Investment

Morgan Stanley’s Thomas Allen: Path to profitability for US operators is not reflected in current share prices

By Conor Mulheir - 30 Mar, 2022

Morgan Stanley’s gaming analyst believes the profitability possibilities of the US sports betting market are not currently reflected in the stocks of major public operators.

In an interview with iGaming NEXT co-founder and MD Pierre Lindh, managing director Thomas Allen said he expects the market to really turn profitable around 2025, suggesting that investors hoping for short-term gains have underestimated the time it will take to get from red to black.

Allen said valuing US gaming PLCs using mid-teen EBITDA multiples is fair: “We’re expecting revenue growth for the industry for the next three, four years, I think about 40% a year, and so high multiples should be justified in this context.”

Commenting on the high-profile example of DraftKings, Allen expects the company to reach $1bn of EBITDA in 2025, suggesting the firm’s current market cap of just under $8bn leaves the stock undervalued at present.

At the beginning of March, Morgan Stanley picked DraftKings as its top pick in the US sports betting and iGaming sector following a 70% dip from the firm’s 52-week share price high.

Recent falls in US gaming stocks are due to an array of both macro and micro factors but are also the result of unrealistic expectations from investors, Allen said.

“The market had to come to the realisation that near-term losses were going to be much higher than the market anticipated,” he explained.

Morgan Stanley’s Thomas Allen: “Where we are most optimistic – and this sounds crazy right now – is actually around marketing efficiency.”

In spite of significant challenges presented by the US market, including fragmented and unpredictable regulation and relatively high comparative tax rates, Allen said there are areas where US operators will be able to mitigate these costs in order to turn a profit.

“Where we are most optimistic – and this sounds crazy right now – is actually around marketing efficiency,” said Allen. “How ironic, when so many companies are spending so much money.

“But the reality is that if you think about the main operators in the US, there are only a few of them, right? So basically five operators in the US market today have over 80% market share. And all of them have a customer acquisition advantage.

“You think about the legacy DFS companies, they have all these old customers. You think about the legacy casino customer companies. They have all these old customers that they can cross sell occasionally and hopefully find ways to retain them in the future as well.”

Allen expects the major players today to dominate in the future, leveraging their first-mover advantage. “We expect the top five operators in the US to get to about 85% market share,” he said.

“That’s between Flutter (FanDuel), DraftKings, BetMGM, Caesars, and Penn Barstool, and that does leave room for a couple of other operators. I think in Australia, the top five operators have about 95% market share, so it does leave room.”

Allen pointed to state-by-state revenue data as evidence. He said: “You can see there are certain operators that came in late in states and they haven’t performed as well versus if they came in on day one.

“I definitely think there is some level of first-mover advantage and if you take the companies at face value, a lot of them have said they’ve been pleasantly surprised by the customer retention they’ve seen in the US market.”

Whatever the future may bring, Allen is bullish on the US online gambling industry but has told investors playing the long game in this space to strap in for a bumpy ride.

“We think the US market is going to see a lot of growth over the next five years,” he said on the podcast. “It’s going to flip to profitability, which is not really reflected in stocks.

“But it’s going to be choppy and it’s going to be volatile,” he added.

Morgan Stanley is co-sponsoring the investNEXT 2022 track at iGaming NEXT New York City ’22.