Wednesday, November 19, 2014

MGT Capital Investments DraftDay.com 3rd Quarter Overview

This isn’t the first time I’ve written about MGT Capital Investments (MGT), and I’ve been following MGT for some time now. To cut down on redundant arguments, I will direct you to some of the previous articles I’ve written:
  1. Sep 2, 2014 - MGT Capital Investments Stock On A Wild Ride
    In this article I explain that MGT’s management expecting to use positive gross margins from DraftDay to fund operations was optimistic at best.  As the numbers show in my article below, the company lost more in 3 months running DraftDay than whatthey paid for the entire site in April. I also explain that daily fantasy sports websites require significant financial investment and MGT does not have the capital (or access to capital) required to sustain operations for much longer.
  2. Sep 4, 2014 - Is CEO Robert Ladd Good For MGT Shareholders?
    One thing CEO Robert Ladd is good at is investing in business units that only cost the company (shareholders) more & more money each passing quarter. I’m not 100% if this is a semi-elaborate way for Robert Ladd to enrich himself and a small number of insiders, or if he’s just a poor businessman. Either way, his mismanagement and odd acquisitions have deteriorated shareholder value and makes investing in MGT a very bad idea even as a speculative penny stock play. In this article I also touch on – what I believe to be (NEAR) worthless business units – MGTPlay, RealDeal Poker, and SlotChamp. Again, I’m not 100% sure if these business units (subsidiary companies) are in existence to actually create something of value, or to funnel money into the pockets of insiders. That or Mr. Ladd simply has poor judgment when making acquisitions with shareholder money. Either way it shows you cannot trust the management MGT – and if the company is still around in a few quarters I’ll investigate further what really might be going on with these business units. For now, all 3 are D.O.A and likely will never materialize any value for the company or shareholders.
  3. Sep 9, 2014 - Low Turnout For MGT's DraftDay Fantasy Sports Website Week 1
    This article was really just to illustrate how daily fantasy sports websites don’t print money. In fact, they are a good way to burn through money, which is probably why the original owners of DraftDay sold just months before the 2014 NFL football season started. I’m not 100% certain the daily fantasy sports website business model (as currently constructed) will even be sustainable in a few years, but that remains to be seen. What is evident (as represented by the 3rd quarter numbers I post below) is that these daily fantasy sports websites are a poor investment for a company that doesn’t have much capital or access to the capital required to sustain a daily fantasy website while the industry is still not profitable.
How is MGT funding operations?
ATM Agreement
Pursuant to the ATM Agreement, the Company may offer and sell shares of its Common Stock (the “Shares”) having an aggregate offering price of up to $8.5 million from time to time through the Manager (Ascendiant Capital Markets, LLC).
For the nine months ended September 30, 2014, and through November 14, 2014, the Company sold approximately 1,274,471 shares of our common stock under the ATM Agreement through an “at the market” equity offering program for gross proceeds of approximately $1,407, before related expenses. The proceeds will be used for general corporate purposes, including, but not limited to, commercialization of our products, capital expenditures and working capital. As of November 14, 2014, the Company has approximately $7.1 million remaining under the program, assuming sufficient shares are available to be issued. (p. 10 3q 10-Q)
The company will raise funds in this fashion in order to keep the company solvent through September 2015 (last quarter the company expected to have enough cash through June 2015, so there is one sign of improvement). While these types of fundraising rounds are not particularly rare, it will create an overhang on the share price as long as the agreement is in place and the company is not producing positive cash flows. Additionally, with MGT stock trading near or under $1.00 per share – it potentially means millions of shares will be added to the share count without the advanced notice a secondary offering usually provides. Essentially if you’re a holder of MGT shares, your valuation metric needs to factor in the company will be issuing and selling common shares in order to continue the already dismal outlook the company has. Considering the company’s loses are accelerating at a rate that will burn through the remaining cash on the balance sheet and the ATM agreement allowance, paring back operations would be the prudent thing to do but becomes more difficult when operating a public facing website like DraftDay.
Do Daily Fantasy Sports Websites Make Money?
MGT’s 3rd quarter spans the months of July, August, September and includes week 1through week 4 of the NFL football season and the tail end of the MLB baseball season.
Revenue - $297
Overlay – ($168)
SG&A – ($892)
R&D – ($40)
Figures in thousands
The overlay figure was one I brought up in September after witnessing very weak signups during the first week of the NFL season and it’s something even the larger sites have to account for. More alarming to shareholders actually should be the SG&A figure ($892) is 3x the revenue figure! Keep in mind that SG&A expense is likely going to trend upward even as revenue trends up, so the company needs to grow the business more than 3x to simply break even!  I thought daily fantasy sports was blowing up? In actuality it’s costing the company & shareholders money it can’t afford to lose. Now you can see why the previous owners & investors in DraftDay sold to MGT for less than FY revenue. As you can see the costs associated with running a daily fantasy website is significant and the ability to generate revenue is small. In September I laid this all out for investors to realize in this article. In fact, evidence shows that the entire US market for daily fantasy sports generates less moneythan the New Jersey regulated casino/poker websites – which have fallen well short of expectations. In case you missed that – one (very small) state generates more revenue on poker/casino websites than the entire daily fantasy sports market. Still think daily fantasy sports websites are a good investment?
