DraftKings Inc. ($DKNG)

Good afternoon, everyone. Very pleased to have with us today, Alan Ellingson, Chief Financial Officer of DraftKings, DraftKings is one of the leading sports entertainment and gaming platforms in North America. They're active in sports betting, iGaming, fantasy sports, lottery, horse racing and most recently, the prediction markets. Company has approximately 507 million fully diluted shares out, trading around $25 for a market cap of $12.7 billion. Net debt is $835 million for a total enterprise value of $13.5 billion. What makes DraftKings especially interesting in today's conference is that it sits at the very intersection of several themes we've been discussing throughout the day, live sports, consumer engagement, technology and changing competitive landscapes. Alan, thank you for joining us today.

Thanks for having me.

Starting high level, DraftKings has grown tremendously over the last several years. You went public through the great SPAC boom of 2020. How do you reflect on the company's evolution since then and the equity investment thesis for the stock today?

Yes. We have had fantastic growth over the past -- more than just the last few years, going public in 2020. The DraftKings origin is actually 2012 with the fantasy era. And so well over a decade of experience growing, expanding. If you look back to what we thought we were, it would be today when we were in 2020. We were pointing at a $20 billion TAM and thinking that was where we would evolve to. Our most recent Investor Day, though, we've expanded the TAM. We're now thinking $55 billion to $80 billion, and it's getting exciting with some of the expansion in prediction markets. So not only are we growing aggressively, but the market is growing aggressively, and we're happy that our capabilities has allowed us to capture a meaningful share of that growth.

Absolutely. At the core business, we're almost 8 years since PASPA was overturned. What does the near- to medium-term organic growth outlook look like for mature states like New Jersey and Pennsylvania, and how much of that future growth will come from deeper engagement versus just acquiring new customers?

Yes, it's fascinating to watch how this industry continues to evolve. And what we're noticing is even in our most mature jurisdictions like New Jersey, which, as you mentioned, we've been in since 2018, we're still able to attract new customers with the growth of the product and the growth of the market, but we're also able to engage with new customers by expanding our product offering into areas that they want to engage and they want to reach out. Whether it's Sportsbook or iGaming or lottery or fantasy, when people engage with the DraftKings product, they want to tell a story about what they think is going to happen. And sometimes that's a story of here's what's going to happen in the football game tonight or here's who's going to win the NBA playoffs. And sometimes it's -- I'm going to buy a lottery ticket, because I'm excited about the possibility for what it could mean for my future. If the odd chances if I win. As we add more products, we're able to reach out and engage with more customers, ways they want to and so our oldest cohorts, we see them growing in gross profit. Our newer cohorts, we see them onboarding and we're attracting new customers. And it's exciting. We -- last quarter, we launched a new product called Same Game Parlay, for golf. It allows people who like to engage with golf to expand how they bet. And as a result, we saw an expanded share of wallet for those players because it was a product that they'd never been able to engage with before. So we continue to expand our product offering. And as we do, we continue to see more and more engagement from our customers. And that's an exciting dynamic.

And where is live betting penetration in the U.S. today versus a mature market like Europe where it's roughly 70%, it's higher-margin live betting, isn't it?

Yes. It's a lot lower than we think it could be in the future. It continues to expand year-over-year. Americans, typically, they love their sports, and there's a lot of different sports that they engage in, whether it's football or basketball, or we're excited for World Cup and what World Cup can bring, but they want a product that can engage with them at the speed of sports. And that means you've got to have a product that is responding very quickly and adapting to how they want. Nobody wants to look at a bet and see that it's grayed out, because the app isn't ready or the book isn't prepared to offer odds, they want to see uptime. And so this is one of the areas where DraftKings has invested very heavily in the technology to maximize uptime availability. And so whether you're wanting to place a point-by-point bet on tennis, whether you want to bet pitch by pitch on baseball or whether you just want to get a parlay down really quickly between plays on a football game. We want to enable you to be able to get that done. And so this is a huge investment for us, and it's materialized in a strong product offering. It's rated as the top product by Eilers and Krejcik for 2 years going now, and we're going to continue to improve because that's the experience that our customers want.

