The DraftKings Bally’s Dichotomy (BALY)

27% Upside with Bally‘s, 17% downside with DraftKings

Bally‘s Corporation (NYSE:BALY) has received a non-binding proposal to go private for $38/share from its Chairman, Soohyung Kim. At the current price of $30, the offer represents 27% upside, should the Board of Directors agree to a deal. Quite to the contrary, DraftKings (NASDAQ:DKNG) is in the midst of acquiring Golden Nugget Online Gaming (GNOG) in an all stock deal, expected to close by the end of May. It is acquiring GNOG for about 10x sales, or 36x adjusted EBITDA in 2025. It seems like an expensive premium, especially when other precedent transactions have occurred at about 10x EBITDA. Since both DraftKings and Golden Nugget report negative earnings, it is necessary to value each on EV/Sales. Not a very reliable practice, and even when doing so, DraftKings should be trading at about $15/share, implying 17% downside.

Take a Gamble with Bally‘s

Back in January the Bally‘s Chairman – Soohyung Kim – who also happens to be the General Partner of Standard General, submitted a proposal to acquire BALY for $38.00 per share, paid in cash. Standard General is already the company‘s largest stakeholder, owning 22% of the shares since Twin River acquired the Bally‘s brand from Caesars in 2020. The proposal seems very cordial, with Kim recusing himself from the Bally‘s Special Committee to let the Board evaluate the offer independently. Consider the following language from Kim‘s announcement:

As you know, Standard General is the largest shareholder of Bally‘s with an equity interest representing more than 20% of the outstanding shares. As a result of our long-term involvement with the Company and its predecessor, we have a detailed understanding of Bally‘s, its business and assets, which will enable us to move quickly to finalize a transaction.

Surprisingly, this deal (or pre-deal) has flown under the M&A radar, with much of the spotlight getting gobbled up by Kohl‘s (KSS) and Macellum. While the Kohl‘s Board remains entrenched and set up for a proxy fight, Bally‘s represents a much more fluid situation, with the buyer (Standard General) standing alongside shareholders, and offering no financing condition nor any due diligence. The fact that Mr. Kim is willing to forego a pretty standard merger process means a deal should get done fairly easily, and reasonably quickly. Even if the deal takes time to coalesce, shareholders can rest easy knowing you‘ve got a savvy Chairman willing to put his money where his mouth is. It is a special situation that should limit downside over time.

Importantly, BALY recently completed a deal for iGaming company Gamesys last year. Bally‘s paid $2.7 billion, and at the time Gamesys reported strong 2020 results with approximately $60 million in net income and $250 million in EBITDA. The merger proxy outlines a few past years in the industry, and in general a decent EV/EBITDA multiple is about 10x. Given that Bally‘s paid 10.8x, the deal wasn‘t wildly overvalued. Sure, there‘s some pandemic pull-forward that went into Gamesys‘ profits, but the deal wasn‘t nearly as exorbitant as DKNG/GNOG.

Currently, BALY trades at 25x (assuming $4.7 billion in enterprise value and $188 million in EBITDA); but if Standard General wants to pay $38, I‘m willing to roll the dice.

What is the deal rationale for Standard General? Considering the long-term financing needed – SG would have to pay about $1.7 billion to buyout common holders – now might be an appropriate time, before interest rates and the cost of financing goes up. Moreover, before the pandemic began Bally‘s earned $147 million in EBITDA. If the business can get to pre-pandemic levels, raise some cash through sale & leaseback transactions, and add $250 million in Gamesys EBITDA, then hypothetically Bally‘s has the potential to be a $4 billion business at 10x. Roughly speaking, you‘ve got to figure Standard General sees an opportunity to own an omnichannel casino business for half price.

I will stipulate that there are a few wildcards within Standard General‘s bid that have to be worked out. First, Bally‘s sold 12.65 million shares to the public at $55/share to help finance the Gamesys deal. Second, Sinclair Broadcast Group (SBGI) invested $50 million at the same price. Third, GLPI has committed to purchase shares of BALY stock upon Bally‘s request, in order to further raise capital. Fourth, (and most importantly), Noel Hayden – the former Gamesys Chairman – agreed to accept BALY shares in lieu of cash so the merger could go through. All of these holders potentially have cost basis well above $38. Specifically, Hayden currently owns 9.5% of BALY, and when the deal went through BALY was trading in the $60‘s. There‘s been significant losses since then, and I estimate Hayden‘s break-even price to be somewhere around $47.50/share. That is, I imagine Mr. Hayden and Sinclair, among others, would turn down any deal resulting in losses. In order to get something done, it might have to be for a higher premium, or involve some sort of tracking stock/contingent value right to ensure the respective parties get to participate in future earnings. While not a deal-breaker, it makes the situation more complicated.

