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If Supreme Court legalizes sports betting in N.J., FanDuel and DraftKings will be rocked

But DraftKings and FanDuel have an early lead in identifying and serving a population of likely bettors.

screen grab from FanDuel website. The firm faces an uncertain future
screen grab from FanDuel website. The firm faces an uncertain futureRead moreinternet

Over the last half decade, FanDuel and DraftKings, the two giants of daily fantasy sports, have raised more than $1 billion in venture funding, deluged the airways with TV ads, defended their existence in dozens of legal challenges, and proposed a merger only to be thwarted by the Federal Trade Commission.

Now the online game companies are bracing for more upheaval: The U.S. Supreme Court seems poised to lift the federal ban on sports betting, a prohibition that opened the way for daily fantasy sports in the first place.

In early December, the Court heard arguments in a case that challenges outgoing New Jersey Governor Chris Christie's efforts to legalize sports betting in the state. If the court sides with New Jersey, as many expect it will, gamblers could be placing bets at the state's casinos and racetracks within weeks.

"New Jersey will end up with sports betting no later than Week One of the next NFL season and potentially as soon as March Madness," says Daniel Wallach, a gaming law expert at Becker & Poliakoff. Other states would almost certainly follow.

Even on a state-by-state basis, any expansion of legal sports betting poses new hope and new peril for daily fantasy sports. For many players, the games have served as a licit substitute for outright gambling. Given the change to place bets legally,
they may decide to do that instead.

At the same time, DraftKings and FanDuel have an early lead in identifying and serving a population of likely bettors. Both say they would welcome the change. DraftKings CEO Jason Robins told Bloomberg in November that it would consider all its
options, including becoming a sports book, if the legal restrictions were lifted. "We're interested to see what that looks like," says Christian Genetski, who serves as both chief legal and chief commercial officer at FanDuel, "but our sense is it
opening up is a good thing for us."

A 2006 federal law created the opening for daily fantasy. The Unlawful Internet Gambling Enforcement Act (UIGEA) addressed ambiguity in the Federal Wire Act and made processing payments for online gaming expressly illegal. An exemption for "games of skill" was included to protect the members of casual fantasy leagues, who manage imaginary line-ups of real professional athletes, then compete with friends to see who compiles the best statistics.

FanDuel, founded in 2009, and DraftKings, three years later, used that carve-out to create daily online fantasy sports games with cash prizes sometimes as high as $2 million. By 2015, the two were fighting for market share and spending hundreds of
millions on marketing. (Each spent time as the biggest spender on TV advertising that fall.) The ads were effective enough to attract the attention of regulators, which in turn forced the companies into a costly state-by-state lobbying battle for legal
approval. FanDuel now operates in 40 states, DraftKings in 41.

Last year, the two accounted for about 90 percent of the $320 million in revenue generated by fantasy sports, according to research firm Eilers & Krejcik Gaming. DraftKings, which has emerged as the market leader, has raised more than $700 million from investors. FanDuel has raised more than $400 million.

Both, however, were drained by the fight with regulators and with each other. In November of 2016, they announced plans for a merger. Last summer, facing opposition from the Federal Trade Commission, they abandoned the effort. Earlier this month,
DraftKings announced it would increase its workforce 75 percent. The company is also developing a new 105,000 square foot office in Boston.

In December, oral arguments in the Supreme Court case foreshadowed more tumult. In 2012, the NCAA, along with the four major U.S. sports leagues, sued to prevent the state from enacting laws that would allow sports betting. The leagues argued that
New Jersey was in violation of the Professional and Amateur Sports Protection Act (PASPA), a 1992 federal law that halted the spread of legal sports betting beyond the states that already allowed it. Courts have so far sided with the leagues. Last June,
however, the Supreme Court decided to hear New Jersey's appeal.

If the Supreme Court opens the door to legalized sports betting, it will test the degree to which daily fantasy players have been merely biding their time. About three-quarters of daily fantasy players said legal sports betting would have little to
no impact on their fantasy spending, according to a survey by Eilers earlier this year. The two products each scratch a different itch, says Chris Grove, a managing director at Eilers: "Fantasy sports generally requires a little more analysis, a little
more number crunching. It's the wonkier of the two products. Sports betting is more of a casual addition to the viewing experience."

Nonetheless, DraftKings and FanDuel will be in more direct competition with casinos and overseas sports books. They may decide to try to serve both markets, but it wouldn't be simple. New Jersey's plan involves issuing a limited set of licenses to
casinos and racetracks and restricting betting to on-site customers. Eventually, says Wallach, the state is likely to move to a model similar to what it has for online poker, where the casinos can work with other online operators to take bets statewide.
In that scenario, books such as MGM or William Hill could partner with DraftKings or FanDuel.

Genetski says that while FanDuel remains focused on its current daily fantasy business, almost all options are on the table, from running its own online sports books, to partnering with other operators, to selling access to their customers. "We're
not in the business of not returning phone calls," he says. "If somebody wants to talk about whether there are any intriguing opportunities to work together, of course we're exploring all those." About the only thing the company won't consider, he says,
is opening a land-based sports book.

"It's going to move fast," says Jordan Nof, head of investments at Tusk Ventures, which bought a stake in FanDuel in 2016. "FanDuel will move at the pace that's required to win the market, or faster."
A DraftKings spokesman declined to comment specifically about the company's plans. DraftKings recently partnered with EuroLeague to stream live basketball games alongside fantasy contests, a set-up popular with gambling apps in Europe.
Meanwhile, the battle for legal approval isn't over for the daily fantasy operators, which are still lobbying state legislatures to explicitly legalize their games. Trying to get licensed as a gambling company could complicate those efforts, if
FanDuel and DraftKings end up asking to be simultaneously regulated as gambling operations and non-gambling "games of skill."

It may not be worth the trouble. A robust national sports gambling market could be a $16 billion industry, according to Eilers, and still sports betting is among the least-profitable gambling products for the operators. "You'd be going through all of
the hassle, and all of the expense, to offer a product that is at the bottom of the list in terms of potential," says Grove.
More likely, it seems, is that established gambling companies look to team up with daily fantasy operators or buy them outright. Gambling isn't ingrained in American society the way it is in regulated European markets, but DraftKings and FanDuel have acquired millions of repeat customers with a proven willingness to spend money on games that work a lot like bets. The two companies also have valuable experience in marketing to and serving these players.

"You're not piggybacking on a society that already loves peanut butter, you are literally introducing peanut butter into the country for the very first time," says Nic Sulsky, a sports gaming consultant who previously ran DraftDay. "But the daily
fantasy companies have been selling almond butter for years now. It's the next closest thing, and it's a huge advantage."
In May of 2017, Paddy Power Betfair, a Dublin-based book, bought New York-based daily fantasy site Draft for $48 million. The valuations on either of the industry's two biggest players are much higher, and Grove said FanDuel is an especially likely
target. FanDuel declined to comment on a potential sale.

DraftKings, the market leader, may have a different long-term strategy. As Robins told Bloomberg Radio in November, "Right now we're marching towards an IPO path."