PENN- Does it pencil?

For many new (Robinhood) traders Penn National Gaming = a chance to invest in the growth of Barstool Sports. To be frank, that’s the only reason I am looking at the business.

Penn National Gaming owns, operates or has ownership interests in 41 gaming and racing properties in 19 states and video gaming terminal operations with a focus on slot machine entertainment. We also offer live sports betting at our properties in Indiana, Iowa, Michigan, Mississippi, Pennsylvania and West Virginia. The Company will soon launch its Barstool Sports book app and products, allowing it to leverage the Barstool brand and marketing engine to drive meaningful market share, as the product is introduced across our leading customer loyalty program, mychoice®, with 20 million casino customers and Barstool’s audience of over 66 million loyal fans. In total, Penn National’s properties feature approximately 50,000 gaming machines, 1,300 table games and 8,800 hotel rooms. In addition, the Company operates an interactive gaming division through its subsidiary, Penn Interactive Ventures, LLC, which launched iCasino in Pennsylvania and, through strategic partnerships, operates online sports betting in Indiana, Pennsylvania and West Virginia.

Cool. While I believe the house always wins I really don’t know anything about investing in casinos as they don’t fit into the larger themes of my investment philosophy. I am exploring the possibility that PENN’s stake in Barstool will grow to outweigh all their other operations. If there is a bull case, that would be my bull case. I just need to find evidence to support it.

On January 29, 2020 PENN acquired a 36% stake in Barstool, valuing it at $450 million. Since PENN is so heavily indebted the stake in Barstool only represents ~10% of PENN’s enterprise value ($15.40B EV). I am disregarding the potential for any accretive developments in the casino space as I am curious what it would take for PENN’s stake in Barstool to become >50% of their enterprise value (holding debt levels constant).

Today, Barstool’s valuation would need increase 5X to become ~50% of PENN’s enterprise value. This would give Barstool a valuation of $2.25 billion. Details of the deal reveal that in January 2023 PENN has the option to increase their stake in Barstool to 50%. Like it or not, the PENN investment thesis is directly correlated with the success of Barstool.

So what really even is Barstool? It’s a media company that earns revenue through merchandise sales, advertising, event tickets, satellite radio, podcasts, pay-per-view content, and soon- a sports book betting app that is set to compete for market share in a multibillion dollar industry. The only other media company that could replicate all 7 of Barstool’s revenue engines is Disney but they have yet to hint at launching an ESPN betting app. Comparing Barstool to a $200 Billion dollar conglomerate may seem inappropriate but both have a gripping mystique that binds fans to the brand. A diehard Barstool fan will likely consume more Barstool content on a daily basis than a diehard Disney fan will consume Disney content. Just like how Disney succeeds by leveraging it’s large library of IP, Barstool succeeds by leveraging the endless supply of news, events, and memes that the internet provides.

A lot has changed since PENN’s investment in January. Unlike Disney it appears that the Covid19 pandemic has actually been a stressor that helped bolster the Barstool brand. The hiatus from sports has forced the Barstool team of content creators to stretch their tentacles further into adjacent markets.

Founder and top personality Dave Portnoy has spent the hiatus from sports venturing into the world of day trading. He has done so with great success gaining 500,000 twitter followers, mainly from the #FinTwit community. This has also expanded his friendship with CNBC media personality Jim Crammer who has given PENN plenty of airtime on MadMoney. Barstool has become such a notable presence within finance that the investor community is gaining first hand experience of the ‘Barstool Effect’. From mainstream financial news to Twitch the Barstool community of content creators have pivoted beautifully during a period of no sports. If nothing this exemplifies the novelty of the connection between Barstool and it’s audience. This is the cornerstone of the Barstool growth story.

Before the pandemic investors were enticed by the idea of Barstool channeling their audience of 66 million unique monthly visitors into a sustained user base for their betting app. It is fair to say that the probability of the Barstool sports book app succeeding has only increased in the previous months. The Barstool betting app is launching after a hiatus in sports where the competition had no opportunity to expand their customer base- initial conditions matter.

