PENN Entertainment, Inc. Q2 FY2023 Earnings Call

Thank you, Frank. Good morning, everyone, and thank you for joining PENN Entertainment’s second quarter and ESPN transaction conference call. We’ll get to management’s presentation and comments momentarily, as well as your questions and answers. During the Q&A, we ask that everyone please limit themselves to one question and one follow-up. Now, I’ll review the Safe Harbor disclosure. Please note that today’s discussion contains forward-looking statements. Forward-looking statements involve risks, assumptions, and uncertainties that could cause action results to differ materially. For more information, please see our press release and for details on specific risk factors. With that, it’s now my pleasure to turn the call over to the Company’s CEO, Jay Snowden. Jay, please go ahead.

Thanks, Joe. Good morning and thank you for joining us. Last night we announced an exclusive long-term agreement with U.S. online sports betting with the worldwide leader in sports, ESPN. I’m here this morning in New York City with my executive management team, including our CFO, Felicia Hendrix; our Head of Operations, Todd George; and Chris Rogers, who oversees Business Development and Strategy at PENN, and worked very closely with me on the establishment and structure of this partnership with ESPN. I’ll try to focus my comments this morning primarily talking about this transformational agreement and the future launch of ESPN Bet. So, we’ll take questions when I conclude my prepared remarks about any and all aspects of our business. We look forward to combining PENN’s operational expertise, wholly-owned and cutting-edge proprietary tech stack, expansive market access, and rapidly growing PENN Play database with the number one sports brand in both the U.S. and Canada with ESPN and theScore. This powerful new strategic alliance with ESPN will create a best-in-class user experience and allow us to significantly expand our digital footprint and online market share while simultaneously and efficiently growing our customer database. We are particularly excited about the level of integration ESPN Bet will have in the broader ESPN ecosystem. With over 105 million monthly unique digital visitors, an audience of more than 370 million across social platforms, over 25 million ESPN+ subscribers, and the nation’s number one fantasy database, ESPN has unparalleled reach within the world of sports. We look forward to receiving exclusive promotional services across all of ESPN’s platforms, programming, and content, including access to ESPN’s popular roster of sports media personalities. I would like to spend a bit of time talking about what makes this deal so unique and special. First, it really starts with the brand. ESPN has built up decades of brand affinity through its customer-centric approach and is truly synonymous with sports content in this country. We are firmly convinced that we’ll be getting significant value for our marketing dollars by allocating those funds to the single best brand and platform in the U.S. to reach sports fans and potential bettors with a robust menu of promotion and integration across all of ESPN’s platforms, including, one, traditional linear advertising; two, digital media; three, in-program integration; four, odds attribution; five, database marketing opportunities; and six, access to some of the biggest personalities in sports media. This is not a typical media sports book commercial agreement. This is an exclusive and comprehensive alliance that will redefine the sports betting landscape with a highly aligned partner that long-term, like us, wants to see ESPN Bet at the top. We have seen firsthand the power of integrating media with betting from our experience with theScore Bet in Ontario. Despite operating in one of the most competitive jurisdictions in North America with over 70 operators, many of whom competed in that market for years and years prior to full utilization when the market was gray, we have been able to achieve sustained double-digit market share in both online sports betting and online casino in the province by leading with Ontario’s top digital sports media brand, theScore, and utilizing our best-in-class technology, which has been built from the ground up with the North American markets and comprehensive media integration not only in mind but as top priorities. This is a proven playbook and will be effective here in the United States as well. Between ESPN’s portfolio of premier sports rights, massive social media following, deep fantasy database, and best-in-class support media app, we have the opportunity to dramatically transform the way fans engage with sports content and betting here in the U.S. markets. Importantly, with this deal, ESPN now becomes a highly aligned long-term strategic partner for PENN. As outlined on slide 10 in our investor presentation, which was posted on our website last night along with our 8-K, PENN has granted ESPN approximately $500 million of warrants to purchase 31.8 million PENN common shares that will vest ratably over 10 years. Upon ESPN Bet meeting certain U.S. online sports betting market share performance thresholds, ESPN could receive bonus warrants to purchase up to an additional 6.4 million PENN common shares. ESPN will also have the option to designate a nonvoting Board observer and upon completion of year three of our agreement, they’ll be able to designate at their discretion a member to our corporate Board of Directors, subject, of course, to regulatory approvals. Over the last several years, we have made significant investments in technology, and we are confident that our newly launched products, combined with the unrivaled brand and reach of ESPN, will catapult ESPN Bet into a strong podium position in this space. We believe we can achieve substantial EBITDA in our Interactive segment over the coming years, and this will translate to very strong free cash flow generation for the Company and value creation for our shareholders. We have learned a lot over the last few years about the recipe for success in the sports betting industry, which we have highlighted on slide 8 in our investor presentation. It all starts with brand recognition among sports fans. And as I noted earlier, there is not a brand more powerful in this space than ESPN. We also know that access to customers is vital. Between ESPN’s unrivaled reach, including the largest fantasy database, as I mentioned earlier in the U.S., and our casino database of over 27 million customers, we certainly check this box. Of course, product