Far are we from the days when neighboring governors and industry analysts predicted Pennsylvania’s online gambling tax rates would be so prohibitive that gambling operators wouldn’t even bother. Pennsylvania is now the nation’s leading iGaming state (in monthly revenue) and consistently among the top five states for sports betting.
In March, PA became the third state, after Nevada and New Jersey, to surpass $1 billion in sports betting handle. And no state has produced more sports gambling taxes ($253.0 million through May 2022). iGaming (online casinos and online poker) have produced even more in revenue and taxes. Through May 2022:
- PA iGaming GGR: $2.58 billion (Second-highest in US)
- PA Sports Betting GGR: $1.06 billion (Third-highest in US)
Morgan Stanley’s recently released 2021 online casino report sheds light on the future of online betting markets in the US, with implications for online gambling stocks. The report also makes clear the importance of iGaming for companies with both sports betting and online casino verticals, and future profitability expectations for these US-facing gambling brands.
iGaming greater than sports betting, but not in number
While they may not always get the same media and legislative attention, online casinos make more revenue for operators for the state (by a lot) when compared with sports betting.
But the pace of legalization of iGaming is snail-like compared to the torrid pace of online sports betting. Legal sports betting is currently live in 30 states (plus D.C.). Online sports betting is live in 20 states plus D.C., with more launches imminent. Meanwhile, only seven states offer live, legal online casino gambling (online slots and table games).
Analysts at Morgan Stanley predicts the trend will continue, with fewer states passing iGaming legislation due to “less public and industry support, louder industry opponents, and the slow rollout to-date.”
Projections for 2025:
- 11 legal iGaming states
- 42 legal sports betting states
On a state-by-state basis, operator and tax revenue from online casinos far outpace sports betting revenues. According to Morgan Stanley:
In the states that do legalize iGaming, we expect revenue to be around double sports betting.
This makes states like Pennsylvania, New Jersey and Michigan (the most-populated iGaming states) desirable destinations for operators. Other winners in this equation are the state (and local entities that benefit from gaming tax revenue) and in-state customers.
How much revenue will online casino and sports betting generate in 2025?
Despite the limited jurisdictions, iGaming revenue is expected to continue on the hot pace it has been on since Covid-19 stay-at-home orders accelerated the industry in March 2020.
The Morgan Stanley report projects the following revenue for the two verticals.
- 2025 iGaming projected revenue $7.8 billion ($300 million in 2018)
- 2025 Sports Betting projected revenue $12.8 billion ($400 million in 2018)
According to the projections, PA will continue among the nation’s iGaming revenue leaders in 2025 (New York is not included).
- Michigan: $1.495 billion
- New Jersey: $1.490 billion
- Pennsylvania: $1.460 billion
- Illinois: $1.336 billion
PA 2021 GGR breakdown:
- iGaming GGR: $1.3 billion
- Sports betting GGR: $505.5 million
Morgan Stanley also projects PA sports betting GGR of $701 million for 2025. Based on 2021 figures, both projections seem well within reach for the Keystone State.
Rising tide of PA online gambling
According to Eric Ramsey, market analyst for PlayPennsylvania, PA iGaming is tracking more than 33% higher than 2021 through April, putting revenue on pace for $1.7 billion for 2022. And sports betting revenue is on pace for a $560 million year, up 10% YoY so far in 2022.
“Pennsylvania is making a strong case for itself as the most successful iGaming market in the US, and we haven’t seen the top yet. While sports betting revenue is subject to seasonal shifts, the local online casino industry has continued to show steady growth, even in the face of broader economic headwinds.”
In March, PA and NJ became the first states to surpass $140 million in monthly iGaming revenue, which seems to be the new bar.
“Expect online casino revenue to continue to outpace sports betting in this market, and really every other market in which both are legally available. Pennsylvania demonstrates with particular clarity the financial benefits of making casino games available online, including to customers who typically prefer to gamble on sports,” Ramsey said.
Online casino lifts operator profit
Looking at the entire US market, sports betting revenue will far exceed iGaming revenue in 2025. But that doesn’t tell the whole story of the importance of online casinos on gaming operators’ bottom lines.