Close the DraftKings App

On the flip side of the coin, DraftKings management seems bent on gaining market share of the sports gambling industry, almost completely regardless of price. Consider the ongoing acquisition of Golden Nugget Online Gaming, which is expected to close by the end of May. Past precedent would indicate it makes sense to pay 10x EBITDA for GNOG; however, GNOG generates negative EBITDA, and will require significant financing over the next four years. For your reflection, below is a snippet from the definitive merger proxy between DraftKings and Golden Nugget:

…the merger consideration to be received by the holders of GNOG common stock (other than excluded holders) in the GNOG merger was fair, from a financial point of view, to such stockholders. Among other points raised, […] absent the proposed transaction, GNOG would soon require significant financing to fund its current operations and its future operations during the next four years.

The above comment occurred in August 2021, at a time when DKNG was trading in the mid-50‘s per share, and it valued GNOG at $1.6 billion. It is perhaps convenient medicine for DraftKings that the stock has dropped over 60%… now GNOG is valued $500 million. GNOG generates negative EBITDA, and by management‘s own admission, the business won‘t generate positive EBITDA until 2025. Only then could the company be valued at 10x EBITDA, and optimistically be worth what DKNG is paying up for now. I for one am not willing to wait.

It might be worth exploring what DKNG would have to do to trade at 10x EBITDA. At current prices, DraftKings is worth $6.3 billion, implying investors are banking on some $600 million in EBITDA at some point in the future. This past year, the business generated $1.3 billion in sales, but $1.5 billion in losses. To put it in perspective, in order to obtain $600 million in EBITDA, DraftKings would have to eliminate all of its sales and marketing expense, all of its product and technology expense, and all of its general and administrative expense. Simply put, that is not an investable scenario.

Suppose we flip the paradigm, buy in to the GNOG deal, ignore the persistent negative EBITDA for both companies, and are willing to pay approximately 4x sales (about what DraftKings is purchasing GNOG for at the moment), we could extrapolate a per share value of about $15. Below is a straight-forward calculation of enterprise value, where from the most recent quarterly report, DKNG had 402.5 million shares outstanding, $1,248.5 million in debt, $2,153 million in cash, and $1,300 million in sales (multiplied by a 4x sales multiple):

From the above equation, we can obtain a share value “x” of $15.17. Assuming an additional 28.8 million shares and additional $133 million in sales post-merger, DKNG‘s value increases to $15.38. Yet, in what valuation model does strictly increasing sales increase value? Considering that EV/sales is already a high-estimate method, at present that seems to be the upside case for DKNG. Notably, we haven‘t even touched upon the share compensation and incredible dilution by management. The intrinsic value could end up being much lower.

The Pair Trade & Conclusion

Doing better than the market is not the same as beating it. The first is often simply luck; the second is finding a statistically significant edge that makes sense, then profiting from it. -Edward Thorp

Generally speaking, with all the passive investment in the markets, stocks trade up and down in unison with the prevailing news. It is completely understandable to see BALY shares drop 5% along with DKNG, and visa-versa on the way up. However, in this particular case, one can find an edge by looking at the respective deals. On the Bally‘s side, we‘ve got the largest shareholder (Standard General) willing to take the company private at a 27% premium. With DraftKings, management is attempting to gain market share regardless of expense; if we were to pay the same sales multiple for DKNG that the business itself is paying for GNOG, we can extrapolate a devil-may-care price of $15/share.

Any time that the market shifts in the direction of tech and growth, DKNG will rocket upwards, making it eminently shortable. In the meantime, buy Bally‘s, and wait for the trip back up. With a little luck, DKNG will see rough quarters, while the invisible put will safeguard BALY. As usual, do your own due diligence; caveat emptor.