and customer experience are also paramount. And this is why we have been so focused over the last several years on developing our own state-of-the-art technology, which we fully and successfully migrated to across the United States last month. Finally, our relationship with ESPN will allow us to create deep media integration that will provide highly efficient customer acquisition as well as increased engagement, loyalty, and friction-free access to betting on the sports teams, players, and events they love. All of this will lead to compelling cross-sell opportunities into online casino, retail gaming, and more. In short, we believe we have all the necessary ingredients to win. In order to reach this goal, we will be continuing to make strategic investments in our Interactive segment for the remainder of 2023 and into 2024. We will be focused on launch, execution, sustainable market share growth, and continually iterating upon our best-in-class technology. As we sit here today and for lots of reasons, including competitive ones, I’m not going to get into specifics regarding the impact of this partnership on our guidance for the remainder of the year. What I can tell you is that we anticipate launching ESPN Bet sometime this fall around the middle of football season, certainly before Thanksgiving. We are committed to spending $150 million in annual cash payments to ESPN for marketing services over the initial 10-year term, which we expect will generate a very strong return on investment. Additionally, we will likely spend a similar amount on off-channel marketing, meaning outside of ESPN. We also anticipate an additional amount of promotional spending as we launch the ESPN Bet product and welcome newly engaged fans as first-time and reactivated depositors in the ecosystem. During this product launch, we anticipate our leverage to increase slightly to approximately 5 times over the next several quarters, after which time, you should expect us to quickly deleverage organically, given our free cash flow generation. Bottom line, we are in this to win, and we’ll continue to invest where we see attractive Customer Acquisition Costs and where we can produce strong returns. Now, pivoting for a moment. We are still seeing stable consumer and overall business trends and healthy operating margins in our core business. Guidance for our retail segment remains unchanged for the remainder of the year. So even with additional investment in our Interactive segment, we will continue to generate positive free cash flow as a company and remain focused on maintaining a healthy balance sheet and leverage ratio. This is not a bet-the-company type of transaction, but we are extremely excited about this partnership and strongly believe it will be a transformational one for PENN. As highlighted on slide 9, looking out a few years, we believe this business can generate an incremental adjusted EBITDA in our Interactive segment of approximately $500 million to well over $1 billion per year. I would like to point out that these EBITDA ranges include the $150 million in annual cash payments to ESPN, which in our view is a very efficient allocation of the marketing dollars we would have otherwise spent to support the Sportsbook. The online sports betting and online casino space is a sizable opportunity, and we are fully committed to leveraging our numerous built-in advantages, now including the power of the ESPN media assets to help fully realize this opportunity. We plan to host an Investor Day before the end of this calendar year, where we will provide you with more color regarding our near-term and longer-term strategy as well as key metrics and financial targets regarding our new partnership with ESPN. As part of this transaction, we are selling Barstool Sports back to its founder, Dave Portnoy. Dave, Erika, Big Cat, and everyone at Barstool have been great to work with over the last 3.5 years and were the ideal partners to help us launch and rapidly scale our digital footprint across 16 jurisdictions in the U.S. With the sale, Barstool will now be able to return to what it does best: provide unique and authentic entertainment content to their loyal fan base, without the restrictions and guardrails that come from being owned by a publicly traded, licensed, regulated gaming company. I really can’t thank Dave, Erika, Dan, and the rest of the Barstool team enough for their partnership in helping us to get to where we are today in terms of online sports betting. We gained a tremendous amount of knowledge and experience with them over the last several years. More importantly, Barstool helped us grow our digital database by over 1.5 million people since launching the Barstool Sportsbook three years ago. Our new relationship with ESPN will enable us to build on this successful foundation as we move forward. It’s truly a momentous day for us at PENN and for the folks at Barstool. We certainly can’t wait to roll up our sleeves and get started with our partners at ESPN starting today. Before opening the line for questions, a few words about our second quarter earnings. We continue to see solid and stable property-level performance across our portfolio with each month showing sequential improvement. Second quarter finished strong with our best month of the quarter in June, and that momentum has carried over into Q3, where we just closed the books on a very strong July and had a good first week of business here in August as well. During the quarter, as I briefly mentioned earlier, we successfully completed the full-scale migration of our U.S. digital sportsbook and online casino offerings to our proprietary, in-house technology platform, which was a huge milestone achievement for our company. This state-of-the-art tech platform continues to drive strong results for theScore Bet in Ontario, and our improved product will provide the foundation for meaningful growth in the U.S., once we rebrand to ESPN Bet later this year. I want to thank and congratulate the nearly 500 members of our Interactive team who seamlessly executed this massive technology project with a lot of skeptics, following more than 18 months of hard work. And as always, I want to give a special thanks to all of our property leaders and team members throughout our organization for continuing to provide a best-in-class experience for our rapidly growing customer database at our properties around the country. We look forward to numerous cross-sell opportunities to come with our new online products. And with that, Frank, I’m happy to open up the line for questions.

