Tom Waterhouse - "Capital is the lifeblood of growth"
Gaming Eminence takes a moment with Tom Waterhouse Chief Investment Officer of Waterhouse VC to see his thoughts on the sport betting industry, market M&A, analysing potential investments, cryptocurrencies and the potential of the U.S exchange market.
GE) Where do you see in the coming years the biggest external influence impacting the way the sports betting industry looks at its current approach to growth?
TW) We think that a significant external influence is a higher cost of capital across all key wagering markets. Capital is the lifeblood of growth and increased interest rates (in response to higher inflation) have forced operators to review their expenditure. This is particularly true for unprofitable operators, who are unable to fund growth through internally generated operating cash flow. The US Fed Funds Rate has already increased from 0.25% to 1.75% this year.
The share market is clearly already demanding profitability considering the current macroeconomic headwinds, with the valuations of DraftKings and Rush Street Interactive both down 80% from their peak. Multiple US-only operators have already rapidly reduced their marketing activities, with a stronger focus on profitability. Churchill Downs is a recent example of a company that has not only reduced its marketing activities but also decided to completely exit its sportsbook business in February. Wynn Resorts no longer plans to go ahead with a marketing spend-heavy strategy to promote its online business.
Operators with scale in their non-US businesses, such as Flutter, are able to fund their US growth through the profits of global operations. For example, in 2021, Flutter delivered group EBITDA of US$1.23Bn, including a US$300 million EBITDA loss in the US. Considering the current depressed valuations of high growth businesses that are not profitable, raising more money in this environment is likely to be very dilutive for existing shareholders.
GE) Across any industry M&A is one clear way to scale a business. What examples within the gambling industry have you seen of an acquisition that was focused not on market share, but acquiring a tech stack or software that ultimately enabled that business to grow organically? And on the flip side, where have you seen this approach fail?
TW) Since PASPA was repealed in 2018, we have seen an increased trend in operators acquiring their suppliers. Examples include DraftKings / SBTech (2021), Pointsbet / Banach (2021) and Penn National Interactive / theScore (2021). Operators have taken this approach in order to move quickly to acquire market share in the burgeoning US wagering opportunity. We believe that it is still too early to make an assessment of the full merit of these acquisitions.
We have seen success in small bolt-on acquisitions, such as BetMakers’ acquisitions of Dynamic Odds and Global Betting Systems in 2019 to round out their suite of leading B2B products. At Waterhouse VC, we focus on B2B suppliers that can dominate their niche, such as Voxbet’s voice and text to bet solution. Further to my prior point, the increased cost of capital is likely to encourage operators towards smaller bolt-on acquisitions rather than large acquisitions, which carry increased operational and integration risk.
GE) As part of your investment fund strategy, I’ve read that you employ your own engineers to look under the hood of potential tech investments. What are some red flags that typically will come up? Do you find it is more product or people related?
TW) It is an incredibly important part of our investment edge to have our engineers assess potential opportunities for the fund. We understand that operators must have best in class technology to run successful businesses. Our engineers work alongside our investment team throughout the due diligence process. Red flags include lengthy integration periods, inexperienced engineering teams and costly maintenance. We have typically rejected potential investments because of issues around product rather than people.
GE) Cryptocurrencies are volatile at the best of times and due to that reason operators can be hesitant to accept or adopt. What is your view of the use of crypto within the sports betting industry?
TW) Back in the mid-2010s while working for a major wagering and gaming operator, I spent a lot of time in Asia learning from some industry experts. We spoke with businesses operating in Asia with significantly smaller headcounts, who had 10 times our turnover (and we were one of the largest global operators at the time). Incredibly, their turnover was virtually all in cryptocurrencies such as Bitcoin. This experience opened our eyes to the cost advantages, speed of settlement and privacy afforded by these payment methods.
In Q3 of 2021, the total number of bets placed using cryptocurrency increased by 181%, while the share of bets in crypto (43.3%) is fast approaching par with fiat (Softswiss). For example, crypto-focused Sportsbet.io (not to be confused with the Australian ‘Sportsbet’ business owned by Flutter) records US$2.7bn of turnover per month. To put that in perspective, in 2021, Australia’s largest operator averaged US$1.2bn of turnover per month and has around 50% market share. We believe that the use of cryptocurrencies in wagering will continue to grow rapidly across the world.
GE) In the U.S market there are two major hurdles stopping a U.S Betting Exchange - The Wire Act and Casino lobbies. Hypothetically, if these were somehow removed do you think it would be successful? And if so, who at this point in time do you feel is best positioned to capitalise on it?
TW) There is no doubt that exchanges continue to face headwinds in the US due to the Wire Act and Casino lobbies. In 2020, Betfair withdrew from the US market (specifically, from New Jersey) due to an inability to pool across state lines and gain traction in liquidity. According to Betfair US CEO, Kip Levin, “The exchange did not manage to reach the critical mass necessary to make the operation profitable and efficient”.
We believe that bettors want the option of an exchange and that it is a part of the wagering ecosystem that is primed for growth. That is the reason why we are spending a lot of time looking at businesses in this space, exemplified by our recent investment in BetDEX.
There are three key requirements for the success of US betting exchanges:
1. Reasonable taxation structure - Preferably a tax on gross profits rather than turnover.
2. Liquidity - Recreational bettors will not use an exchange if it lacks liquidity on their desired markets.
3. Great user experience - It should be just as easy to wager on the exchange as it is with a sportsbook.
There has been signalling that the DGE will allow out-of-state programmatic trading if the liquidity providers get a New Jersey CSIE licence (Casino Service Industry Enterprise License), which would allow them to bet across state lines.
If that is the case, and certain providers can get enough liquidity, then we believe that the exchange model becomes viable. Bettors know they can put a bet on with bookmakers at fixed odds even if the odds are not attractive, but with an exchange, scale is paramount to ensure liquidity and enable bets to be placed. We have seen how important scale is in the UK, with Betfair ultimately cornering the market because of its advantage in liquidity. Betfair now operates in over 100 countries and is the clear global industry leader, counting over 1.4 million average monthly players.
In the US, whilst the regulatory landscape is in a state of constant change, we are very excited to invest in businesses exposed to the growth opportunity. It is not clear who the winners will be, which makes it a very interesting opportunity for investors. If the Wire Act and casino lobbies are overcome, we believe that Betfair is likely to re-enter the market and apply its global operational success to the US opportunity.
About our contributor
Tom formed Waterhouse VC in August 2019 and is the Chief Investment Officer of the Fund. In 2010 , Tom launched an online wagering company, TomWaterhouse.com, with just three people. By the time the business was sold to William Hill in 2013, the company employed more than 100 staff and had 250,000 clients. In 2014, Tom was appointed as CEO of William Hill (Australia) with around 500 staff and one million clients, achieving USD 2 billion in turnover. Visit https://www.waterhousevc.com/ or https://tomwaterhouse.com/
Please note the above information in relation to DraftKings, Rush Street Interactive, Flutter, Pointsbet, Penn National Gaming, Churchill Downs, Wynn Resorts, Sportsbet.io, BetMakers, BetDEX and Voxbet is based on publicly available information in relation to the company and should not be considered nor construed as financial product advice. Waterhouse VC has a position in BetDEX, Flutter, BetMakers and Voxbet. The information provided in this document is general information only and does not constitute investment or other advice. Readers should consult and rely on professional investment advice specific to their individual circumstances.