The Daily Fantasy Sports Takeover

A new subset of the fantasy sports boom is well on its way to becoming a multi-billion dollar business, but who will walk away with the biggest chunk of the pot?

Oct 29 2014, 2:00pm

During November and December, Peter Jennings will work a banker's schedule, more than 100 hours a week, spending his days peering at a stock trader-like setup that includes three computer monitors and four televisions. The gig makes sense as the 26 year old previously worked for Charles Schwab. He's making banker money, too, he says, grossing $4-5 million this year alone.

But Jennings doesn't work in finance. He makes his living playing Daily Fantasy Sports (DFS), an exploding subset of the fantasy sports world that is gaining traction because of its rapid-fire play, near instant gratification, simple rules, and, of course, the ability to win real money. During peak baseball season, Jennings puts down between $25,000-30,000 a day, and in August, he won $1 million during a single fantasy baseball tournament. This fall, he found himself playing in somewhere between 4,000 and 5,000 NFL contests per weekend with a total of $100,000 on the line. It's not the stock market, but it's pretty damn close. And it's a hell of a lot more fun.

Jennings is one of the most successful members of a small group making huge money playing DFS, but there will soon be many more both playing the games and making—or losing—the cash. Millions of dollars from venture capitalists are surging into the space as FanDuel and DraftKings, the two biggest players in the industry, are locked in a battle for dominance and spending massive amounts on customer acquisition, marketing, and advertising. Both professional leagues and media entities like NBC Sports support the games, which have been shown to increase fan engagement.

Legal issues, although a concern, are relatively minor. The result is a world in which more people signed up to play DFS since the beginning of the football season than had done so previously in the category's history. Still, only about a million of the estimated 40 million season-long fantasy players participate in DFS, so advocates argue the potential for growth remains massive. FanDuel alone says it will pay out $500 million in 2014.

Jennings and others like him—sophisticated players with algorithms and spreadsheets that rival stock market day traders—are laughing in their man caves, minting money.

Peter Jennings after winning a lot of money. Photo via DraftKings

The Rapid Rise of DFS

On July 21, 2009, entrepreneurs Nigel Eccles and Tom Griffiths changed up their prediction market game Hubdub and launched FanDuel along with Lesley Eccles, Rob Jones and Chris Stafford. It wasn't the first DFS offering in the space, but it quickly became the largest. The premise is simple. Instead of selecting players for an entire season like traditional fantasy sports, DFS matches require a person to pick a lineup for a single night (or week, in the case of the NFL), while staying under a salary cap. Participants can play one-on-one battles with their friends for free or a set fee, or join a one-day league with the winner(s) taking home the spoils. The fast metabolism works for our wired world.

Brian Rosenworcel started playing fantasy sports years ago as a hedge against the boredom of a tour bus. The drummer for the band Guster also used the leagues as a way to stay in communication with his college friends, and eventually found himself competing with his musical hero, Pavement's Stephen Malkmus. While Rosenworcel spent hours researching and doing analysis for the leagues, he would occasionally grow weary of the long seasons.

DFS fixed that problem. "As soon as I put some money in a FanDuel account, I realized, 'Oh my god, this is the thing that scratches whatever itch brought me into fantasy sports to begin with. It just scratches it more regularly,'" he said.

Other players agree, and the explosion of participants took everyone by surprise. "Everything has happened way, way faster than I thought it would," DraftKings CEO Jason Robins said about the rise of the industry in which his own company has gone from not existing two and a half years ago to estimating it will pay out $100 million during this football season.

According to Paul Charchian, president of the Fantasy Sports Trade Association, "There has never been a bigger change in our industry than what's happened with Daily Fantasy Sports over the past two or two and a half years. We've had more investment in the fantasy industry over the last year than we have had in the entire history of the entire fantasy sports industry."

He's referring to the more than $110 million invested into FanDuel ($70 million by Shamrock Capital Advisors, NBC Sports Ventures, and others) and DraftKings ($41 million by the Raine Group, Redpoint Ventures, GGV Capital, and Atlas Ventures) this fall, which brought the total VC money to more than $160 million.

It's a shocking amount of cash, and everyone involved is trying to grab a piece of the future.

So Is it Legal?