And speaking on the World Cup, DraftKings is the only national operator with a fully translated Spanish app. So any thoughts on what we can expect in terms of handle or engagement? What have you got planned?

Look, we're viewing World Cup as a fantastic acquisition moment. About 18 months ago, we looked at the product offering and said if we wanted to win World Cup, we wanted to have the best product available. What does that mean? And what do we need to add to the product? And we built out a road map, which included Spanish language and not just translating the Spanish language through an app, but real natives coming in and saying, how would this look if I wanted to feel like this was my language, and this was my app. And we took the time to get the terms and conditions and get the language and get all the different flows working just perfectly because we do believe that this is a moment that we can reach out and get to a different community, and treat them in a way that they feel like this is more home for them than maybe if they're working through a secondary language. Excited for what it will come. I'm not going to go too far out and say what we think is going to happen, but World Cup is a unique opportunity that only comes every 4 years, and we plan appropriately to capitalize on it.

The industry today feels a lot more rational competitively than it did a few years ago. 3 years ago, you had over 2 dozen operators in New Jersey, today, it's half that. So what do you think changed? Was it just the realization that scale advantage is and what you're doing in terms of the tech, it was just harder to overcome?

Yes. There's a lot of components to it. Some of the ones you mentioned, I think rationalization of the operators. Remember when Sportsbook first launched in some of these states, especially the states that offered unlimited licenses, you had 30 to 50 operators that were showing up and trying to compete for the same people. And the easiest way to compete is on promotional intensity and offers to new users. But that isn't always profitable. And so at the end of the day, product wins out, companies need to turn around and they need to get to a place where they're making the right decision for the bottom line as well as for the customer. And at that point, it comes down to who can do it the best, who follows the data, who builds the best product, who invests in the back-end technology to give users the best experience. And I'm very proud of the fact that we're down to 2 operators that have about 80% of the market right now, and they're competing on product and they're competing on technology and they're competing on the ability to create the breadth of markets that customers want and not just competing on promotional intensity. And there's a whole graveyard of companies that thought they could win in Sportsbook 5, 8 years ago. And now the top -- the best have risen to the top. And I'm very proud of what DraftKings has been able to do to be one of those operators.

It's very impressive. The market has become more cautious on the gaming sector, given dynamics around higher state taxes, prediction markets, competition and increasing investor focus on profitability, so how does DraftKings continue delivering on its margins and earnings targets while still investing for growth?

Yes. This is the balance that we have to continue to maintain because there is an investment expectations that we return profits to customers. And I want to be really clear, DraftKings has created $500 million of adjusted EBITDA over the past two quarters. And much of that flows through to free cash flow. We have a very high conversion rate from adjusted EBITDA to free cash flow. Our core business is extremely strong. When a new entrant comes in like prediction markets that has an opportunity to expand the TAM, capture new customers, especially in states where we don't have a Sportsbook offering, we're going to invest to get there. And it is a J-curve investment. We spend a little bit upfront to acquire the customers, and then those customers generate profits long term. One of the things I love most about the Investor Day deck we put out a couple of months ago is there's a slide in the appendix that shows the gross profit by cohort year every year since we acquired the cohort. So for the 2018 cohorts, you're going to have 7 years of profit -- of gross profit for that and every year thereafter. And what you'll notice when you see that is for every single one of our annual cohorts, our gross profit for that cohort has gone up every single year year-over-year. Because we know how to expand the profitability of customers once we have them on the platform, we know how to reach out to them and give them something that they want. It's more than what they were getting the year before. We know how to optimize our promo to those customers to not give them stuff that doesn't mean anything, but actually give them promo that reinvests in a way that they want to be reinvested in. So not only do we have the biggest -- the broadest breadth of product available to them, but we also know how to treat them in a way that they want to be treated, whether that's a CRM outreach when the Yankee's game is about to start to remind them, the game is starting, whether it's a push notification, whether that's a promo boost, we reach the customers where they're at to the degree they want to and they feel comfortable. And we do in a way that makes them want to keep coming back every single year in a way that's healthy and that works well with them. And we're very proud of that relationship and that trust that we've built with the customers. As a result, we understand that when something like prediction markets comes out, we invest in customers, we acquire customers, and then we learned to monetize them over time when we get them to where we want. And this is a fantastic opportunity. And every year, when somebody says, well, it's time the markets are going to stop creating these new opportunities, we find we get another opportunity, maybe not as a state launch, but a prediction market or a new product offering or a new derivative of a product that attracts new users. And we've got a fantastic road map over the next 18 to 24 months of what we want to launch and how we want to engage with customers. And so I'm pretty excited about what's going to happen for the next little while. Maybe it doesn't last forever, but we've got 8 years of history now proving that we can do this. And I feel very confident that the next 2 to 3 years are going to continue that trend.

