DraftKings Inc. (DKNG) Earnings Call Transcript
August 23, 2022
Earnings Call Speaker Segments
Good morning, everyone. With me is Jason Robins, Founder and CEO of DraftKings. I am Ryan Sigdahl, senior research analyst at Craig-Hallum Capital Group. So these are short fireside chats, topic-specific. So with Jason, we will be talking about B2C operators' path to profitability. I think a very relevant time, as always, but I think especially right now given the bull-bear debate on the stock in the industry and given the near inflection point for the industry. So as a quick background, just -- I think many on here know this, but PASPA repealed 4 years ago. We have 35% or so of the U.S. population that has legal online sports betting; another 10%, a little better that has legalized waiting to launch here over the next coming months and quarters; iGaming, legal, live in about 12% of the U.S. population; the pace of legislation, they built in the industry, the long-term TAM; DraftKings #2 market share in both iGaming and in sports online sports betting; ultimately, the growth forward outlook, all those are undeniably positive here. So we want to dig into profitability over the past there, too, and not just profitability by Q4 of next year 2023, but to potentially billions in annual profit per year. So with that, Jason, I appreciate the time, everyone else, for listening in. And we'll get started here.
So I want to start, Jason. So on what kind of flow-through unit economics first, then go to state and kind of work our way through. But on the unit economics, the players, so can you talk through payback period? So you talked about 2 to 3 years. But how did you come to that target? Why is that the right target? And then if you can give any quantification on LTV-to-CAC and how you think about that longer term.
Absolutely. So ultimately, we want to look at the net present value of a player and get a good return on our acquisition spend against that. I think early on especially, we felt like with limited data, we did have a good amount of data from our DFS days, but we really didn't have any sports betting data in the first few years. So we felt like 2, 3 years is kind of a reasonable payback period that both balanced, allowing us to do -- to spend in a manner that we thought would ultimately be very justifiable and would allow us to be competitive and do well in the market. But also it wasn't relying on too lengthy of a payback period, where -- we didn't want to get caught in a position where we found that some of the return assumptions that we had made were just wildly off, and we didn't have cohorts that were paying back adequately. So felt like 2 to 3 years is a good balance and that ultimately, we'll refine it as we get more data. But our philosophy has always been to invest where we see a return that exceeds our cost of capital. And we are pretty confident that even with the most conservative assumptions, a 2- to 3-year payback would meet that criteria.
Any way you could talk through LTV-to-CAC? And I know it's really tough given there are only a few short years in and a lot of cohorts that are just legalized. But how do you think about LTV-to-CAC?
I mean, I think it's really about getting more and more data. And I think in the meantime, you make assumptions in -- early on, when you have less data, you go more conservative on those assumptions to the point where you know you won't be wrong in a way that materially would have affected your decision. And maybe you're trading off some missed opportunity, but you're not going to regret having made investments. Obviously, you're always testing marketing, so some things don't work. But from like more of a target return standpoint, you're not going to say, 3 years later that the data is saying something that would have materially made you pull back earlier. And then as you get more data, just being more precise in the assumptions that we can make. We also always build in a variety of, kind of, downside assumptions for things that may occur. So even though we've seen absolutely 0 deterioration in our consumer spend during some of the recent macroeconomic events, we built in some assumption around potential downside there. So things like that where we want to make sure that, okay, even if like -- it's nothing about the market itself or any previous data we've gathered but more about something that's happening now that has an effect that we weren't anticipating, we're being conservative there, too. So really, that's kind of, I think, how we look at it. And the more precise we can get and more confidence that we can develop in investments that we're making that they'll return at the levels we seek, I think, the more that we can lean in. And so we ask our team to just continue to sharpen up the models, continue to test things. There's always budget set aside for testing, and we know some of that's not going to work. But we feel like we can manage the overall portfolio to a return that meets that 2- to 3-year threshold on payback.
What are the assumptions, kind of if you talked through kind of model conservatively? So customer retention, your Analyst Day earlier this year, you reported customer retention over 80%. Each of the last couple of years, revenue retention over 120%. So DraftKings, you're retaining your players. More importantly, you're retaining the high-value players. But can you talk through kind of how those assumptions may be what you were hoping for or expecting a couple of years ago relative to what you're seeing today? And then what do you think the biggest reasons are plus retention?
