Daily Fantasy Sports: Is now the moment to invest?

Last year, I got to know a guy who is a legend in the North American fantasy sports video game space.

Tom Frisina is not only a lovely guy, but if not for him, I wouldn’t have wiled away my youth playing games on the Amiga, and my first PC, and just about every piece of electronics since.

So when he turned up at the President’s Club conference in Nassau, telling me about his new daily fantasy sports portal, I was interested. Granted, it wasn’t making a lot of money, being as FanDuel and DraftKings had the industry sewn up, and were pumping literal billions into advertising to keep their market share.

But Fantasy Aces (FAS.V), Frisina’s ‘solid #3’ competitor, had all the sound of a good backdoor bet on the business. After all, when the top two run out of places the put their ads the next best use of money in building market share is to acquire smaller players.

Frisina wasn’t shy about the possibility of this, saying, “It’s going to happen at some point. Our job is to make sure that we eat away at them a little at a time, make some money, and just keep growing.”

Then the industry collapsed. The New York state attorney general (rightly) decided that DFS, in which players pick real life professional sports players and score points based on their real life professional results, was gambling.

And it is. Back in the day, the UK Pools was essentially a lottery based on the results of random UK soccer games. Earlier than that, gangs of ‘number runners’ would hold local lotteries out of random homes in which the winning numbers would be based on anything from the last four numbers of the Cuban national lottery to the winners of the last four horse races in a given town, to numbers picked using a bingo wheel.

Of course, the winners of these games are completely random. DFS players will tell you winners in their events are using skill to improve their likelihood of a win.

Poker players say the same thing, and nobody wonders if that’s gambling. Blackjack likewise. Even roulette players would claim they have a system that ups their odds. I know of one guy who plays craps, and has a full sized craps table in his basement, a copy of one at a Vegas casino, upon which he’s spent days on end tossing dice in an effort to find patterns and improve likelihoods he’ll get the number he wants if he tosses it this way or that.

When he hits Vegas, he destroys. Bouncers follow him trying to figure out how he’s cheating.

Game of skill, mixed in with chance, with money on the line = gambling.

So let’s not argue that DFS isn’t gambling, let’s look at how it can be legitimized. That fortunately, appears to be how most states in the US are handling daily fantasy sports. Yes, there are still court cases rolling and many sites don’t do business in many states while the rules get sorted out, but it has become quickly clear that nobody wants to shut DFS down.

Even the professional sports leagues don’t want that, because teams are making bank on advertising DFS sites in stadiums, on TV breaks and more. TV sports companies such as ESPN want DFS legitimized. The people who play want it legitimized. And states, realistically, would prefer to make tax revenue on the thing rather than kill it off and incur the wrath of enthusiasts.

A few months back, DFS looked doomed. Today, it looks in flux, but is rapidly moving to the same place weed was this time last year – where you know it’s getting easier to do business, and that within a year it’ll be mainstream.

Fantasy Aces lost money in 2015, which is hardly surprising given the flux of the industry, but actually points more to their desire for growth. In order to maintain their actual ‘top 6’ place in the business (the top 3 claim being bandied about earlier is a nice selling point but not accurate), the company needs to offer large prize pools That means, if a given number of players don’t turn out for an event, the company loses money on it.

In a perfect world, they’d just return 85% of their revenue as prizes, the same way a slot machine does, and the company could accurately finance and plan going forward, but the big two aren’t going to play that way. If you want to compete, you have to actually compete, and that’s been rough on the small fish in the last year.

An FAS news release from a week ago said:

There was a measurable reduction in our user’s intensity starting in October, 2015 concurrent with the regulatory situation. That reduction was measured on all DFS sites. It not only affected the GPP tournaments but also the non-guaranteed “cash tournaments.” In 2016, the Corporation has seen both the intensity of its users, as well as an increase in its user base, grow measurably, an indication that much of this anxiety is receding.

Which, really, is what you would say, whether it was true or not.

But there’s actually a lot of indication out there that the corner has been turned for fantasy sports. States are coming to terms with the industry and setting rules in places, which companies like Fantasy Aces are not only agreeing to but enthusiastic about.

Players appear to be coming back as the baseball season hits full swing.

Cue Tom Frisina:

“The industry has been demonstrably impacted by the U.S regulatory mood since last fall. Since then, we have witnessed an expected and impressive evolution in the process to adopt laws state by state to fully legalize DFS and to date in 2016 five states have adopted full regulation. We anticipate that the process will continue to advance even more rapidly on many fronts as a result of these initial adoptions.”

Games played on Fantasy Aces, according to recently published numbers, are way up. In fact, they’ve almost doubled since 2015. Cash deposited has doubled. The amount paid out in prizes has hit around $5 million, which sets¬†after-prize revenues at about $500k. Not a lot of margin, granted, but pretty much industry standard.

Fantasy Aces has activated a search for a strategic investor to help it get to the next level, and that’s a smart move. Whether or not they’ll find that godfather is the bet you take. If they do, the current $0.03 share price and $2.9m market cap will look terribly tiny and big profits will be had.

And if they don’t? You know, they could sell the whole kit and kaboodle tomorrow to FanDuel for five times market cap and FanDuel would look at it as a rounding error.

The big risk at FAS has been that they’d be legislated out of existence. They appear to have beaten that threat back.

The alternate risk was they’d run out of money and not be able to do business going forward. If they’re smart, and focus less on the amount of their prizes and more on the percentage return of winning a game with fewer players than the juggernauts, improving the fan experience, and getting their new app out to as many people as possible, they can most definitely grind out growth.

I’m not buying in. Yet. I want to see how ¬†they do with the baseball season underway and the NFL season coming soon. A few more states legitimizing the business wouldn’t hurt.

But if FAS.V drops below its current $0.03 range, it might be worth a flier. Certainly the odds are better than figuring out whether the Blue Jays are going to win tomorrow.

Disclaimer: ALWAYS DO YOUR OWN RESEARCH and consult with a licensed investment professional before making an investment. This communication should not be used as a basis for making any investment.

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