The 2006 Unlawful Internet Gambling Enforcement Act (UIGEA)—the bill used to shut down online poker sites—included an exception for fantasy sports on the federal level. It states a game is legal if it "has an outcome that reflects the relative knowledge of the participants, or their skill at physical reaction or physical manipulation (but not chance), and, in the case of a fantasy or simulation sports game, has an outcome that is determined predominantly by accumulated statistical results of sporting events." Practically speaking, that means that when it comes to fantasy sports a "game of skill" is okay while a "game of chance" is not.

The debate over the legality of DFS revolves around the definition of skill versus chance. DFS games fall somewhere in between pure games of skill (chess, checkers) and pure games of chance (lottery, bingo). Picking a winning lineup involves a level of skill, intelligence, and talent that can be improved but also, Peyton Manning could tear his ACL in warm-ups and sorry, bro, your lineup is done.

The DFS CEOs believe these random acts of God don't mean their games aren't skill-based. "We can show statistically that our game is one of skill," Eccles said, noting that their research shows a superior player—think Jennings and his spreadsheets against a newbie picking on feeling and the fact that maybe he likes a certain player—will win 90 percent of the time.

Robins agreed: "Optically, it looks different from what people expect a game of skill to look like, but the data doesn't support that."

Looks like a sport to me. Photo via FanDuel

The argument, essentially, boils down to the fact that while any given player might win on any given Sunday, over the course of all the given Sundays (and Mondays, Tuesdays, etc.), the better player will prevail on aggregate. The numbers on win percentages support the point.

Anecdotally, the overlap between successful online poker players and successful DFS players is another point in favor of the skill argument. Max Steinberg, who won almost $2 million playing poker and six-figures so far this year in DFS, told me that the critical thinking skills were similar in both games and he went through the same learning process recently with DFS that he did years ago with online poker. A number of his poker buddies have migrated to DFS and are making easy money, the sharks in a sea of inexperienced fish.

States, however, are allowed to define skill and chance on their own terms and some have more stringent standards than others. FanDuel currently restricts residents of Arizona, Iowa, Louisiana, Montana, and Washington from playing with real money because of legal concerns. Reasons vary. Washington State prohibits internet gaming. Others are what's informally known as "any chance" states, meaning that any game involving any chance at all—Manning's torn ACL, an unexpected delay for a water main break—are actually games of chance. On the other end of the spectrum, Maryland and Vermont passed laws that lifted restrictions.

For now, questions about legality will be settled on a state-by-state basis rather than federally. "In Texas, you can't have a 'gambling place' and you can't be a bookie," Kevin Vela, a founding partner at Vela | Keller P.C., a law firm that has consulted on legal matters with some DFS startups, said. "But if I have a server in my office that runs a site like FanDuel, is that a gambling place? Texas doesn't have its own Gambling Enforcement Act. Gambling is regulated under the Texas penal code. So, am I violating the Texas penal code because I have a server in my house that's running FanDuel or because I'm accessing FanDuel? Am I now a participant and a player?

"In Texas, this hasn't really been pursued. In other states, it has and it's starting to come out okay because weekly fantasy football leagues are a game of skill."

It's certainly possible that the U.S. government could close the UIGEA exception for fantasy sports. Ryan Rodenberg, an assistant professor of sports law at Florida State University, told the New York Times last year, "on the spectrum of legality to illegality, they're getting pretty close to the line."

But, if anything, the trend is towards legality (and the legalization of sports betting). It's hard to see how daily fantasy sites will ever be any less acceptable than they already are, and easy to picture a near future in which all legal issues are eliminated. (There's also the potential or perhaps perceived hypocrisy of a player such as Rob Gronkowski being allowed to endorse DFS sites, but that's another matter entirely.)

The best indicator is the embrace of DFS sites by the leagues and media conglomerates, and how rapidly some have changed their tune. In the Times article from 2013, Robert Bowman, the chief executive of Major League Baseball Advanced Media, said "[DFS is] akin to a flip of the coin, which is the definition of gambling." A little more than a year later, MLB signed a partnership with DraftKings.

Additionally, when FanDuel went searching for investors this fall, they found a willing partner in NBC Sports Ventures. "We're clearly on the side of the law," Rick Cordella, senior vice president & general manager of NBC Sports Digital, told me. He sits on FanDuel's board.