Thank you. Our first question comes from Barry Jonas with Truist Securities.

Hey. Good morning, guys. And congrats on the deal. Jay, is it possible to give a little more color about how this came together overall?

Not really. I’d prefer not to get into the inside baseball of how it came together. I would just say that as we got to know the folks at ESPN led by Jimmy Pitaro, it felt good. And we’ve met a lot of people at ESPN, and what I’ve been blown away by and the folks that we’ve spent time with is they share a passion for wanting to be the best at everything that they do. And ESPN Bet is no different. They’ve been working on this behind the scenes for some time. It’s very clear when you meet with them. The excitement, the energy, the passion, and the alignment on what the future will look like is very exciting, but I’ll leave it at that.

Understood. And then, I guess just from a demographics perspective, how is the new ESPN Bet positioning compared to what you previously had with Barstool? I guess, I’m just trying to understand how to think about your overall omnichannel strategy there.

Yes, it's a great question. The ESPN brand is quite different from the Barstool brand; Barstool tends to attract a younger audience, with an average age of about 29 among our digital users. This is fantastic, especially since we now have 1.5 million people in that digital database who joined after launching Barstool Sportsbook. We have a strong base of younger customers who also visit our casinos, allowing us to cross-sell into iCasino. In contrast, ESPN is a globally recognized brand that appeals to all age groups. It has widespread affinity and is not limited to a specific demographic. We believe it will complement what we have developed over the past three years extremely well. We are excited about the potential to reach a broader audience. It's become clear over the last three years that the online sports betting market is increasingly consolidating around a couple of key players, and having scale is essential to compete. There is a specific strategy for achieving this scale, which I discussed in my earlier remarks and in our presentation slides. We believe we meet the criteria of this strategy and are ready to compete on a larger scale.

Our next question comes from Carlo Santarelli with Deutsche Bank.

Jay, just going back to the comment that you made about kind of leverage topping out at 5x. It would imply that maybe spend this year is not as significant on the initiative. And clearly, if you’re launching sometime in November, that very well could be the case. But as we move into 2024, in addition to the committed spend, how are you guys thinking about kind of the promotions and going about customer acquisition? And do you have any kind of, I don’t know, guidance that you could perhaps give that would give us maybe a better sense of what we’re thinking about on a 2024 basis?