So I mean, first, retention, of course, is like at the heart of LTV. The better you retain, the better your LTV. So it's a big focus area for us. We really focus on revenue retention. Obviously, you activate players along the way, but you can activate somebody by giving them free money. That actually has a negative impact on revenue if they just immediately cash out and go somewhere else. So just activating someone who's not going to play and not going to continue to be a customer is not something that we seek to do. So we really focused on revenue retention. We've had really strong numbers there in our Investor Day. We had published it. Our first year, we had over 100%. I think it was like 108%. And in the last Investor Day that we published in March, we said that we're now over 120% in some of our more recent cohorts with both OSB-only states and states that have iGaming. So it's not just because of the addition of iGaming. So that's really great to see. I mean we look at that as a measure of not just how good are our LTVs but how well are we doing by the customer. We really start there. We preach customer-centricity at the company. We start with to do the right of things to keep the customer happy, give them a good experience. Then we believe that there's money to be made in this market. And so we really start there. And I think that approach has led to having really strong retention rates.
Yes. It's something we've preached from the start is product and user experience is going to win the day in the end, even if it's not as evident early on, a lot of the promo dollars. So you kind of talked about that user experience, but I look to technology, kind of product improvements. You've had a couple of kind of notable milestones, I'll say. But you get the tech migration in-house for Kambi. You have enhanced parlay options, which is the big focus now. And then you have added Marketplace, NFTs. You're really building the biggest ecosystem here. But can you talk to kind of each of those step functions? Maybe there's other that I'm missing that have been really kind of integral in that retention and what you're seeing players like and that you think you're doing better than others.
Well, I think always improving the product and the customer experience is the most important part of retention. Also very important is service. Brand is important and trust and loyalty. But the most important thing, the centerpiece is the product and the experience that the customer has consuming the offering that you put out there. So that's really the thing that we focus. The largest chunk of resources on our biggest department is our product and technology department. Second and biggest is customer service. So those are our top 2 areas, I think, of making sure we get it right. And really, I think just continuing to improve the product. Customers notice that. They notice that -- you can tell when you're playing a game and there's new stuff that keeps appearing and you're like, wow, I'll try that. I'll try this, and it's fun. It keeps you engaged. And I think that, that, in the same way like a promo can engage people, new product features can engage people. So we really think about it as the same way we think about everything else, which is how do we engage the customer, how do we make sure that the customer feels like we're trying every single day to create fun things for them. And that also has the sort of secondary effect of developing very strong brand loyalty, too, which I think is something that has almost a very difficult to measure but, of course, has a halo effect over the entire LTV and acquisition equation. So we think that all of that really emanates from having a great product that's constantly evolving, constantly adding new things. Marketplace and Rainmakers is a great example. When some softness started to happen in the overall NFT marketplace, we completely pivoted to a gaming format which is, I think, just a totally different experience than pure profile pic-based NFTs or pure collectible NFTs. And so far, we've been seeing incredibly encouraging engagement. People seem to love it. And it's having that effect, I think, that I mentioned of people viewing the company is innovative, the brand is innovative. And I think that we've kind of developed a reputation since our early daily fantasy days with some of our customers across the country as being the one that's kind of pushing the industry forward through product innovation and always coming up with new things. So we're really proud. I think the Rainmakers is the most recent example of taking something and modernizing and meaning fantasy and modernizing it in a way that is obviously appealing to a lot of our customers who are into blockchain and cryptocurrency.
Yes. I think gamification of NFTs is certainly a very unique go-to-market. And when you have the DFS business, it makes a lot of sense and does seem like what we can see selling out and doing very well early on good demand. Last one, kind of on the player, just promotions. So we know new state launches, heavy promotional cadence from everybody in the industry. But can you talk through kind of, as markets mature, the level of promotions from kind of targeting new players versus existing players and then what you guys can do from a creativity standpoint, uniqueness, relative to others kind of to retain those players and promote to them?
