambi’s stock. In fact, the company’s share price plummeted 30% to SEK119.70 ($12.65) on the First North Nasdaq Stockholm exchange, prompting trading in its shares to halt. The stock had stood at around SEK172 when the market closed on Friday 20 December. However, the steep and rapid drop was accentuated because the merger announcement came the day before Christmas Eve. This is known in Sweden as klämdag, which translates as a ‘squeeze day’, so in other words, a single workday sandwiched between a weekend and a holiday.

With most traders probably doing a last bit of Christmas shopping, and the market lacking normal levels of liquidity, it wouldn’t have taken many sellers to trigger a steep drop in Kambi’s share price. On 27 December 2019, Kambi CEO Kristian Nylen said DraftKings had given no notice to terminate the contract, so the price rebounded around 17% to SEK140, where it has remained steady until now (SEK141.2 at the time of writing).

“I would say 90% of the [Swedish] population didn’t work on 23 December, so I’m not sure Kambi would have dropped 30% if everyone was at work. It was an overreaction, but it was valid for the stock to go down on the negative news,” says Christian Hellman, equity research analyst at Nordea Markets.

DraftKings is Kambi’s largest US customer and probably one of its top-five clients overall, so to lose this operator – the clear second-biggest sportsbook in New Jersey in terms of market share and a huge DFS brand – at some point in the future is clearly a blow. After all, DraftKings would have guaranteed Kambi access to a host of states with regulated sports betting. Plus, it’s just nine months since another of Kambi’s key customers, 888, acquired the betting platform and traders belonging to the shuttered BetBright business in Dublin. While 888 is still partnered with Kambi, the gradual rollout of 888’s proprietary software is due soon. “During the course of this fiscal year, you could say that Kambi has lost two of its top-five clients,” Hellman says.

Still a major player

Despite this, there are still plenty of positives for Kambi. The 10-year-old sports-betting supplier, which employs over 700 staff, still boasts over 20 operators from six continents on its books. In fact, 11 of the operators included in EGR’s Power 50 rankings use Kambi to run their sportsbooks. Meanwhile, the SEC filings published on 6 January showed that the earliest DraftKings could, if it wanted to, break its contract with Kambi is December 2020, so DraftKings will still be using Kambi’s services for at least the next 12 months, and it could be some time after that depending on how long it takes to fully transition to SBTech’s tech stack.

In addition, the departure of DraftKings is unlikely to harm Kambi’s ability to retain and acquire new online customers in the US. For a start, Kambi is partnered with Chicago’s Rush Street Interactive, as well as Greenwood Gaming – owners of Pennsylvania’s Parx Casino – and Mohegan Gaming & Entertainment. Kambi also inked a multistate deal in August with publicly listed Penn National Gaming, a regional gambling outfit that operates 41 properties in 19 states. Addressing the supplier’s attractiveness, Thomas insists Kambi, which recorded a 12.3% year-over-year rise in revenue to €23m for Q3 2019, is a “very strong brand in terms of what they do in Europe and the US”.

DraftKings may well have been eyeing up an acquisition for Kambi initially, not just for its proven technology and in-house expertise but because DraftKings already has a relationship with Kambi. However, the big problem for any potential suitor is that with Kambi – spun out of parent company Unibet (now Kindred Group) in 2014 – Kindred holds the trump card in the form of a convertible bond. This is a so-called poison pill, or deterrent, designed to discourage hostile takeover bids. In the event of any attempt to acquire the supplier, the bond kicks in and Kindred would automatically own the majority of Kambi. “Kambi was probably DraftKings’ first choice but it’s impossible, so they had to settle with SBTech,” says Hellman.

Customer relations

What the deal means for SBTech’s existing clients is not clear at this stage. There could be a few executives more than a little perturbed by the implications of a large US-based operator now having their third-party supplier’s platform, development pipeline and the whole caboodle in its back pocket. Furthermore, SBTech sportsbooks could end up being managed in a way suitable to DraftKings’ priorities. EGR Intel reached out to a number of SBTech customers but, alas, none were willing to discuss the ramifications.

“I can’t really see how they [SBTech’s customers] will benefit from this in any way in the long term,” Hellman says. “And I think it is positive for Kambi because one of the biggest competitors is off the map.” That said, the merger is a potential game-changer for SBTech as an established international B2B business looking to raise its profile in the US, which is poised to become the world’s largest regulated sports-betting market.

“From an SBTech point of view, this jumpstarts them massively,” says Thomas. “It moves them into becoming a technology provider for what is one of the biggest operators of real-money and fantasy play across the US, and [DraftKings] could be one of two or three brands that has the most chance to turn into a mega-business in the US – if they are not already that.”

As for DraftKings itself, it probably explored the option of building a sportsbook internally, although that would have taken a year or two and there is no guarantee it wouldn’t turn out to be a sub optimal product. So, SBTech was for sale, DraftKings wanted to raise capital through a float alongside owning all its technology, and Diamond Eagle helped make it happen. As the hard-fought battle for supremacy in regulated US sports betting continues to heat up, the world of online gambling seems set to become a little more consolidated.