A few days ago, Penn Entertainment (PENN -1.92%) announced a $2 billion deal with ESPN, sending shockwaves around the sports betting world. Let's look at Penn's partnership with the Disney-owned sports network, and why this deal could make sense for both parties in the long term.
What's the deal?
Penn Entertainment has long been a staple of the betting industry. However, a few years ago the company made headlines after acquiring media company Barstool Sports for over $550 million. The rationale behind the deal was to combine Barstool's brand with Penn's operations and create a new online sportsbook geared toward competing with industry juggernauts DraftKings and FanDuel.
After three years of working with Barstool Sports, Penn has decided to go in another direction. The company recently announced that it formed a joint venture with sports network ESPN. Per the terms of the transaction, Penn will pay ESPN $1.5 billion in cash over a 10-year period. ESPN was also granted $500 million in warrants to purchase 31.8 million shares of Penn stock over the 10-year term.
Given the hefty price tag, investors may be curious about what Penn gets out of this partnership. As part of the deal, Penn now has the exclusive right to the "ESPN Bet" trademark and thus will rebrand its online Barstool Sportsbook.
Does this make sense for Penn Entertainment?
Image source: Getty Images.
According to data collected in 2021 by Morning Consult, the U.S. market in the sports betting space is dominated by two players: DraftKings and FanDuel. Although this data is a little dated, when assessing some of the more recent themes in sports betting, it becomes more powerful. For example, a company called PointsBet, which partnered with Comcast-owned NBC Sports a few years ago, lies in the middle of the pack. The U.S. business of PointsBet was recently acquired by sports entertainment unicorn Fanatics.
Higher up on the list is another media brand's sportsbook, Fox Bet. Fox Bet is owned by Fox Corporation and betting company Flutter Entertainment. Per the survey results, more than half of the participants were familiar with Fox Bet. Unfortunately, this brand awareness did not translate into meaningful market share or financial tailwinds for Fox Corp or Flutter, which decided to shut down the betting app.
The evidence seems to suggests a common theme among sports betting companies -- that there is meaningful consolidation taking place within the industry among smaller participants. Moreover, these smaller players seem to struggle against the two primary heavyweights in the market. Given some of the themes above, Penn's deal with ESPN could be an example in a long line of attempts to partner with a media conglomerate and leverage its talent resources and brand equity.
Is there a best option?
There are several ways people could invest in this type of situation. On the surface, it may look like Penn is the big winner here. But remember, the company paid a hefty sum for Barstool Sports and spent nearly three years integrating the media company with its own operations, only to part ways with it soon thereafter. While Penn's ambitions with ESPN are understandable, I would be hesitant to buy the stock until it is a known quantity that this partnership is paying off.
On the other side of the equation is ESPN's parent company, Disney. Disney's linear television network division has been feeling the heat from cord-cutters for a while. As a result, management has alluded to potentially selling some of these cable assets as part of a broader organizational restructuring. Given these comments by Disney's leadership, the licensing arrangement with Penn seems to have arrived at an optimal time.
While the annual licensing fees ESPN is owed are a clear benefit, Disney's management also shared during its most recent earnings call that the company should still be able to generate advertising revenue from other sports betting companies. In other words, Disney can make money from Penn via the licensing component of the deal, but it is not required to exclusively advertise with the company, thereby leaving the door open for other potential suitors.
Personally, I am intrigued by Penn's partnership with ESPN. However, I would like to see some initial results and data from both Penn and Disney before investing in either. The benefits for each company look obvious, but there are some risks. Just because ESPN/Disney can continue taking advertisements with other sportsbooks doesn't mean it will happen. There could be a scenario in which current advertisers on ESPN seek other distribution due to the Penn deal.
Furthermore, given that Penn did not make meaningful inroads with the Barstool-branded sportsbook, I'd like to see how the market reacts once ESPN Bet is formally launched before diving into the stock.
