Analysis: Does New DraftKings Surcharge On Winning Bets Add Up?

The new DraftKings plan to charge additional fees on winning sports bets in select high-tax markets has become the main talking point for investors and analysts throughout the industry.

CEO Jason Robins said last week the company will implement a “fairly nominal” gaming tax surcharge in Illinois, New York, Pennsylvania, and Vermont beginning in January. Per its Q2 earnings presentation, the surcharge is designed to help DraftKings maintain an operational effective tax rate of approximately 20% across its national footprint.

It is an audacious response to localized market conditions and an escalation of the feud with policymakers in those states. Operators have so far been unsuccessful in their attempts to lobby for change, warning of possible adjustment to their pricing and payout structure in the absence of tax relief.

DraftKings is the first to make good on that threat in front-facing fashion.

High-tax markets vital for operators

The highest-tax markets are, not coincidentally, among the most desirable pieces of real estate for US sports betting operators. Lawmakers from the states in DraftKings’ crosshairs were well-aware of their prospective value when they drafted taxes and license fees far above going rates at the time.

• Illinois did a bit of a statutory rug pull this year, updating its sports betting law to increase the tax rate from 15% as part of the 2023 budget package from Gov. JB Pritzker. The new tiered tax structure starts at 20% and scales up to 40% of operator GGR for the largest operators like DraftKings, with licenses topping out at $20 million.
• Pennsylvania is a notoriously high-tax gaming state, and its 36% tax rate on competitive sports betting revenue was the steepest in the country from its late 2018 debut until New York’s online expansion in early 2022. Sports betting licenses in Pennsylvania cost $10 million apiece.
• Prospective operators in New York willingly yielded to the 51% ask from former Gov. Andrew Cuomo, specifically the FanDuel consortium as part of its proposal to regulators there. DraftKings and other competitors agreed to match those terms, while also forking over the $25 million license fee in exchange for access to the largest market in the country.

These three markets are critical to DraftKings’ business, together accounting for just under a third of all US sports betting handle and revenue nationwide. As a note from Regulus Partners touched on, these are also the key markets in which a major operator cannot afford to be uncompetitive.

Assessing fees on winning bet slips

Regulators in Illinois publish the most granular monthly data in the country, including the total number of tickets across each reported category. This detail allows us to do some rough math on the potential impact of this decision for DraftKings.

Look at 2023 in isolation, since it provides a full seasonal sports cycle to analyze. For the year, DraftKings wrote 115,904,240 tickets worth a combined $3.92 billion for an average ticket size of $33.78. Holding 8.1%, those bets yielded $316 million in gross operator revenue while creating $49.8 million in tax liability to the state.

Applying the new tiered tax structure to those 2023 numbers, DraftKings’ theoretical tax payments would increase to $104 million for the year.

Adding a surcharge to DraftKings’ bottom line

For the purpose of this exercise, we will use an assumption of approximately half of DraftKings’ tickets being winners for the customer, making them subject to its new surcharge. While a true winning percentage is likely several points lower, roughly half works as essentially the maximum bound for these estimates.

The 57,952,120 winning tickets in 2023 represented a combined face value of approximately $1.96 billion, and the $3.60 billion in total payouts produced a net win of $1.64 billion for the customers holding them.

An illustrative slide in the Q2 presentation shows a $10 bet slip with a $20 payout less a $0.32 surcharge, putting the fee at 3.2% of net customer win. At that rate, DraftKings would have collected an additional $52.6 million from Illinois surcharges over the course of the last year.

These fees would offset as much as half of DraftKings’ obligation to the state under the new structure, reducing its blended tax rate on annual gross revenue from 33% to 17% and essentially negating Pritzker’s squeeze on the bottom line.

Per-ticket impact of DraftKings surcharge

Of course, another way to say “generate more revenue for the operator” is “take more money from the customer.” This surcharge would simply pass half of DraftKings’ Illinois tax burden onto local bettors in order to improve its margins.