So there's really kind of 2 buckets, you alluded to this, that we look at promotion. One are promotions explicitly designed and eligible to only new customers they are eligible for. And then there's promotions that are available to maybe not the whole database, sometimes depending on what it is, but to an existing user that is not necessarily a new sign-up. The new customers, of course, you have to invest more in. And really, we look at it as a percentage of revenue, which ultimately drives margin. So because a new customer is new and they're just trying to product out their revenue, certainly their life-to-date revenue will be low and the promotional spend will be relatively higher. So that percentage will be higher. As a customer matures, you have both the benefit of us optimizing promotions based on a lot of testing as well as just them growing their underlying spend. And of course, we feel it's important to continue to give some of that back. That's why loyalty programs and things like that exist. So it's not that we ever think you should just never give credits to -- or promotional givebacks to a customer even if they're not new. It's just that as time goes on, as a percentage of their total spend, we feel that, that number will normalize more in the 20 to -- I think we said like low-20s percent. And that's just based on some modeling that we've done as well as looking at other markets around the world. But it's different in different markets. And it hasn't necessarily affected the margins of the business because sometimes in some markets, I think, they found that it's more effective to have that investment instead of an external advertising. So you look at a country, for example, like Australia, which has a higher rate of promotion. It's, I think, close to 30%. And they call it generosity there, I think. And still the -- and by the way, it's a fairly high tax rate market, too, not as high as New York, but it would be the highest state otherwise. So not a low tax rate, and the profit margins in that country are quite good. So I think that there are always different levers that you can play with. We're always testing. And we continue to believe that low 20s is the ultimate settling place as a percentage of revenue -- gross revenue. But in the end, we're going to continue to test, and we have high confidence we can hit or exceed our profit margins. And if it ends up being a point or 2 more on that and somewhere else we cut back or a point or 2 less, then it wouldn't shock me. But I don't think it's going to be too different than what we laid out just based on the modeling we've done and looking at some of our more mature states like New Jersey and where they're trending. It looks like it's heading towards what we think it will.
Good. Shifting over to the states. So just maybe one here and then we'll keep flying through. But -- so you've all 2 to 3 years payback period on the state level. So that's contribution-positive. So we look at one example. You've disclosed New Jersey. But you look at the 4 years, 2018 through 2021, you were negative 48%, negative 6%, plus 5%, plus 28%. So seeing really good traction there kind of from the earliest cohort state. But the company is targeting about 45% contribution margin longer term. So that's taking your gross margins in the mid-50s; 10%, external marketing; gets you to kind of that mid-40s. So I guess talk through how long does it take to achieve that long-term contribution margin, whether it's by cohort level, by company, but kind of talk through that path of trajectory, whether it's -- you want to talk specifically New Jersey or kind of the higher level. But...
Yes. We've said -- so the scenario we presented, we've said is after all states that are needed to reach that assumption around the equalization have been live for 5 years. So some are even longer. So you can imagine that 45% would then probably for the assumptions we made in that model end up being a little on the high end for a fifth year state. But probably states that are more than that, some of them will be higher. Specifically in New Jersey, we're considering whether we update as we have in the last couple of years. Next year in New Jersey, we'll make that determination as we sit down and review what we think the most relevant materials for investors to share in -- early next year from the 2022 data. And New Jersey may be something we look at. But what I will say is New Jersey, we think, is going to land above that 45% mark in that period of 5 years or so. So really encouraging trend there. I think that New Jersey is a state that we feel is a good proxy. We've shared a lot of material in our Investor Day as to why for the average state in the rest of the country. So to see it trending towards -- above that 45% target, we believe, in probably that 5-year period is really encouraging to see New Jersey just for us completed its fourth year launched in 2018 in early August. So we think by the end of year 5, we'll be north of 45% there.