So what does the sports betting landscape look like? Is sports betting a good business? How does the PENN/ Barstool partnership stack up to the competition?

Overall the online gambling market is nowhere near mature. This is unlikely to be a winner-take-all market as each of the various betting apps are not competing for 1 market but rather 50 submarkets. Each state has its own regulations and hurdles before an app can even launch. Investors believe the Covid19 pandemic will jump start these battles as cash strapped states will welcome the tax revenue collected through sports books. The final form of the market will likely be geographically fragmented with certain apps excelling in certain geographies and failing in others.

The most notable players in the sports betting app market are DraftKings and Flutter Entertainment, with a combined market cap of ~$32 Billion. Flutter Entertainment operates through the FanDuel & Fox Bet brands. The incumbents have already developed a significant user base through their daily fantasy sports games which capitalized on a loophole in the US gambling laws. The loophole allows daily fantasy sports to legally exist in 43 states under the guise these games are ‘skill-based’. It is almost certain that the day 1 launch of the Barstool betting app would require DFS in order to succeed (since the sports book portion of the app will not be legal everywhere).

DFS prize pools are a function of the total number of users. More users equates to a greater number of total prize pools and larger sums to be had for winning each prize. The fact that DFS depend on network effects underpins the very reason why Barstool has a fighting chance to compete with the incumbent betting apps.

For end users the incumbent offerings function as apps of utility with consumers feeling like they’re choosing between Coke or Pepsi. As I touched upon earlier, there is something special happening between Barstool products and the Barstool audience. ‘Stoolies’ will likely be drawn to the Barstool betting app precisely because of the unique features that only Barstool can provide. The Barstool betting app can copycat the incumbent’s playbook to match their functionality but the inverse is not true. The incumbents are not able to replicate the unique engagement and content of which will be the bedrock of the Barstool betting app.

While highlighting the uniqueness of the betting app it is important to note that this may limit the addressable market. A no frills betting app is fine for most consumers. The very same features that attract the existing Barstool audience to the app may deter non audience members and steer them to the incumbents. Limiting the addressable market only makes sense if the betting app can generate a higher ARPU with content layered on than without the content. The bidirectional nature of Barstool’s content supports the idea that the betting app can generate more engagement and in turn a higher ARPU.

While the incumbents earn ~70% gross margins they rely heavily upon their marketing efforts to onboard users. Barstool’s CAC is structurally different as they are the media company funneling consumers to the betting app, opposite of the incumbents who need strong media partnerships to onboard new users. The ability for Barstool’s media presence to drown out marketing efforts by the incumbents should not be overlooked. A Draft Kings ad may be aired during commercials of an NFL game all the while their target audience’s eyeballs are scrolling through memes aggregated by Barstool’s Instagram page.

Despite having a smaller addressable market the Barstool betting app competes by potentially having a higher ARPU and a lower CAC. Another potential boon to margins is the possibility that users would accept alternative payouts. A user with $25 in winnings may be offered $30 to the Barstool store. Not only would this improve margins but would contribute to the virality of the brand-the flywheel ensues. Alternative payouts may even include something less tangible where Barstool leverages their social media presence to give winners some social capital.  

With some estimates pegging the US black market for sports betting at $150 billion investor enthusiasm for the gambling market is justified. Most TAM estimates for the betting apps come nowhere near this black market figure but I tend to disagree. The vig taken by an online sportsbook versus your neighborhood bookie may be the same but one option certainly has less friction. I tend to believe what can be digitized eventually will be as new features and levels of customization provide a superior experience.

In sum, if the Barstool betting app can gain traction amongst it’s own audience then the app itself should receive a valuation comparable to the incumbents. Barstool only needs to covert ~8% of their 66m unique monthly audience to their betting app to match Draftking’s 5M lifetime players. The success of the betting app paired with the continued success of the media company as a whole does support the idea PENN’s stake in Barstool can grow to outweigh all their other operations. It’s my opinion that an investment in PENN offers asymmetric risk/ reward to the upside.