And you're bringing all your products together through the Super App, which depending on each state's regulatory framework we'll have predictions in California, Sportsbook in New York. How does that change customer behavior? And what are you seeing in the early days in terms of cross-sell and engagement across the ecosystem?

This is kind of a fun evolution of DraftKings this year specifically, where historically, we had 7 different apps with 7 different intents for customers of how they could spend money. And what we've realized is we've improved our technology and as we've cleaned up our -- behind the scenes is that it makes a ton of sense to customers to have 1 single place they can go to that just has all the offerings available to them. They don't want to open up the Sportsbook app in California and realize, oh, I should have opened up the prediction app instead. They want to be able to buy a lottery ticket from the same app that they're placing a bet on the next. They want to be able to spin the slots if they're in New Jersey, for example, from the same place that they play their fantasy games. Not only does that give us an opportunity to cater to the experience you open up one app, and you know that whatever is available, wherever you are, you don't have to think about state lines. You don't have to think about jurisdictions. If it's available, you can see in front of you, it also allows us to better utilize the national footprint for marketing that we have because we spend a lot of money on marketing each year because the money returns value we acquire customers, those customers generate profits over time, but there is a need to ensure that every dollar that gets spent on marketing has the highest return. And that means that if we spend money on advertisement that shows in California because they're watching the next game as well, they should be able to open up the DraftKings after and be able to do something with it. And we want to make sure that those dollars we're spending it, we have the partnerships, it needs to be effective.

And from the customer's perspective, how different is that California sports events contract from a New York Sportsbook bet?

Today, it's -- there's a difference between it. prediction markets have not fully developed. They have the same depth of market that the Sportsbook app does. But that difference gets narrow and narrow every single day. And in fact, this week, we launched Milestone 2, our second phase of prediction market product, which in my mind is significantly better than what we had before. The Super App is already integrated. If you're in California right now, open up the app, you're going to see prediction market products. It's the same app. It's DraftKings sports and casino. It's not Sportsbook anymore. And it's going to get better and better. And we have a very firm goal as a company to narrow that over time as much as possible, because we want to ensure that your experience regardless of where you're at, is the best experience possible.

And I've always seen this company as more of a technology company rather than consumer discretionary. How much of that competitive moat comes from pricing and risk management sophistication versus scale and the brand that you've built.

