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With all the discussion heating up regarding the legalizing of online gambling, most investors have probably missed that skill-based gambling is already legal in most states. Betting on fantasy sports and other skilled based games is legal in nearly all states and has a preferential carve-out on the Federal level under the Unlawful Internet Gambling Enforcement Act of 2006. According to Forbes contributor Marc Edelman, daily fantasy sports are insulated from federal liability if it meets three conditions as follows:

  1. The value of the prizes is not determined by the number of participants.
  2. All winning outcomes reflect the relative knowledge and skill of participants.
  3. No winning outcome is based on the outcome of the score of games or the single performance of an individual athlete in a single, real-world event.

According to Edelman, no court has assessed whether daily fantasy games fall into the safe corner of the law, which could actually be good for the small websites. A clear legal view on daily fantasy games could signal the all clear sign for the major websites of The Walt Disney Company (DIS) subsidiary ESPN, CBS (CBS) Sports, and Yahoo! (YHOO) Fantasy Sports. Edelman has an interesting point that as long as legal risks exist, these small websites can build a commanding lead in the sector while the big boys sit it out.

Versions Of Skill-Based Games

The interesting part is that while skill-based gambling has been legal for years, the market is just now heating up. Several small caps including Glu Mobile (GLUU) and MGT Capital (MGT) are pursuing two entirely different aspects of the market while also pursuing the more traditional luck based gambling segment. Glu Mobile is focused more on turning mobile games involving skill into competitions and tournaments. As an example, Glu Mobile plans to take the popular Deer Hunter game and create tournaments with prizes.

MGT is focused on the fantasy sports category where fantasy players have increasingly spent more and more money to bet on season long leagues. MGT though is focused on the new daily concept where users can bet on daily outcomes versus the traditional full-season that took multiple months to finish.

This article intends to focus on the daily fantasy sports segment that has obtained considerably less attention. While MGT has aggressively moved into the sector with the purchase of a majority ownership of FanThrowdown.com, it already faces stiff competition.

Surging Growth In Daily Fantasy Sports

The daily segment is only getting started with 5 million users versus 35 million users of the more traditional season long games. The upside potential is incredible as users slowly move over to the more exiting competition that allows for instant gratification for an increasingly mobile centric society. Who wants to wait months to win?

While the daily sports concept is relatively new, it already includes the full slate of major sports including the NBA, NFL, NHL, MLB, PGA, and NCAA basketball and football with plans for NASCAR. Fantasy sports addicts can compete virtually every day via the diverse sports. The users draft a team, place a wager, and get paid in the same day. In some cases, the wager might involve a week or maybe the four days of a PGA tournament. Either way, the skill-based games are relatively short in duration in order to provide instant gratification and wagering turnover. That constant turnover of wages equals more and more fees.

The sector is still in its infancy, but FanDuel.com commands a market lead while DraftKing.com is another serious player. MGT hopes to inject capital to turn the compelling offerings of FanThrowdown.com into a service that threatens the market share leadership of those two sites. Other sites including Draftday.com, DraftStreet.com, and StarStreet.com offer competing websites with numerous others around the corner. Probably more worth watching at this point will be whether the more traditional fantasy sports players such as Yahoo! Fantasy Sports, ESPN, and CBS Sports decide to enter or transition existing offerings into the daily sector. It is possible that these media leaders could swiftly swamp some of the relatively obscure smaller players. Likely though, a few of the better-developed sites will manage to thrive with first-mover advantages and a focused management team.

Fantasy Sports Trade Association

As mentioned above, the Fantasy Sports Trade Association (FSTA) estimates that 35 million people play fantasy sports in North America with some 5 million playing the daily version. The total players have soared 60% in the last four years. Though based on a 2011 report that doesn't encapsulate the recent surging growth in daily sports, the industry demographics captured by FSTA include the following:

  • The overall mean age is 41.4 years.
  • The most popular sport is football with 72% playing that sport.
  • Around 74% of fantasy players viewed at least 4 websites to obtain information.
  • 92% attended college.
  • 70% make $50,000 or more annually.
  • $92,750 average household income.

Based on the research, the average fantasy player is educated and dedicated to spending money and time on the games. The question is whether the typical player is willing to shift over to daily wagering.

Per FSTA the average site rakes a 10% cut of the amount wagered, which could become huge as the daily nature of this new concept allows for continuous wagers.

Reviewing The Leading Daily Sites

With an influx of cash, the leading daily fantasy sites are starting to rise to the top as more cash allows for advertising and development of the websites. The numbers are still relatively small in comparison to the opportunity, so investors should expect more news in the not too distant future. Below is a summary of the top sites and the capital invested:

FanDuel is listed as having 60% of the market and started up in 2009. The company claims to have paid $50 million in winnings for 2012 and is currently paying out over $2 million in prizes every week. This pace places the company at over $100 million in prizes for 2013. According to the website, the company has raised $18 million to date and includes Comcast Ventures, the venture capital arm of Comcast Corporation (CMCSA) as an investor. In fact, the company raised $11 million Series C financing in January where Comcast partner, Andrew Cleland, joined the board of directors.