Looking at per-ticket numbers might help frame the practical impact. Using the data above, the average DraftKings ticket in Illinois has a face value of $33.78 and produces:

The average surcharge across all tickets would be approximately $0.45, doubling to around $0.90 when calculated across winning tickets alone. For DraftKings, the increased per-ticket net revenue would represent a tidy 20% boost to its current operational margins.

What DKNG surcharge might look like in practice

Let’s run the numbers on the most straightforward example, where two bettors take opposite sides of a -110 market for $110 apiece.

In this scenario, the winning ticket would be worth $210, while the losing ticket would generate $10 in gross revenue for DraftKings. Under the tiered structure in Illinois, DraftKings will pay the state between $2-4 of that and leave itself with a net win of $6-8 on $220 of volume.

If we include a 3.2% surcharge, that winning ticket would instead be worth $206.80. The surcharge of $3.20 goes back into DraftKings’ column, immediately improving its net margins and likely bringing a smile to the faces of shareholders.

This change is the practical equivalent of moving the odds to -114, moving the standard breakeven win rate from 52.4% to 53.3%. The overwhelming majority of bettors are long-term losers to the vig even at the typical -110.

DraftKings adds up the fees

Using those numbers as a guide, the total impact across the impacted markets would be around $220 million annually.

• DraftKings is particularly hot in Illinois, its revenue trending up 37% YoY across H1 2024 as reported through May. That puts it on pace to generate $431 million in gross revenue this year, which would yield $74.2 million in local surcharges from winning bettors.
• Similar YTD performance in Pennsylvania (+37%) should see DraftKings end the year with around $238 million in gross revenue and $38.2 million in theoretical fees.
• Shallower growth in New York (22%) would bring gross revenue close to $700 million for the year, with the potential to capture an additional $110 million in surcharges. Given the higher tax rate to offset in New York, customers there might even expect to see a fee of 4-5% in order for DraftKings to reach its target margins.

These are serious numbers for a company seeking to move its share price from Tuesday’s close near $32 back toward its all-time high of $72. These fees conceivably could end up being even more lucrative for DraftKings, given the assumption that the average winning ticket is larger than the average losing ticket, as well as the idea that these fees are more likely to repel winning bettors than losing ones.

Notes on tax treatment for surcharges

The manner in which regulators account for these fees will go a long way toward determining how much revenue DraftKings derives from them. Are surcharges included in the state’s calculation of transactional sports betting revenue, or are they detached from the wager/payout/taxation mechanism and tacked onto the bottom line?

The previous scenario with $110 wagers in Illinois illustrates how pivotal this distinction could be. The difference between net revenue with pre-tax surcharges ($7.92) versus post-tax surcharges ($9.20) represents a swing of almost $100 million that will either end up on DraftKings’ bottom line or in the coffers of those four states annually.

Wins and losses

Analysts seem to be following DraftKings’ lead on the idea that these surcharge fees will be treated as a separate, detached transaction functioning more like a service charge. Notably, taxable revenue usually derives from money lost by customers rather than from money won.

It is not clear, but these calculations assume surcharges are untaxed, pending clarification. Actual amounts will additionally be situation-specific and vary with the size and pricing of the winning wagers that incur the fees.

Crucial response from customers, competitors

How customers and competition respond will ultimately let DraftKings know whether this is a sustainable idea. The data folks at DraftKings have no doubt done better math than we can, and presumably arrived at the conclusion that this decision is plus-EV for their EBITDA.

“Obviously, some people might just react negatively to the idea of being charged at all,” Robins told investors. “We feel it is an important step that consumers will ultimately understand if they feel the product and experience is better, then they’d rather pay for that than somewhere else that maybe doesn’t have as strong a product.”

BetRivers announced it will not impose such a fee, while neither BetMGM nor Caesars made mention of it during their recent presentations.

The big item to watch is reaction from customers, which largely will be influenced by the forthcoming decision from market leader FanDuel. If DraftKings finds itself on an island as the only sports betting brand charging customers an extra fee for winning, it may have to consider cutting its losses and abandoning this plan altogether.