You've got to factor in both. We had an Investor Day. Again, I mentioned back in March, and we highlighted you got marketing is a moat, technology is a moat, product is a moat. And then the last one which gets underplayed a lot is actually trust. And it's the trust that the regulators have that we're going to treat the consumers in their jurisdictions, right? It's the trust that the players have that they're going to get a fair return for their experience and that we're going to treat them right. But we have a fantastic product. It is our Sportsbook product, our iGaming product has been rated the top products in the country for the past 2 years now, not every single -- it's a biennial survey, and every single time it comes out. A lot of people don't see the technology behind it and what it does and how it affects the experience until the first time they're using a competitive product and they want to place a bet and the market's grade up, because the competitor can't price it at that moment because of what's happening on the field. And we used this example a lot, but if -- and the value of the real time. If you're watching a football game and long pass down the field into the end zone and it gets disrupted, but there's a flag on the field. Most companies will take down the markets because you don't know what the flag is a pass interference, which means it's first and go on the one yard line or if it's a holding call, which means it's second and 20 on the 35-yard line. But we have real-time data coming from the field, and so we can see where that flag is. And if that flags in the backfield, we know it's a holding call. We're going to leave the suite the touchdown lines open. And if the flag is in the end zone, we know it's likely to be a past interference, and so we're going to take down the lines. That difference in experience is meaningful for betters who are really engaged in the game and are watching. And so having the technology to be able to do real-time play-by-play on every single game and give people the markets they want to bet on is important. And that same technology is going to translate to us being able to price prediction market trading and give people the same experience in prediction markets that they're getting in sports betting. That's going to be a critical differentiator over the next 6, 8, 12 months as people start to learn what prediction markets are and they try to evaluate that versus sports betting in the markets where both are available.

Also at the Investor Day, you went into detail on the broader market opportunity for predictions and how you compare the economics of it versus the traditional Sportsbook. But can you just lay that out for this audience again, please?

The -- just general economics?

Yes.

At the end of the day, when a customer is out there trying to engage in for money entertainment, they have a certain expectation of return to player of how much money they're going to get back when they put money in. And so for a slot machine, you expect that you get 96%, 97% back and casinos are pretty public on those. For sports betting, typically, we have a metric we call net win margin, which is the amount of revenue we get as a percentage of the handle that's played. And in Q1, that was about 7.8%. For prediction markets, generally speaking, the economics in aggregate are going to be roughly the same. The users expect to get a certain value back, a certain percentage back, a certain amount that they win versus what they lose. As far as the economics of the prediction market goes, there are more players engaged in the supply chain that have to split and share those economics between them. Our goal and our objective is to, long term, have all of the pieces of the chain of the vertical integration to be able to capture all of the economics. We have almost all the pieces right now. We recently did an acquisition of a company called Rail, which is the exchange. We currently have partnerships for some of the other pieces that you take a little bit of the economics, but we have the customers on the front end. We have the expertise on the back end to create the market. We own the exchange, and we will -- we believe we can capture all the economics long term.

And there's not really any public company financials from a prediction markets operator. But if a Sportsbook can achieve 25% to 30% EBITDA margins, where should a prediction markets operate or land?

Currently, one of the headwinds we have on margins in Sportsbook is going to be state taxes as well as there are some revenue share payments that we work through, with states for licensing or to get access to their licenses. Prediction markets don't have any of these headwinds to the margins. So in theory, the margins for prediction markets could be meaningfully higher. It's early days. I'm definitely not going to go on a limb and say what margins could be. But if you dig through our financials and look at some of the numbers that we have, and we do call out some of those things like state taxes, and how much we're paying taxes each year, prediction markets could have meaningfully better margins, assuming you can capture all the economics.

I think one of the real fascinating things about the prediction markets is this debate on federalism versus the state jurisdictions of gaming. What do you think the long-term regulatory framework or end state for sports prediction markets ultimately looks like. And as you've engaged with the CFTC, what are some specific changes that you think would help create a more robust framework for that industry?