DraftKings recently raised funds from Atlas Partners that sees the market expanding 20 fold through 2020 hitting $2 billion in fees versus less than $100 million today. The venture investors invested $7 million in Series A funding that places the website on par with the cash raised by other leading websites. According to Forbes, DraftKings claims the No. 1 provider of daily fantasy sports mobile apps and expects to award over $20 million in prizes for the MLB season alone.

DraftStreet launched in 2010 and recently got an investment from online media conglomerate IAC (IACI). According to the WSJ, IAC recently confirmed making an investment in DraftStreet without providing the details. DraftStreet raised $1.6 million in Series A funding back in 2010 so one can probably assume that the deal was similar in scope to the amounts raised by the other firms.

FanThrowdown sold 65% of the company to MGT for 627,500 shares or restricted common stock plus $200,000 in cash. With the stock trading around $4, the deal cost MGT around $2.7 million and valued FanTD LLC at around $4.1 million.

MGT Best Pure Play Around

With so many large firms now involved in minority or even majority positions in the daily fantasy websites, MGT provides the only investment option where this business line will move the needle. Even though Comcast and IAC are public companies that now have stakes, it will take decades before this relatively small business line impacts either stock. Conversely, MGT could be greatly impacted by the success or even failure of the daily fantasy concept.

MGT recently hired industry veteran Michael Haller to lead the push into skill-based gaming. Mr. Haler has experience at Electronic Arts (EA) and Dreamworks Interactive, but most notably turned around THQ, Inc. during the 2000s to make it into the third largest third-party video game publisher in North America. He will be tasked with building out the mobile gaming platform called Hammercat Studios with an expected beta launch at the end of the year. The platform will be used for wagering on skill-based games in the legal jurisdictions that currently count 36 states.

Anybody following MGT knows that the company isn't a one trick pony completely focused on fantasy sports now. The company is currently involved in a patent lawsuit over casino gaming systems. Basically it owns US Patent No. 7,892,088 that covers a gaming device having a second separate bonusing event and filed a patent infringement suit against several major players in the casino sector. For more details, please read MGT Capital: Small Patent Stock With Huge Potential.

The company also recently sold its portfolio of medical imaging patents related to Medicsight, Inc., a medical technology company with intellectual property and operations in imaging software and hardware devices. The deal provides MGT with $1.5 million in much needed cash to fund the development of the online daily fantasy sports wagering business and continue pursuing the patent infringement lawsuit.

With a market cap of around $30 million, MGT provides the best pure play in the public markets. It also should provide some interesting quarterly details on the sector.

Reviewing The Traditional Fantasy Sites

Anybody that has played season-long fantasy sports has probably entered a league at Yahoo Fantasy Sports, ESPN, or CBS Sports. Whether playing in a NFL or MLB league or playing the college basketball tournament, users historically played for pride and the chance to test their skill against friends or strangers around the world with equal interests. These sites serve the estimated 35 million adult Americans that play fantasy sports each year. That number has grown an estimated 60% the past four years. That number should only increase as the expansion of daily based games attracts a larger user base looking for immediate gratification similar to gambling at a casino or horse race.

Yahoo Fantasy Sports offers a Pro Leagues that generate revenue from its Trade Review Service and Scouting Report that each cost $14.99 per season. Most of the traffic for the site is attracted to the free services that allow competition against friends or random people. ESPN commands a large industry footprint and mainly focuses on generating ad revenue while CBS Sports has a $179.99 seasonal package with revenues over $50 million per year. Sirius XM Radio (SIRI) offers a dedicated channel for fantasy sports.

In general, the details are limited as all of these services are part of large companies where the revenue from fantasy sports is almost incidental. Regardless, all of these companies will benefit from the advancement of wagering in daily fantasy sports whether each individual company enters the actual wagering. The demand for services will only expand as users value the best information more when playing for cash instead of pride against friends.

Conclusion

The skill-based gaming sector is starting to command considerable industry interest from venture capital firms to industry leaders such as Comcast and IAC. For investors, MGT Capital provides the only real choice to invest in the daily fantasy sports sector with the planned expansion into other skill-based gaming sectors.

Glu Mobile also provides an entry into the skill-based sector via mobile games. That stock offers an interesting investment though it has continuously struggled to reach stated goals. Regardless, the stock will be worth watching to see the progression of the whole online gaming and skill-based sectors.

For now, FanThrowdown, FanDuel, and DraftKings have the opportunity to greatly expand the business without any majors offering competing games. If either can obtain substantial user bases in the next year, the services could become the indisputable leaders with first mover advantages. MGT Capital could see a considerable increase in value if it is able to move FanThrowdown into a sector leader where growth will be substantial during this decade.

Source: Skill-Based Gaming Heating Up, Especially In Daily Fantasy Sports

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.