That's great. So let's go more kind of bigger picture for the company, some marketing. Obviously, there -- again, promotion, spending a lot early on, a lot of marketing build the brand, educate new players, et cetera. But your adjusted sales and marketing was a little over $1 billion, trailing 12 months at 67% of sales. So long-term targets are for $7 billion of sales, $700 million of marketing, 10%. So revenue is going to increase 4x. Marketing dollars are going to decrease. Can you walk through kind of how you think about your philosophy and strategy on marketing and things that will enable that intensity of spend to come down kind of as the TAM and revenue grows?
Yes. I think the number you're quoting includes the fixed cost. So it's a little bit lower when you look at just an apples-to-apples, the number you're referencing in -- is just the advertising spend. But the idea, and we've hopefully been very consistent in saying this and, is -- there's sort of 2 things that occur. And if you look at the New Jersey data we've disclosed, you can see, at least on a state level, the first one I'm going to talk about. First is, when a state first launches, there's more marketing investment to acquire customers. You have to remember, this is not a market we're building. It will get to a point where we're more focused on trying to introduce new players that haven't bet before. But right now, because there's been a ramp in illegal market for so many years, there are tens of millions of people in the U.S. that already bet. So going after them, it's a land grab right now. And so when a new state opens up, there's this entire built-in market, and you can acquire a lot of it pretty quickly in the first few years. Obviously, we'll continue to see new players come into market. We'll continue to try to find ways to get new players into market that haven't tried the product and haven't bet before, have been more casual. But there's more aggressive marketing spend, look no further than New Jersey to see what we shared there in the first year or 2. So that's point one. That will naturally kind of come down as more states mature. And remember in the scenario you're describing, we're assuming the least tenured state is still in year 5. And then secondly, we are starting to see a positive tailwind from being able to shift more local dollars into national. I think we'll always do some local heaving up at a state launch, but it will be a shorter burst and probably more lean on national advertising than it was in the early days when we didn't do any national advertising because it didn't economically make sense to do so. Now that we've gotten to a point where well over that kind of 33% to 35% of the population is eligible for sports betting, we can do that and it will be more economic. And the nice thing about that is as more states open up, you don't have to buy more national ads. It's already reaching people based on what you're already buying. So it should be a continuous tailwind also. So those are kind of the 2 things that we think create this sort of parabolic flow of marketing to would have been -- again, it's all based also on us looking at payback. So there's also a built-in assumption there on when -- but New Jersey, I think, has been a decent proxy. But there's a built-in assumption in there on like when we'll stop seeing as much new customer acquisition come in. Potentially, once you pass the first few years, you'll see some of the value of the customer dip a little bit, which we can tell very quickly as early as first deposit. We can do a pretty accurate, we think, projection at this point of the first 3 years of spend. So that's all built into the assumptions as well.
How much maintenance marketing, and maybe a poor term, but I think of CapEx and you have the maintenance and growth. But how much maintenance marketing is there in the business? Or do you think -- and maybe it's too early to tell kind of how much you'll need 5 or 10 years from now versus kind of that upfront land grab. You got to build the brand, once you go to national, once you market for several years, maybe you can pull back. But is there a level of maintenance marketing? Or is it all performance-based marketing?
Well, I think everything is performance-based. So you wouldn't do it if you thought it was going to cost more than what it was generating. So even if you're thinking of maintenance as like retention-based, I think we would have to believe that the impact on retention were more -- were in excess of the cost. There's also other things that I think even beyond sort of just pure retention, introducing new products, introducing new parlay features, those are things that can increase revenue per user. And that also, again, you can evaluate in the same framework of what's the payback I'm getting on that spend. But in the end, it's still always performance-based. We wouldn't spend it if we didn't think there was a good return on it. That said, I think that the assumption you've seen and that you referenced earlier, the $700 million, we think that it's a lot of money. It's a lot of marketing. We can make quite a -- have quite a presence with that. So we feel like longer term, that will be plenty to accomplish our objectives.
How much of your current marketing spend or budget is locked into multiyear deals? So we see kind of the big ones out there, ESPN, et cetera. But how much is it kind of really locked in where you don't control it versus ones that you can pivot kind of realtime?
Pretty low percentage. We, I think, disclosed long-term commitments in our Q. That includes rent and other things in there as you have to make some assumptions. But even if you look at that, you assumed 100% of it, which it isn't, we're long-term marketing commitments, it would still be low double digits.
