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August 14, 2023

ESPN-PENN Deal a Gamble on Both Sides

PENN Entertainment Inc. (NASDAQ: PENN) recently announced it would be rebranding its online sportsbook as part of a new deal with ESPN. The 10-year pact includes $1.5 billion in cash and $500 million in warrants.

The company subsequently unloaded ownership of Barstool Sports to founder Dave Portnoy for $1 (along with some non-compete agreements and a 50% claim on a future sale). SEC filings suggest the company is absorbing a $800-$850 million writedown to switch strategic media partners.

PENN is hoping the ESPN brand will serve as a catalyst to grow its sports betting –and iGaming– market share.

“But who is the customer that is not already betting, that is going to start betting because ESPN Bet exists,” Chris Grove (partner emeritus, Eilers & Krejcik Gaming) asked.

It’s not clear that individual exists, and if he or she does, how many of them there are.

“And who is switching from where they are currently betting because ESPN Bet exists,” Grove wondered.

Most industry insiders’ have modest expectations for the company converting existing sports bettors into users of its app.

So, this deal is not guaranteed to turn PENN into a market leader.

But the truth is, none of PENN’s options were a slam dunk, and the company had to do something.

“Once they reached the conclusion the Barstool partnership wasn’t going to work, it’s not as if they had a ton of choices. Every path [forward] was going to be a gamble,” Grove said.

Every one of the options at PENN’s disposal was risk laden and absent of clear opportunity–including the status quo.

Sticking with Barstool and maintaining ~3% market share was a losing proposition.

“If you don’t get more than a 5% or 10% share, it’s very hard to build a big profitable [online gaming] business,” David Van Egmond (founder and CEO, Bettor Capital, and former EVP of strategy at Barstool Sports and FanDuel) said.

And there is no real reason to believe PENN would have grown its market share any further with the Barstool brand.

The company could have tried to reset expectations, run its OSB business lean and profitably (think: Rush Street Interactive), and refocused growth efforts on casino.

“But they invested [$2 billion] into the acquisition of [Score Media and Gaming] to build out their own proprietary sports betting technology. They almost had to take another shot on goal,” Van Egmond said.

PENN also likely recognizes digital’s increasing importance within the gaming business.

PENN could have started a new sportsbook brand. But that is a costly and also uncertain endeavor, and it may have run into timing issues (in terms of states passing legislation etc.).

So, a tie-up with ESPN –and a subsequent move to dump the Barstool brand– was viewed as the most attractive option.

“This is clearly the best remaining U.S. sports brand, and the only major national media partner left on the market,” Van Egmond said.

But it remains a gamble.

“PENN is paying a lot of money and doubling down on a media-integrated strategy that didn’t lead to meaningful market share [gains the first time around],” Van Egmond said.

And it’s not like there is a long track record of the approach working abroad, either. SkyBet remains the lone exception.

But Van Egmond seemed less concerned with history and more focused on what seem to be misaligned incentives.

“The vast majority of this deal is in cash for brand licensing. ESPN gets some warrants, but it’s di minimis in the context of Disney being a $165+ billion market cap company,” he said. “So, it is hard to envision ESPN aggressively pushing go the extra mile to drive audience conversion for PENN.”

Even if that ends up being the case, PENN should still see some semblance of a lift from the partnership.

“Maybe there are people who haven’t trusted the idea of online sports betting yet, but will if it’s happening under the ESPN brand,” Grove said. “Or maybe there are people who need that final nudge to go from interested to actually signing up for an account, and so greater exposure [on ESPN] will make a difference.”

Remember, just a small percentage of sports fans are currently betting; even when one accounts for the fact that roughly half the states have yet to pass legislation.

But PENN’s deck cites the iCasino (8-16%) and online sports betting (10-20%) market share ranges needed to reach $500 million to $1 billion of annual adjusted EBITDA. And few believe the company is going to reach those milestones.

“I don’t see ESPN as a brand being a catalyst to drive 3, 4, or 5x [OSB] market share expansion to achieve PENN’s goal,” Van Egmond said.

And as mentioned, that’s problematic in a scale business.

“Sports betting is only a 50%-ish gross margin business, and then there is a lot of tech, R&D, and marketing costs. So, even at maturity, it is inherently a 20% EBITDA margin business. You need a lot of share [to make it work],” Van Egmond said.   

It’s hard to imagine this deal driving meaningful online casino growth, either.

“Disney/ESPN is unlikely to push casino cross-sell, and PENN rebranding their iCasino product to Hollywood may only provide a limited catalyst in converting their land-based database,” Van Egmond said.

PENN likely needs to make outsized product or marketing improvements in online casino to exponentially increase its market share position.

There would seem to be more overlap between PENN's core casino customer and ESPN’s older, more mainstream, demo than there was with Barstool's database. But even if that is the case, it seems unlikely to be enough to turn the brand into a market leader.

“The midpoint of PENN's iCasino market share guidance is 12%, which represents a material increase from the less than 3% share that they’ve had during their operations over the last three years,” Van Egmond said. “I’m skeptical [they can reach that mark] given the growing competitive focus from land-based casinos on growing their digital casino presence.”

In other words, even if the ESPN deal transforms PENN’s OSB business, the company probably isn’t going to meet the high expectations it set.

ESPN looks have gotten a great deal on paper.

“PENN certainly bid more than anyone else; Disney CEO Bob Iger stated as much,” Van Egmond said. “That’s a big win because [ESPN has] been trying to monetize their brand around sports betting for a long time.”

But with PENN having an out clause after three years, and ESPN having to terminate existing tie-ups with DraftKings and Caesars, it’s not as clear a victory as some think.

“I would bet this deal gets terminated in three years for a lack of market share,” Van Egmond said. “It’ll be too expensive for PENN if they’re seeing the projected market share gains [or lack thereof].”

In that case, ESPN may net as little as ~$300 million, and the company could find it difficult to monetize the category in the years ahead.

“Sportsbook operators aren’t going to pay a premium to a media company if they are the former partner of DraftKings, Caesars, and PENN, and their audience converted in a way that may not have been transformative,” Van Egmond said.

Portnoy is clearly a winner in the deal getting to buy his company back for $1 after it was acquired for $550 million.

Some have suggested PENN’s decision to all but giveaway the brand reflects its minimal value amongst sponsors. But Van Egmond argues the decision says more about PENN’s platform than Barstool’s audience.

“It’s not that the Barstool audience doesn’t convert,” Van Egmond said. “They just didn’t convert at the expected scale, and competitors were very aggressive with arguably better products.”

He pointed to High Noon’s status as the top selling spiked seltzer as an indication of Barstool’s clear and positive influence.