DFS 2.0 Companies Facing Opposition from States, ‘Hypocritical’ Establishment

DFS 2.0 Companies Facing Opposition from States, ‘Hypocritical’ Establishment

The mainstream emergence of daily fantasy sports (DFS) 2.0 has arrived. And with it, the inevitable power struggle between the next generation daily fantasy sports companies (think: PrizePicks, Underdog) and licensed sports betting operators/daily fantasy incumbents looking to protect their turf (think: DraftKings, FanDuel).

The two sides have been embroiled in a public feud over the legality of against-the-house pick’em games since June. In recent weeks, state regulators from Wyoming and Florida have sent cease and desist letters to several DFS 2.0 businesses.

“It seems like this new wave of DFS [companies] is going through the old wave of scrutiny,” Doug Mishkin (partner, Bryan Cave Leighton Paisner) said.

DraftKings and FanDuel were ultimately rewarded for pushing legal boundaries.

“The current regulatory environment for daily fantasy was paved by the shake-out from all those lawsuits back in 2014 and 2015,” Mishkin said. “Some courts found that [DFS] was fine under current laws based on the element of skill, and some states actually changed their laws to expressly legalize and regulate it.”

By then the DFS leaders had already captured the market.

Mishkin believes DFS 2.0 could follow a similar arc, and anticipates eventual clarity –whether through the courts or legislation– regarding where these games stand.

“Assuming it breaks your way, there’s inherent business value in legal certainty,” he said. “I doubt any of these companies welcome cease-and-desist letters, but if they ultimately yield greater clarity it may be a net positive for [them and] the industry overall.”

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A key difference between traditional DFS and DFS 2.0 is who the player competes against. In traditional DFS, players compete against one another (or at least one another’s respective rosters) on a peer to peer basis. In DFS 2.0, players are competing against the house.

Peer-to-peer contests require large pools of players for liquidity and competition, which has proven difficult for upstart operators to achieve given DraftKings and FanDuel’s long history in the market. Against-the-house options can be scaled more easily.

“The object is to predict, for multiple athletes, whether each will have more or less than a given stat line established by the operator,” Mishkin said. “So, it shares the basic mechanics of parlaying player props, but the selection options are more limited.”

Against the house pick’em games are not, in fact, a new phenomenon. Monkey Knife Fight (MKF) began offering them shortly after PASPA was ruled unconstitutional in 2018. That company was acquired by Bally’s Corporation in early ‘21 for $90 million.

It’s worth mentioning that Bally’s effectively wrote off its entire investment in MKF, while shuttering the company, as part of an organizational restructuring earlier this year. It’s possible regulatory concerns played into that decision.

But companies like PrizePicks and Underdog have undoubtedly raised the format’s profile and built meaningful businesses over the last two years with national advertising campaigns and high-profile sports sponsorships. PrizePicks was recently named to the Inc. 5000 list of fastest growing companies with a purported 3-year growth rate of 3,712%.

In states without regulated DFS “they maintain these are games of skill, just like DraftKings and FanDuel did [during the rise of DFS 1.0],” Mishkin said. “And in the states that have regulated [fantasy sports], they either have the requisite license where required, or maintain that these games meet the requisite criteria established by legislation. There are also many states where they simply stay away, presumably because of laws that would unambiguously prohibit this game mechanic.”

Concerns regarding DFS 2.0’s legality have been discussed in industry circles for years. But the public discourse around it was elevated this past summer when FanDuel executive Cesar Fernandez made a comment at the National Council of Legislators from Gaming States conference suggesting several new generation fantasy sports operators were running illegal sportsbooks.

The establishment argues the challenger brands are offering sportsbook products without a license. It’s worth noting that DraftKings and FanDuel do not offer against-the-house style DFS products in any markets.

Of course, Underdog General Counsel Nicholas Green noted in a recent whitepaper that the brick-and-mortar gaming companies used the same argument in opposition of DFS 1.0 nearly a decade ago.

Underdog CEO Jeremy Levine also hit back with a public post accusing the DFS-turned-sportsbook operators of being hypocritical and trying to leverage political muscle to stave off the threat of competition.

It seems as if the noise caught lawmakers’ attention. Two states have notified DFS 2.0 companies that they may be operating in violation of existing laws.

But ironically, the cease-and-desist letters sent in Florida would appear to target DFS 1.0 as well, despite apparently only being sent to DFS 2.0 operators.

“Those letters include a reference to an Attorney General Opinion from 1991 opining on traditional season-long fantasy,” Mishkin noted. “The letters on their face therefore do not appear to be distinguishing between the mechanics of traditional daily fantasy [and] these newer pick’em games.”

In all events, it’s fair to assume these companies won’t roll over without a fight.

While DFS 2.0 is facing an existential threat, those playing in the space may not be.

In a best-case scenario, the DFS 2.0 companies can continue operating as is.

Worst-case, they probably just pull out of some states, or pivot altogether. PrizePicks and Underdog do not currently offer regulated sports betting products. However, it remains a likely growth avenue as they seek to further monetize large databases of vetted bettors.

“The challenge for them, [though], is they don’t have an exit right now,” one industry advisor who asked to remain anonymous said. “You can’t take a company like this public” with legal threats hanging overhead.

It seems unlikely an established gaming operator would acquire them at this point for the same reason.

And while both PrizePicks and Underdog have historically been able to raise a lot of money, raising more in the face of regulatory headwinds is challenging.

“Without a clear exit via M&A or the public markets, it will become more challenging to raise capital,” the advisor said.

Remember, these companies hold valuations upwards of $500 million (see: Underdog raised a Series B at $485 million). Investors are going to want to see a monetization event.

So, the DFS 2.0 market leaders are likely to continue harvesting cash flows while the legal process plays out.

“The dominoes could start to fall, as they did for traditional daily fantasy in 2015, when it was one Attorney General inquiry after the other,” said Mishkin. “Of course, [DraftKings and FanDuel] survived that process, and are thriving now.”

Of course, more so as sports betting operators than DFS companies.

“We know Underdog is planning to launch a sportsbook; maybe others are considering the same path,” Mishkin said. Then again, “the ability to secure and maintain a sportsbook license would be jeopardized if a company were ultimately found to be in violation of state gambling laws.”

It never reached that point with any of the DFS 1.0 operators, however, even though many of the same laws were in question.

“If anything, there’s more legal clarity now around daily fantasy sports, given the court precedent and various states that have since passed fantasy-specific laws,” Mishkin said.

DraftKings filed a trademark application for ‘CashPicks’ back in May. And there’s been speculation that the company may be preparing to offer its own version of against-the-house pick’em games to protect market share.

That seems unlikely, at least at this point.

The incumbents are no doubt paying close attention to how the regulatory inquiries around DFS 2.0 play out.

“Their preference is presumably for these games to be deemed unlawful absent a sports betting license,” Mishkin said. “But if their legality as skill-based fantasy games is challenged and generally confirmed, I imagine the next best option is to at least be prepared to offer their own versions of them as well.”

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