As the Morgan Stanley report notes, operators are able to reach break-even quicker in states that have both sports betting and iGaming. That means they can achieve profitability sooner (even despite high tax rates).
Top operators including DraftKings, FanDuel and BetMGM are projecting “1-3 year positive payback periods.” More details from the report include:
- In NJ, DraftKings saw profits ramp up in Year 3 (net gaming revenue of $239 million; positive contribution of $68 million, or 28% of NGR)
- BetMGM saw positive contribution profits in MI after 9 months. (This was helped by cross-sell, with around 75% of online sports bettors crossing into iGaming play.)
- DraftKings expects net profits beginning 2-3 years after launching in a new state.
- FanDuel expects net profits to kick in 12-24 months after launch.
- BetMGM guides breakeven contribution profits at 12-24 months for online sports betting states and 10-14 months for iGaming states.
Plenty of short-term investors have deemed these unacceptable timelines, as reflected in recent stock plunges. In stock investing, however, patience is often rewarded in high-growth industries that are still in their infancy.
The ‘long game’ for online gambling operators and stock investors
The iGaming and sports betting stocks Morgan Stanley covers include $DKNG, $MGM, $PENN, $CZR, $BYD, $WYNN, $FLTR and $ENT. On the whole, this group of stocks:
- Outperformed the S&P 500 by 82% in 2020/1H21
- Underperformed by ~26% in 2H21 and by 10% YTD in 2022
- Lost ~$2B on online sports betting and iGaming in 2021
- Expected to lose ~$3B on online sports betting and iGaming in 2022
The report attributes the underperformance over the last year to a concern among investors that the industry will never be profitable. In answer to that, Morgan Stanley also forecasts:
- FanDuel and Penn National to reach profitability in 2023
- DraftKings, BetMGM and Caesars to reach profitability in 2024
A second chance to get in early on Amazon and Netflix?
Morgan Stanley likened online gambling companies in the US to other “high-growth, early-stage industries” like Amazon, Netflix and Snap Inc. For stock investors intent on playing the long game on online gambling market leaders, this should be a welcome comparison.
AMZN, NFLX, and SNAP all had similar tricky transitions from revenue to profits, but following quarters where they achieved significant margin outperformance, they returned 96% in the following year, on average.
We believe once sports betting/iGaming operators begin to demonstrate profits in key early states, the stocks could follow a similar rebound in performance.
NJ, PA and MI all fit the “key early state” description, and longterm profitability seems achievable in all of them – at least for the market leaders.
Morgan Stanley projects US sports betting/iGaming market leaders to deliver around 25% long-term margins (24% in 2025 for DraftKings). These projections are based on some other expected trends including lower promo spend and customer acquisition costs (CAC) and high lifetime value (LTV), or customer spend over time.
The cross-sell benefit for online gambling operators
According to the Morgan Stanley report, legalization of iGaming is important for company margins because sports betting and poker platforms are the easiest to cross-sell into iGaming.
A few gambling companies have benefitted much more than others from lower CAC due to cross-sell. DraftKings and FanDuel are the simplest example of this advantage as they have been able to leverage their DFS databases, reducing their CAC to around 2/3 that of competitors.
The Stars Group, owned by Flutter, was able to reduce CAC in early markets because of PokerStars. The same company also now benefits from cross-sell from FanDuel DFS and sports to online casino.
Since the launch of online casinos, gaming companies are also cross-selling from loyalty databases at land-based casinos to iGaming. This “omni-channel” approach has proven successful for the top gaming brands in PA including Penn National, Rush Street/Rivers, Caesars and Boyd Gaming.
The same operators are also benefitting from cross-sell from retail sports betting to online sports betting and retail table games.
Hopeful future for US gambling stocks
To sum up, higher margins (and profitability) should be achievable by iGaming/sports betting companies in the near future thanks to:
- High/increasing LTV (with a focus on customer retention)
- Lower CAC (less marketing/promo spend over time as markets mature; leveraging cross-sell from other verticals including land-based casinos)
- Legal iGaming states where operators can offer the full omni-channel approach to help lower CAC
As margins rise in the longterm, the big winners in online gambling are likely to see stock prices follow suit. What happens in the short term stock prices, however, is anyone’s guess.
Lead image via Shutterstock.
