DraftKings, Fox and the Ethics of Round-Trip Business Deals
.jpg">Daily Fantasy Sports may or may not turn out to be the next big thing in online gambling; it’s still to young of an industry to say whether it’s here to stay, or just a passing fad. Whatever the final outcome, though, it’s currently a booming market, and the sites themselves are locked into a competition for ever-escalating stakes. Market leaders FanDuel and DraftKings are engaged in an advertising arms race, with both sites now having raised nine-figure sums of funding, most of which will go into their marketing efforts.
But whereas FanDuel’s funding was led by KKR & Co. L.P – a private equity firm – half of DraftKings’s newfound capital comes from 21st Century Fox, who will also be the recipients of most of that money. While 21st Century Fox is providing $150 million of the $300 million raised by DraftKings, the deal struck includes a commitment by DraftKings to spend $250 million on advertising with FOX Sports over the next three years.
Naturally, this has led some to wonder about the ethicality of such a deal.
People went to jail in the '00s for the kind of "round trip" ad deals that DK is offering (to ESPN, Fox) http://t.co/odKu2qoZhN
— Joe Brennan Jr (@joebrennanjr) July 27, 2015
A win-win-win for Fox
One thing is for sure: this is a very good deal for Fox.
Firstly, they get equity in a company which is well-positioned in an emerging market. Their stake in DraftKings at this point is reported to be about 11 percent; if Daily Fantasy Sports does ultimately end up competitive with and comparable to online poker, that share could end up being worth much more than the $150 million they’re paying for it.
On the other hand, if the trend ends up being short-lived, their share in the company could be worth very little. That’s the way investment works, after all. However, there’s very little risk to Fox in this case, because all the money they’re handing over is coming straight back to them and then some. As long as DraftKings survives for at least three years – and there’s no reason it shouldn’t last at least that long – they will get back not only their own $150 million, but at least $100 million of other investors’ money.
Finally, it’s both intuitive and provable that sports betting in general, and fantasy sports specifically, will tend to cause people to tune into sports broadcasts with greater frequency. Whereas a casual user of conventional sports betting may only place bets on a game he or she was planning on watching anyway, the nature of fantasy sports is that people will tend to have players from multiple teams on their roster, perhaps leading them to watch games they would not have otherwise. This theory is apparently supported by data, as DraftKings CEO Jason Robins claims that they’ve determined that 80% of their user base spends more time watching and reading about sports than they did prior to joining the site.
A brief history of reciprocal deals
There’s an excellent article by Daniel Gross on Slate which discusses the history of these sorts of reciprocal or “round trip” deals in which two companies each purchase a similar value of goods or services from the other, such that little money ultimately changes hands. In a nutshell, these deals are a form of barter, Gross explains, allowing companies to procure necessary goods and services without worrying about cash flow, by offering something else in return – their own products in some cases, or equity in other cases, as here.
Gross points out that there are many cases where such deals make perfect sense and don’t necessarily raise any significant ethical issues. One of his examples involves two fiberoptic network companies operating in different geographical regions; rather than expanding into one another’s regions, or paying one another cash for access, the two simply swap equal amounts of bandwidth. What could be wrong with that?
Well, Gross goes on to point out that there are a few ways that this can go wrong, and has gone wrong in the past. For one thing, it allows companies to engage in a bit of deceptive accounting, depending on how they declare the money involved. Even if the deal amounts to barter in practical terms, there’s still technically money being moved around: it goes one way, then it goes right back. That gives companies an opportunity to declare the money out as an investment, but the same money coming back in as revenue, thereby conjuring profits out of thin air in order to deceive investors. When the goods and services being exchanged are similar in nature, there’s also the potential to drive up prices artificially; since both companies are getting their money right back, there’s no reason not to pay each other a exaggerated price so as to be able to point to that sale price in future to convince others of the product’s worth.
So is this okay or not?
In the case of Fox and DraftKings, there’s no reason to assume there’s any funny business going on. The advantages of the deal to both parties are evident; DraftKings desperately needs to keep up with FanDuel in its marketing efforts, which it can do with Fox’s help. Fox, meanwhile, acquires equity in a company which synergizes well with its sports network, in exchange for nothing more than airtime on that network.
Still, in my non-expert opinion, there is potential for this to turn ugly in future if interest in Daily Fantasy Sports wanes, if FanDuel wins the marketing battle, or if Yahoo (or Amaya, for that matter) ends up beating both of them. Because DraftKings’s advertising commitment exceeds the value of Fox’s investment, there’s very little risk to Fox. Even if Fox holds on to their stake in DraftKings, the worst case scenario for them is that they’ve effectively sold airtime at a discount. Conversely, Robins said last year that a DraftKings IPO could come as early as 2016; if that happens, Fox could easily sell off their shares at that point and be left with all profit and no downside. Whatever happens, the bulk of the risk will be held by the investors who followed them into this round of funding.
That risk is not insignificant, either, because this latest deal is not the only such commitment DraftKings has made. All told, they’ve committed themselves to a total of $500 million in advertising, nearly half of what they’re currently worth even with the $300 million they’ve just received. Like I said, the stakes are high, and all parties involved are betting big on continued growth.
Alex Weldon (@benefactumgames) is a freelance writer, game designer and semipro poker player from Montreal, Quebec, Canada.