Fixed costs. So you talked about $100 million of cost efficiencies that you've benefited in the past 2 quarters. But -- so really a cultural mind shift is what you referred to on the past couple of conference calls. But how do you incentivize employees? I guess thinking more, putting the head on, it's often easier to grow, spend more. It's harder to pull back and get employees really rallied behind that. So talk through culture shift, employee morale. How do you really incentivize people to look for cost cutting versus where can we spend?
Well, I think it starts with every employee in the company as equity. Everyone's a shareholder. So people understand the importance of being profitable. We've talked about in the past that we were going to slow down fixed cost growth materially in 2023. To do that, you have to do the work in 2022. You can't start doing that work in '23. So people expected it. We've messaged it for a while. And people understand why, and they're excited to do something that will help the company become profitable, which is our ultimate goal. And we've been very pleased that some of the efforts that maybe we at the beginning of the year didn't think were going to yield as much fruit in '22. Might be some benefit, but would really be yielding good cost savings in '23. We've been very pleasantly surprised and happy and really pleased with the efforts of the team that we've been able to achieve so much of that in '22. I think it's a great testament to the quality of people that we have that they've been able to rally around something, and frankly, exceed my expectations and how quickly and how effectively we're able to identify those opportunities, and most importantly, to do it without also taking our eye off the ball on top line. We've really preached like this can't be a trade-off. This can't be we're going to slow down on revenue growth to focus on costs. This has to be an and not an or. And again, I've just been so proud and so impressed at the team for stepping up and doing that. For 2 straight quarters, we beat now what we expected on both revenue and EBITDA. And that's because the team has been able to balance those things. And we said, "Look, find costs that don't affect revenue. Find ways we can just be more optimized. Find ways to renegotiate with vendors." Also, I'll tell you, some of the macro conditions help with that. It's a lot easier to call a vendor in 2022 and say, "Listen, I need a price break than it was in -- this time of year in 2021." So that helps, too, I think, having a little bit more firepower to be able to go out and have some tougher negotiations. And the team has really been very good about capitalizing on that.
One of the few industries who we're hearing that you can actually go and negotiate in your favor versus cost inflation hitting everyone else, so that's great.
You're growing [indiscernible].
Yes. Absolutely. One last question here. I know we're a minute over, but I think we have a couple extra on the 0.5 hour. But I want to talk to competitors, not expecting you to opine necessarily on what other competitor targets are. But of all the large operators, they're basically all expecting EBITDA-positive next year at some point. You have FanDuel [indiscernible], still talking for the full year. You have others, DraftKings and the list goes on, that are kind of talking second half or Q4. But what do you think is the biggest challenge or change that has to happen in the industry for that to happen?
I don't know that a whole lot has to change. I think a lot of the things that are already happening, the rationalization of marketing and promotional spend, the slowing of fixed cost growth, those are things that are happening now. So I think it's just continuing to see those things play out, and I see no reason to think it will change. I think this is a natural evolution for the industry. People sometimes forget that, that there's a natural arc to these things, and they decide that whatever in the moment is happening is forever true. But that's just not how it works. We've been through this with daily fantasy. There was a crazy spend period, and then it leveled off, and that business is quite high margin now. So I think that -- that's just the natural evolution of things. Particularly, I mentioned some of the dynamics earlier where there was this large built-in market of people. So it was very economically justifiable to land grab. But now that you're seeing us get to approaching almost half the U.S., you're starting to see real contribution profit kicked off by some of these more mature states. We mentioned we have 10 states that we believe will be contribution profit this year. Those states will all generate meaningful cash flow for us next year. So I think it's just continuing to execute on the plan that we have and continuing to see the overall natural evolution of the market occur in the way that it's occurring today.
That's great. We've seen it in other markets. U.K. was unprofitable for a couple of years, and we saw a big inflection. We're seeing it in early states. So I think it's a highly scalable model, and you can do it. So Jason, appreciate the time. I will end it there. But thanks, everyone, for joining.
Thank you, Ryan.
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