Winner, Winner

Ultimately, the most pressing issue for DFS likely won't be legality, but rather which of the big two companies will rule what FanDuel's Eccles describes as a "winner-take-all" market that eventually could produce a billion-dollar business.

Currently, FanDuel and DraftKings dominate the nascent industry, with the former site enjoying what appears to be a comfortable advantage. How comfortable? Depends on who you ask.

DraftKings' Robins says that his company is "similarly sized" to FanDuel, has a larger player pool at some price points, and overall is within 10 to 20 percent of its rival's size. By contrast, FanDuel says it owns 70 percent of the DFS marketplace, while Eccles claims that thanks to his company's recent growth, DraftKings' chance to become number one has "virtually disappeared."

The numbers tell a mixed story. On one hand, FanDuel is on pace to pay out nearly a half a billion dollars this year in prize money, $300 million more than DraftKings expects to fork over. In the third quarter alone, FanDuel awarded $100 million, up from $28.7 million last year. Do some back of the envelope math, and FanDuel seems to have captured about 65-70 percent of the DFS market, with DraftKings claiming 25-30 percent, and other other sites mopping up whatever's left.

On the other hand, both companies are experiencing explosive growth: DraftKings claims its user-base has increased by a factor of 12 since last year, with revenues increasing eightfold. So perhaps the battle to be the biggest DFS site won't be a zero-sum game, but rather one in which multiple companies can be successful by giving players different options.

DraftKings offers more sports and mobile apps across multiple platforms. FanDuel touts its higher number of players and the fast success of its iOS app. DraftKings' NFL game doesn't have a kicker spot. FanDuel's does. Guster drummer Rosenworcel says that he likes the layout and feel of FanDuel too much to try another site—even though he thinks he might be able to win more money on DraftKings. Steinberg, on the other hand, believes that DraftKings' scoring systems offer more balance and decrease the role of chance, as $1,000 spent on a quarterback or pitcher nets players about the same number of points as investing a similar sum into a running back or first baseman.

Of course, DraftKings sponsors Steinberg and many of the biggest and most successful players. Unsurprisingly, FanDuel has its own roster of celebrity endorsers, trotted out at events or put on the phone with willing journalists. These are moves ripped straight from the days of online poker, where companies fought each other to get their hats, shirts, and logos on players such as Chris Moneymaker, Phil Ivey, and Phil Hellmuth. Like their poker predecessors, FanDuel and DraftKings hire DFS success stories (or poach them from each other), bombarding television and the internet with aspirational "this man turned $50 into $31,000 in three weeks" tales. Both companies eagerly detail a rapid rise in pot values: this season, $1 million winners are a major talking point; by next year, it could be $2 million, $3 million, or $10 million.

In the end, FanDuel will likely hold off DraftKings and remain the industry leader. Size matters. So does momentum. But in the meantime, competition appears to be benefitting players and fueling growth—growth that left one person unaffiliated with either site expressing hope that both companies could become $1 billion businesses.

The Future

Money aside, DFS sites are changing how fans relate to sports. "I was a Knick fan and I'm still a Knick fan, but if the Knicks are playing a team where I have a guy, a horse in the race, all I care about is whether my guy gets the rebounds off the missed free throw," Rosenworcel, who avoids playing fantasy baseball because he doesn't want it to detract from his Mets' fandom, said. "We missed the free throw and we've been absolutely awful for 15 years, but Marc Gasol got the rebound and he's on my team."

This isn't new—you can link the rise of the NFL's uber successful Red Zone directly to more traditional fantasy sports—but the increased metabolism of DFS sites is altering the landscape. As more players migrate to DFS, a figure that could approach 10 million or higher within a few years, the world will continue to change. We'll relate to athletes in a "what have you done for me lately" sense even more dramatically, loyalty only as firm as performance during a single 24-hour period. Did the athlete provide value or not? Sports become an ever-simpler equation.

So we rush onward, hundreds of thousands of people hitching their financial success to the wild ride. FanDuel will have its $1 million event at the Playboy Mansion and Jennings will inch toward $20 million in revenue. Everyone will play happily ever after, and then again tomorrow.