Yes. I've learned long ago not to speculate on how the federal government and the state government is going to interact long term. I do think that DraftKings, we've positioned ourselves in the absolute best place to take advantage of whatever happens, while the federal government has strong support for prediction markets, and we're hearing very vocal advocacy from the CFTC. We will continue to push our product forward and launch and compete at the federal level. And we're being very careful as we do so, though, because we very much respect our relationships with the states. We aren't launching prediction markets in any state where we're operating OSB product, Sportsbook product. For that very reason, we want to maintain those relationships. And we believe that the Sportsbook product, as I mentioned before, right now, is a significantly better product offering and better cater to customers. We'll continue down this path. One of the things we've asked -- we put a public letter at the CFTC about some of the changes that we wanted to see from them as they go through a rule-making process they're going right now. And a couple of the components of that, that are really important is, first and foremost, a lot of what's happening right now is the CFTC operating by lack of action rather than explicitly saying what the rules are. And so the CFTC choosing not to enforce a rule is not the same as them saying, this is the rule, and we want to go forward with it. And so we've asked for them to be explicit about sports trading contracts being allowed rather than just not them not enforcing anything against sports trading rules. We've asked them to treat these options and these contracts more like equities and less like future contracts. That affects the collateralization requirements, the margin requirements and a couple of other aspects of how they're treated. And then we also want just real clear transparency on the rules of engagement, and how operators should be acting and interacting and engaging. We believe there's a lot of potential right now. We believe that the markets have a huge opportunity to absorb this, and it's definitely filling a demand, as you can see by the rapid growth of the industry. But we operate by the books and we follow the rules, and we would like the rules to be explicitly defined so we can make sure that everybody is acting on a level playing field. There's a couple of more nuanced things we've asked for, but generally speaking, we want transparency, and transparency allows everybody to operate on equal footing. And we've proven over the past decade now that when we have an equal footing, we can operate, and we can exceed, and we can beat, and our investment will pay off our investment in technology and product will pay off if we're able to compete on an equal footing.

Just a few minutes left. Do we have any questions from the audience.

And I do apologize. I talked somewhat fast. It comes from a decade of listening to podcasts at 1.5 speed.

I'm a little new to this data set, but I've spent some time.

Sorry, can you speak closer to the mic please?

Can you hear me?

Yes.

Okay. I'm new to this data, but I've spent some time doing due diligence. Owning the entire stack, in my perspective, feels like the ad server and the content owner and the third-party measurement, all being owned by the same company. I'm just curious like how you guys are thinking about, I guess, like not creating your own homework if you're owning the whole stack?

Well, the -- as far as the markets go, especially the prediction markets, what we're trying to do is create parity to what we already do on the Sportsbook side? So for example, right now on the Sportsbook side, you enter into the DraftKings app. And it's DraftKings on the back end is the house that's market making and is telling you what the odds are, and then you place the bet. Right now in prediction markets, you've got some of them who own the entry point, it's called the FCM. Cash owns the FCM, and then they have the exchange as well, but they don't necessarily do the market making. And Robinhood and Susquehanna, they want to have an exchange in the market making, and then maybe feed the FCM as well. And so there's -- there are varying degrees of companies that own different aspects of the stack already. We believe we can do it very well. We want to be able to, and we think that the rules allow for it. If you get that point, it's not really creating your own homework. It's more like creating an experience where you've got the parking lot the customers can park and you've got the store they can shop and you've got the checkout stands where they can checkout, and you've even got somebody who's taking the groceries to the car, helping them to leave rather than having 4 different companies that are doing each of those different things. And so it's about optimizing the experience to be as close as possible to experience that they're already familiar with, that they're getting on the Sportsbook side right now. And so a little bit less onerous than maybe in some other industries and more just what people are already used to and one of the barriers that they're facing to wanting to engage with the product more right now.

Do we have another hand up in the back here.

Thanks for the presentation. By the way, I use DraftKings a lot more than FanDuel. So don't worry about it. Just -- you drilled down quite a bit on poly market and Kalshi, prediction markets and I'm just wondering, there have been some very high-profile bets, if you want to call them, that have been placed on them, for example, on Maduro, on Khomeini. Can you start getting into situations where you're bidding on people's lives, you're bidding other things in the real world like elections. Where does your Board of Directors draw the line when they see something come out on one of these prediction markets and say, maybe we shouldn't have this up.