I don’t want to get into too much detail on 2024 yet, Carlo. We will hold an Investor Day before the end of the year to provide much more information on that. Launching is very important to us, and we want to ensure a flawless launch, likely after which we will have the Investor Day to give us better visibility on trends. Regarding promotional spending, think of it this way: we aim for a November launch, though we don't have a firm date yet. The team is working hard on the app reskinning for ESPN Bet. For promotional expenses, most will be associated with bringing new users into the ecosystem through incentives like the first-time deposit match, which typically takes around two months to fully earn. Therefore, November and December will see higher promotional spending, followed by significant sporting events like the NFL playoffs, the Super Bowl in February, and March Madness in March. From a promotional standpoint, most of the spending will occur in the fourth quarter and the first quarter. In terms of general marketing spend, we aim to match our off-channel spending, which is outside of ESPN, to what we spend with ESPN. This is not a precise number, but it reflects our planning. Based on these assumptions, we expect to be comfortable at around five times our peak spending level. This will decrease as we move further into 2024, but the free cash flow we generate will allow us to reduce that back into the fours fairly quickly. We are committed to our strategy and want to avoid any regrets about our product and brand launches. We have strong alignment with ESPN to ensure that our launch is compelling for consumers. People will definitely know when we go live, and I feel very confident about that.

Got it. Jay, you addressed my follow-up within your response. The $150 million committed through ESPN will lead to an additional $150 million from other vendors and customer acquisition channels. Promotions will be treated as a separate category, correct?

That’s all correct, Carlo. And the $150 million is not a perfect number, but just to say roughly, yes.

Okay. If I could, I have a follow-up regarding the core business. Your margins have generally remained stable, with a slight increase. There’s some seasonality involved, but they continue to stay around the 36% mark. Clearly, the top line has experienced some pressures. How do you view the retail brick-and-mortar guidance for the remainder of the year? Is this margin level sustainable in the current climate as we progress through the second half of the year, taking seasonality into account?

Well, let me just answer your question by saying, generally, yes is the answer. Todd, I’ll let you jump in there in terms of what we’re seeing in the business and why we’ve been able to keep those margins in that 36% sort of level over the course of the last several quarters.

Thanks, Jay, and thanks, Carlo. Yes, it’s sustainable. We continue to assess our position compared to 2019, and the growth we've experienced marks a new beginning. Evaluating our labor and marketing conditions, not only for us but also our competitors, reflects a more rational environment. Entitlement programs have diminished, which gives us confidence as we proceed, knowing these are the main expense drivers and we are in a solid place. Additionally, our technology improvements are expected to enhance our margin profile. We are quite confident that these margins will be viable for our future, keeping in mind some seasonal fluctuations that may occur.

Our next question comes from Bernie McTernan with Needham & Company.

To start, it's clear that the market is reacting positively to this announcement. However, I am hearing some concerns regarding market share and the historical challenges of partnerships between media operators and online sports betting companies. What makes you confident that you can achieve the expected market share? Jay, you mentioned being in pole position and driving market share and scale. What gives you that confidence?

Yes, it’s a fair question and I appreciate the opportunity to address it because there really is no comparison to ESPN. First, this relationship is exclusive and ESPN-branded, which is very important. It’s fully integrated and includes access and endorsements from top ESPN talent. Importantly, this is a strategic relationship that will help us achieve higher levels of market share over time. As we gain market share, the warrants that they hold for PENN will become more valuable, especially when it exceeds 20%. If we find ourselves discussing the dilutive effect of warrants over 20%, that will be a great outcome for everyone involved, and we are focused on achieving those long-term goals with ESPN. I often reflect on the UK market and how market share changed during the first, middle, and last three years; it’s a dynamic situation. The idea that the established market share in the U.S. is fixed is unfounded. While it may not shift dramatically from where we are today, it will fluctuate. What we announced recently is innovative and likely wasn’t considered by others just a day ago, and it will influence overall market share. We believe we will be a significant player in this space.

