The casino industry was ‘one of the brightest surprises’ in 2021: Analyst

Macquarie Analyst Chad Beynon joins Yahoo Finance Live to explore the online sports betting space and explain Penn National Gaming’s disappointing 2021 performance.

Video transcript

ZACK GUZMAN: Well, gaming stocks have been hit hard in 2021, with Penn National Gaming and Las Vegas Sands seeing their worst performances out of the S&P 500 this year. With the former down 41%, and the latter down 36%, it's been a tough go for those gaming stocks. And here to break down what to expect from those companies And more in 2022 is Macquarie analyst Chad Beynon here with us.

And Chad good to see you again. I mean you know it's been an interesting year for a lot of sectors. So maybe not too shocking to see some ups and downs in the gaming sector. But when you look at maybe some of those names, what do you make of the year they had, given all the pandemic interruptions and maybe some of those benefiting from earlier bets on online gaming as well.

CHAD BEYNON: Sure. Thanks for having me, Zack. Happy New Year. So from a fundamental perspective, the casino industry in the United States was probably one of the brightest surprises. I think as people came back from the COVID restrictions, casinos were actually a place that they found to be very comfortable, and also a place where they wanted to spend their entertainment dollars. So across the US, including Las Vegas, we saw record fundamentals, record revenues, and that also translated to record profits.

Now on the flip side of the coin, while all this was going on, there were two other things. One, you had China and Macao that essentially was in lockdown. One of the reasons why Las Vegas Sands was one of the worst performers in the S&P as you mentioned, just because of their focus on China. And then the second thing was this new thing called sports betting and online gaming, which has essentially been legal for three years.

And there's two approaches in sports betting and online gaming. One is, acquire as many customers as possible right now. Spend the marketing dollars, do what you need to do get them in your pockets and then show them the product that you built or bought. The other approach is, try to have a break-even business and not really go bonkers in terms of acquiring customers.

And that was the approach that Penn National took after they bought Barstool back in 2020. Penn National was one of the best performers in 2020, and I think people expected that Barstool, given its brand appeal and reach, would secure a double digit share in sports betting in the United States. And that has not been the case, hence the reason why Penn National was one of the worst performers in the S&P this year.

ZACK GUZMAN: Yeah, and I guess when you look ahead to next year, too, they are not on the list of companies that were receiving licenses, right, to operate in New York as they roll out sports betting as well. So that's another blow that some of their competitors are going to have on top of them. And how huge is that, right? Because we've been seeing some of these free bets to onboard users in New Jersey. The case of Caesars I'm not going to say I participated in it, but I did. It was $5,000 that they were giving away for people for free bets just to sign up. And how big of a boost are you expecting from New York, and which companies are you expecting to maybe benefit in that to get 2022 kicked off?

CHAD BEYNON: Sure, so you have companies like Caesars that have announced losses up to a billion dollars over the next year. DraftKings is in the same boat. They're expected to lose between $600 and $700 million this year acquiring customers. Most companies have a plan to break even in 2023 or maybe 2024.

From a state perspective, all companies are expecting to be positive in that state between year two and year three. As it pertains to New Jersey and New York, New Jersey has been one of the strongest markets in the US by far. And we believe that somewhere around 20% to 25% of the New Jersey revenues are coming from people who reside in the state of New York. So New York, they had a very different licensing process, there will be nine licensed companies.

We think one of the big winners here will be DraftKings. DraftKings has a very aggressive marketing plan as they did with Daily Fantasy back in 2014 and 2015. When this goes national, their marketing plan that is, I think they'll be able to get that leverage on that marketing dollar. They will have different advertising contracts, they also have really strong ties with different leagues and teams. I think they'll be a big, big winner in New York.

In terms of the profits that they'll actually derive in New York, because it's a 50% tax rate, which is the highest in the United States. For comparison, the average is somewhere between 10% and 15% in other states. They probably won't be making that much money in New York. But I do think it's an important state. It's important for the stock. It's important that they're a top three player. And I think that will be one of the things that drives the stock higher in 2022.

ZACK GUZMAN: That's what's so interesting about the strategy, right? To lose so much money in the front end, it's caught in the attention of some big short sellers. Jim Chanos earlier this month revealing his big short on DraftKings saying that they're spending too much to ever make sense. When you look at that, how do you digest the numbers there and the runway that DraftKings has to really turn it around eventually down the line?

CHAD BEYNON: You really have to trust them. The customer acquisition costs in this industry right now is somewhere around $500. And DraftKings and others in the space believe that the annual revenues from the players that they acquire is in excess of $1,000. So if you look at of a three year period, the lifetime value divided by the customer acquisition cost is somewhere between five and six times, and the payback period is within six months. So what they're saying is the churn is very low.

They also have their own technology and the goal is to cross-sell these people to other products, such as iGaming. They just launched Marketplace, which will include NFTs. They're dabbling in the ticket space. So we do believe in their strategy. It's certainly one that required some patience this year, and the year where they're going to lose hundreds of millions of dollars. Our revenue estimates continue to go higher as do our competitors. And I think that's one of the things like we've seen with the software space that will drive the stock higher in 22.

ZACK GUZMAN: It's interesting to see all of these offers. We'll see how my weekend bets fare here, Chad, because there's a good chance I might be in the red when it comes to FanDuel's additional promos as well. But lastly just kind of wrap up. You talked to us last time we had you on about one of your bets for takeover plays, Rush Street Interactive. That one was looking like it was playing out and we saw the pullback in the widest, in the gaming sector writ large. Talk to me about, as you're discussing some of these companies leaning into iGaming, what those potential takeover plays might look like and how you see that shaping up next year.

CHAD BEYNON: Sure, we think Rush Street has done a very good job with low marketing dollars this year. They're a top player in the iGaming space, so that's people playing slots and table games online in states like New Jersey, Pennsylvania, Michigan, hopefully more to come. This is only legal in six states where sports betting is legal in 30, so Rush Street is a leader in that space. And they haven't been losing much money, they have a clean balance sheet. They have a good, loyal customer base that could be cross-sold to other things.

DraftKings is in the middle of acquiring Golden Nugget Interactive. We look at Rush Street as a company that probably has slightly better fundamentals than a Golden Nugget. So I think other companies who are looking to get into the female first iGaming user base will probably look at Rush Street and look at a clean way to grow that presence.

It's very hard to market. Right now all the marketing is done towards a male audience, a sports betting type of person and Rush Street is a leader in iGaming. So I do think it's one that could be acquired. We really like it here, we have a $28 price target, about 60% upside. And then also in the space, there's a few other names that play in the platform side of things.

One company that we like is Gan, we have a $23 price target. They essentially run the player account management. So Zack, when, you signed up for your account in New Jersey, gone through some Gan technology. And I think the technology is very critical. DraftKings made a billion dollar acquisition to have that vertical integration. So those are two names we really like who might not it might be part of a bigger company by the end of 22.

ZACK GUZMAN: We'll see how this all goes, but those are the best bets for 22. Appreciate you coming on Chad Beynon to highlight all those. We'll see how the parlay goes, too. It's Bears, Packers, and Titans, and I got a lot riding on this, so we'll see. We'll have to have you back either way it goes. Chad Beynon, Macquarie research analyst there with us, appreciate--