It's a really good point. I'm glad you brought it up. One of the things that I highlighted that I'll continue to highlight is there is a need for everybody involved in this process to develop a sense of trust from who's engaging from the consumer side. And that trust transcends just making sure you're avoiding insider trading and you're avoiding some of the things, but also the markets that you're allowing and creating the right environment for people to feel comfortable with it and what it is. And so betting on wars and betting on deaths and these kind of things should not be allowed and will not be allowed. And again, if you go into the rule making, this is one of the things we requested the CFTC is there needs to be some framework for what we should and shouldn't allow people to place money on because you don't want to incentivize bad behavior. If these things exist as they should exist, which is either an entertainment product, which is what we're really special at or as a hedge product, then you should be very clear about what kinds of activities you want to encourage hedging against and what kind of activities you want to encourage people to find entertaining. And so I think that there needs to be a lot of conversation about markets that should be allowed and should not be allowed. There needs to be clear rules about it. And I'd like to believe that DraftKings will be at the forefront of those conversations because that's how we already operate on the sports betting side, and there are just certain markets we don't allow. And I look forward to continuing engagement because what you raised is a valid critique of the industry as it currently stands and something you will not see on DraftKings platform.

We have time for one more front and center here. Sorry, someone will come with the mic so they can hear -- so I can you hear.

Can you hear me okay?

Yes.

Super. By the way, empathizing with that question, but sort of on a positive thing, then I'm going to zero down on my question. I spent a fair amount of time with the CEO of Kalshi recently. And one of the points that he made, which I thought was very thoughtful was what you guys do is force a calibration in thinking that in a very polarized world, potentially gets people to think about it a different way, right? Because if you're polarized in the way you bet or calibrate, you probably don't do as well as if you're more nuanced. But I guess my question would be, there are several dynamics here that I see in many situations like this, there's competition, there's collaboration, and then there's a dynamic of how that all affects the market. Specifically with Kalshi, how do you see yourself on all 3 pieces? From a competitive viewpoint, from a potential collaboration viewpoint and potential how the dynamic will affect your TAM going forward?

Look, I do agree that forcing the conversation on things allows for a more rapid resolution of issues. Sometimes that's healthy. And sometimes you don't need to go to war to force a peace treaty. And so the question is to what degree do we go too far? And I'd hate to think we ever get to a spot where we go too far, and then have to say we got to take a step back. I'd love to just step by step until we get to what's appropriate level, and then stop because sometimes you go too far and you can't unwind those things. As far as the competitive with Kalshi, we recognize a lot of what they're doing. We see their product out there. We know where they're winning and where we think we can do better on their product. We are excited for what we plan on launching over the coming weeks and months and what we've already launched, and we think that we can go create a competitive offering that really caters well to the consumers of these products out there. We are excited. We have a lot of experience creating a product for consumers that like these products. We have a lot of experience marketing to them, understanding how to market to them, how to incite them to engage with the product. And we'll see how the next few months play out as we start to roll out our product and engage. But in the aggregate, this is an exciting industry. This is a huge opportunity. This is a chance for everyone in the United States to have access to a product that has been restricted to a smaller population. This is an opportunity to force conversations with states about what it means to regulate these industries. And it's a chance to talk to leagues and expand and educate people. Those are all good things. Engagement is good. And sometimes companies will push the limits a little bit and they get flat, and then we talk about it, and we figure out what the right rules are, and we go forward, and that's part of the healthy dynamic of the industry. And we're happy to be part of it. We're pleased to be able to participate and to engage and to have these dialogues happening, and we'll see how it plays out. But I hope you never go so far that we look and say, "Oh, everybody went too far. We've got to rein back. I hope we can very thoughtfully take one step at a time until we understand what these industries should look like. And to that point, I'm really happy the CFTC. [indiscernible] has engaged in rulemaking for this because I think that that's the first step of really understanding what should and shouldn't be allowed and how participants should and should engage is just defining clear rules of the road that everybody can understand and look at and say, okay, this is how we're going to be engaging. And it will be fun to see how it plays out.

I like to just go back to the point you made at the very beginning about trust. I think trust is your barometer and you anchor the consumer around that. That will always be your guide because that will expand your market, more they'll do more business with you.

Absolutely. You should come up here. That's absolutely right.

I'm afraid we have to stop there to keep on schedule. Thank you, Alan, again for being with us. Thank you all for your interest.