At first glance, Landcadia Holdings II (NASDAQ:LCA) stock looks like an easy winner. The SPAC (special purpose acquisition company) is merging with Golden Nugget Online Gaming. GNOG is serving a fast-growing online gambling market in the U.S. — and posting strong early results in the process.
Indeed, Golden Nugget has leading market share in New Jersey, the largest state (so far) to have legalized a full suite of online gambling options. Online sports betting has soaked up much of the investor attention this year, and again after a series of electoral victories. But iGaming looks like a better, and more profitable, business, even if the market is smaller at the moment.
The combination of top share in a growing market has driven a number of the market’s biggest winners in recent years. I can see why investors believe LCA stock, ahead of the merger with GNOG, is likely to be the next one.
But a closer look shows the story isn’t quite as attractive as it appears. Q3 results for Golden Nugget, as well as revenue numbers in New Jersey for October, highlight why that is.
The Case for iGaming
Online sports betting stocks have done particularly well so far in 2020. DraftKings (NASDAQ:DKNG), which too went public via the SPAC route, has more than quadrupled. Thanks in large part to its ownership of FanDuel, Flutter Entertainment (OTCMKTS:PDYPY) has rallied 45% though all of its profits come from outside the U.S.
Penn National (NASDAQ:PENN), which is planning to use its stake in Barstool Sports to back its online sports betting efforts, has gained 180% even with the novel coronavirus pandemic pressuring its legacy brick-and-mortar business. It’s soared an incredible 1,850% from March lows. Other casino operators have posted triple-digit rallies of their own.
But Landcadia and GNOG argued in the merger presentation that iGaming is a much better business than online sports betting. I’m inclined to agree.
After all, iGaming is 24/7. Sports betting is not. It’s easy to forget outside of the NFL season, but the options become much more limited between February and September. Mid-week betting options are mostly limited to the NBA and Major League Baseball, neither of which have the same appeal or import.
Meanwhile, hold (the amount won by the house) is higher in iGaming than in online sports betting. DraftKings, for instance, has cited long-term hold of 6.5%. Particularly with online slots, iGaming operators do far better. That helps not only revenue but profits, as net of gaming taxes that extra win drops almost straight to the bottom line.
So GNOG’s focus on iGaming certainly seems like a good thing, particularly given its early lead.
Can GNOG Really Win?
The problem, however, is that the lead is shrinking.
It might not seem like it, given Golden Nugget’s growth. Late last month, the company disclosed selected figures for the third quarter which showed that net revenue increased 92% year-over-year. In New Jersey in October, the company simply had another strong performance, with revenue up 69%.
The problem is that those numbers are being driven by market growth. That growth in turn is coming at least in part from the pandemic, which has kept users at home.
In fact, Golden Nugget is losing share. October numbers in New Jersey were a bit better, but the company had been on track to give up its lead before that improvement.
Looking at year-to-date numbers, the same trend holds. GNOG’s online win has grown 87%. The market as a whole has more than doubled. The Borgata, owned by MGM Resorts International (NYSE:MGM), has seen its win increase 161%. Thanks to its partnership with DraftKings, Resorts Digital posted growth of 115%.
Bigger operators with more resources and entrenched databases are coming for Golden Nugget in New Jersey, and will battle with them in newer states like Pennsylvania and Michigan. I’m not sure why GNOG is supposed to win.
LCA Stock Is Cheap (Kind Of)
To be fair, investors aren’t valuing Golden Nugget like they are bigger players. DraftKings has a market capitalization of $19 billion. Pro forma for the merger, GNOG is valued at just over $1 billion.
But this seems like a market where investors should be paying up for quality. If the opportunity is as big as bulls believe, the bet (pardon the pun) should be on the winner. If the market disappoints, a lower valuation likely won’t be much help if it’s combined with lower market share. (Golden Nugget also will have debt after the merger, as part of the funds raised by Landcadia II are going to pay down debt at Golden Nugget’s corporate entity.)
It’s not as if LCA stock is cheap enough that declining market share is priced in. But that’s the trend at the moment. And it’s hard to see how that trend reverses.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