Is the “3rd Largest” daily fantasy tag safe?
I’ve always found it a bit confusing (and somewhat laughable) the company boasts being the 3rd largest in the daily fantasy sports website – with no tangible plan laid out by management to move into (or even compete with) #2 or #1. It’s almost like the company is comfortable being #3. The main problem with that logic is MGT doesn’t currently generate positive cash flows from DraftDay and/or FanThrowdown, so being #3 isn’t even sustainable. While it’s likely the daily fantasy sports market expands in the coming years, it could be argued most of that growth will flow to top and/or will require considerable investment until that day comes. Additionally, if the market expands enough to support multiple (profitable) operators, the competition to be “#3” will become harder for MGT to hang onto as more nimble upstarts enter the market. And in fact, there’s evidence that MGT’s DraftDay is already facing competition from sites that recently launched.
To give you an idea how quickly daily fantasy sites can gain traction, Ruckus Gaming, opened it’s office in April 2014, reported a $2m fundraising round in August 2014, launched in beta mode in August 2014 – and now has guarantee NFL prize pools that are larger than MGT’s DraftDay.
The largest guarantee prize pool on DraftDay on Sunday November 16, 2014 was the $12,500 guaranteed "The Benjamin.”  On Victiv.com, the site owned by Ruckus Gaming, the highest prize pool was a $22,000 guarantee "Lombardi" contest … nearly double that of DraftDay. Additionally the second highest guarantee prize pool on Victiv was a $11,000 “Lambeau” contest - only $1,500 less than DraftDay's highest guarantee.  So while guarantee prize pools aren’t the only measure of success for a daily fantasy website, it does display that competitors that were opening new offices in April and in beta mode in August can boast larger guarantee prize pools than DraftDay, which has been around since 2011. Competitors without an eye to the bottom line, shareholders, or excessive executive compensation packages likely have an advantage over MGT who can’t afford to be as nimble and forward thinking as upstart competitors can. In conclusion, if your thesis to invest in MGT is because they share a piece of the daily fantasy sports market, it appears that piece will get harder to maintain as competitors with a few million dollars in fundraising and not even 1 year in the business can gain market share. Imagine if companies with the resources like Yahoo, ESPN (ABC), CBS, or even the NFL itself decides it wants to dip it’s toes into the daily fantasy sports market? How safe will the “#3” tag MGT places on itself be then? Will MGT brag about being #4 or #5 in a few years?
NBA now owns a piece of FanDuel
In an interesting move last week, FanDuel announced a partnershipwith the NBA – where the NBA acquired an equity stake and seat on the board at FanDuel. While competing sites like DraftDay & DraftKings will still offer NBA contests, the NBA is now clearly in bed with FanDuel, which should be a cause for concern for every other daily fantasy website. One threat to DraftDay & others would be if the NBA decided to make FanDuel the “exclusive” provider of NBA real money daily fantasy games (or a version of a game), much like they’ve done with apparel, TV, trading cards and other business relationships. While I think that threat is minimal, now that the NBA owns a piece of FanDuel – it’s something that could materialize in the future.
Conclusion
Investing in MGT because they own a fraction of the daily fantasy sports market is ignoring the facts while being in love with the story. Sometimes (often times) the story is better than the stock. That is the case here. Larger competitors like FanDuel and DraftKings are blowing through money faster than a teenage girl at a shopping mall. Other competitors and MGT are doing the same thing on a smaller scale. In my opinion, all daily fantasy sites are still several years away from being profitable, mainly because the barrier for entry appears to be about $2 million dollars of seed money and some office space. Additionally, if/when daily fantasy sports sites become profitable – that’s when larger players will sweep in like Yahoo, ESPN and/or CBS to take all the moneyconsidering they have massive player databases due to providing free contests for over a decade. As a side note, I’m not sure why the daily fantasy sites haven’t tried to attract more of the free and/or season long league action that is monopolized by the three companies I mention. Wouldn’t a freemium model work well for these daily fantasy sites? Draw players in like Yahoo/ESPN do – only to upsell them to the daily leagues as they check their lineups each day. Seems like an easy way to acquire potential players – and likely would cost less than it does to run some TV ads or partner with a league. Just a thought.
In my opinion, taking even a small speculative stake in MGT is like throwing money down the toilet. You’d be better off depositing the money on DraftDay and trying to win cash in the daily fantasy sports contests the site offers. The company doesn’t hold regular conference calls and the communication you get from management is always light on strategy or plans for the future. Management could have kept the business model much simpler (and less capital intensive) by not acquiring public facing companies like FanThrowdown and DraftDay – and collected compensation for years by flying under the radar and stringing out a patent litigation lawsuit that will take years before any verdict is handed down or any royalty checks are written. With that being the case, I actually lean toward CEO Robert Ladd just being a poor businessman/leader/decision maker over MGT being a semi-elaborate way for Mr. Ladd and a small group of insiders to enrich themselves. Either way Mr. Ladd is not someone you’d want to trust with your investment dollars with, and the entire history of the company’s share price has proven that to be the case.

Disclosure:
I’ve never owned shares of MGT – long or short.

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