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Welcome to 2023: “It’s just a little gully”

Setting the Stage

We believe that 2023 will be the beginning of a multi-year bull market in the online gambling space. That is likely obvious to any reader since we are launching a gambling-centric venture capital firm, but you may be surprised to know that we believe things will likely get worse before they get better.


David and I often quote one of our favorite movies when we encounter individuals who are exhibiting overwhelming positivity, but who do not understand the size of the problem: “its just an itsy-bitsy little gully” from The Big Short. We generally misquote it as “its just a little gully," but the point remains. In the 2015 film, a real estate agent is looking at the declining home prices and seems unable to appreciate the implications of some of the changes happening in the industry. David and I often feel like we are Steve Eisman of FrontPoint partners riding along in that car looking at the online gambling industry.


Similar to those involved in creating the 2008 housing crash, we did this to ourselves. Our industry rode low interest rates, willing (and often naïve) cash flush investors, and a general exuberance over the industry to irrational valuations. We saw companies that were blatantly illegal raising money at staggering valuations from ‘tourist investors,' who are not familiar with the regulations that govern the gaming industry. We saw B2C companies acquiring customers using promotions that would require multiple years or rosy expectations for customer play to ever generate a return on that spend. We saw deal after deal signed that made little to no economic sense if viewing it objectively. People committed capital to deals that were largely backed by vaporware and raised SPACs that were designed to slap lipstick on a pig and sell it to eager investors. We had both large and small companies making commercial or product claims that simply could not be verified by anyone who cared to look. We had a public company report negative quarterly net revenues of -$300M in their online segment – I honestly didn’t even know you could have negative revenues. All the while, no one seemed to care. If you know The Big Short well (and you all should), we often felt like we were at that “American Securitization Forum”, which was – funnily enough – held in Las Vegas.


Decisions Meet Consequences.

We are starting to see the beginning of the consequences of those decisions. The capital markets are beginning to heal. Stocks are down materially across the online space, management teams are saying the right things, they are making the right decisions, and they are fighting to get to the other side of this bear market. We do not believe that we have reached the bottom though. The collective decisions from 2020-2021 will have a very large impact on the capital and cost structures of 2023. If you cut staff to save $5M, but you signed a 5-year marketing with a league for $30M a year in 2020 – you have barely impacted your financial position. If you are a high growth start-up that raised on an inflated valuation and hired a large team under the assumption that capital would always be available at similar market valuations, then you are likely in a very tough situation (even if you made great capital allocation decisions starting last spring).


Allow us to introduce a version of a chart we have seen 100 times over our investing career:





Ask yourself: Where are we on this chart? How do you feel? If you are reading this blog post, you likely have an informed opinion. Based on our network, the entrepreneurs we talk to, and reading a whole bunch of gambling & financial twitter: we are somewhere between Anxiety & Denial. We have seen almost no signs of panic, capitulation, or real anger.


Is the point of the post to upset the industry and depress everyone? No. Bottoming is a healthy process and it’s important that we get through it. If everyone in our industry says, “things are about to get better,” then we run the risk of not being prepared for the likely scenario that they do not get better in a quarter or two. People who say that often don’t realize how long it takes for the sort of capital markets decisions made over a prolonged period of time to roll through an industry.


If you are looking for our juicy “what will the bottom look like?” informed but likely wrong hot take: we will have one bankruptcy of a tier 2 player in the US, multiple tier 2-3 bankruptcies (or fire sale acquisitions), potentially a restructuring of a Tier 1 player, an acquisition of another Tier 1 player by their partner, and then lastly and most painfully for our future partners, a large number of down rounds of private companies (not all of them – just a good number). The layoffs that have started at the large public players in the last couple of months will also likely roll down to the smaller players. If you want a ‘way too specific to be right’ idea for when the market turns, its probably June before we start to see the winners emerge from the chaos and Q4 before the market really begins to recover.


We have invested through a market cycle and invested across lots of industries around the world – so we hope our perspective might be helpful even if unpopular.


What Should You Be Doing:


1. Make the Hard Decisions: Make whatever decision gets you across this market transition with whatever capital you need. Just to be safe, assume the world is capital starved until Q4’23. If you have to reduce headcount, do it deeply once vs. death by a thousand cuts. As the saying goes, if you are going to eat sh*t, don’t nibble.


2. Be Patient: Bear markets and recessions take time to work through an industry, so do not assume that you know when the end is coming. The consequences of being a month late to the expansion is a lot lower than the cost of being early to the real bottom.


3. Learn: You can learn 10x more in a crisis than you can in a raging bull market. Be in the moment, be flexible, and learn as much as possible. Talk to your customers all the time as they manage their businesses through the storm – opportunities will emerge.


4. Prioritize your Investments: Do not mistake the advice in #1 to mean you should blindly cut your team to the bone as you might not be able to effectively rebuild on the other side. Identify the key value driver(s) of your business and continue investing behind that, while right-sizing the other parts.


5. Identify & Partner with the Winners: This industry has been characterized by everyone signing deals with everyone, but those deals are only valuable if the counterparty not only survives but thrives longer-term. If you are a start up (or public market investor), start thinking about who is guaranteed to be larger in 2025 than they are today as the market rationalizes and consolidates.


We believe that the US online gambling market will ultimately be larger than the US physical casino business, so we are extremely excited about the future of this industry. We are building a business to invest in that future, but we also continue to see too many people thinking ‘it’s just a little gully.’ A dose of reality can go a long way in preparing the industry for a difficult period, so we are trying to be helpful vs. depressing! There is a growing wave of innovation in our industry and the economics in the US should start to right-size over this next year, so there is a lot to look forward to. We cannot wait to be writing a welcome to 2024 blog post about the dawning of a new expansionary cycle.

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