Thank you. I have a follow-up regarding slide 9, which mentions expectations for EBITDA margins in the high-teens. I would like to hear your thoughts on how this operating plan differs from the previous one regarding potential margins for the business. Additionally, concerning the illustrated market shares, we are receiving inquiries about the year three termination. How should investors view the market share necessary to maintain this partnership beneficially for both parties?

Let me address the question about margins first. It is crucial to achieve scale to improve margins in this sector. Everyone understands that aiming for 20% margins with a 5% market share in online sports betting is unrealistic. That's the first point to emphasize. Additionally, regarding the margin assumptions mentioned on slide 9, these are based on Gross Gaming Revenue (GGR). If you’re comparing our figures to those provided by others regarding long-term margin expectations, most of their analyses are based on Net Gaming Revenue (NGR). If we translate our margin assumptions from a GGR perspective to what that could mean for NGR, our figures may be slightly lower than what others project. This is simply a matter of being conservative. When we achieve scale and establish ourselves in nearly every state, as we intend to do, we believe we can approach the margins that others have indicated for NGR, but for now, we’ll proceed cautiously. Regarding market share assumptions, could you please repeat that part of the question? I want to ensure I address it accurately.

There’s a 10-year partnership with the option to terminate after three years if certain market share thresholds aren’t met. We’ve been receiving inquiries from investors about what those market share thresholds are.

Got it. Sorry. We haven’t disclosed it and we’re not going to. That’s in our agreement with ESPN. But I would just say that probably safe to assume that the bottom end of the range on slide 9 is going to be a level that we’re starting to get excited about, both ESPN and PENN. And below there is not really exciting. So, just sort of think about it that way.

Our next question comes from Chad Beynon with Macquarie.

Congrats on the announcement. And thanks for taking my question. Jay, I wanted to ask about the rights portfolio. It’s a 10-year deal with ESPN. And there’s been some other companies buying up rights to different sporting events and different contracts. What gave you the confidence that ESPN will continue to be a leader with the content that they currently offer? Thanks.

Yes. Look, I’m not going to sit here and speak on ESPN’s behalf with regard to their sports rights. What I would say is I think they’ve been crystal clear publicly in how much they value the ESPN brand long-term and how important owning sports rights are for success long-term. And so, we feel great about that. And if you look at the agreements they have in place with the major leagues today, the NFL, NHL, MLB, NBA, it looks really good and it goes out pretty far. And so you can do your own research on that. But I think most importantly is there’s a high level of conviction from everybody we’ve met at ESPN that sports rights are a big part of who they are and what they do, and that won’t change.

Thanks. And on the tech side, you mentioned up in Ontario, you’re a double-digit market share leader in sports betting and iGaming. So that clearly speaks to the brand but also the tech. You recently adjusted the tech down here, and this is certainly an important part of the equation. So, anything else you can just talk about where the tech stands today, the menu of offerings that you’ve recently launched and when you launch ESPN Bet in November, kind of how your tech stands against some of the other market share leaders in North America? Thanks.

Yes, I'm glad to share. We've been operating on our own technology stack in Ontario for over a year, and everything has gone very well. We're continually improving and maintaining a complete range of options for Parlay and in-game betting. The user interface and user experience are excellent, and we believe it's very competitive with leading online sports betting platforms. We anticipate that when we launch ESPN Bet in November, we will present similar capabilities. The advantage of our approach is that we've developed this technology from scratch specifically for the North American markets, allowing us to continue evolving. We've also demonstrated our ability to integrate fully with media platforms. In Ontario, users can access theScore media app, where they can fill out their bet slips, view game odds, and place their bets. When they're ready to make a wager, it smoothly transitions them into theScore Bet, giving the impression of a single cohesive application. We plan to follow a similar strategy in the U.S. with ESPN, ESPN Bet, and betting slips. Some aspects will take time to implement, but we have made significant progress already. It's mainly about prioritizing our product roadmap and enhancements. We are confident about our position at launch and optimistic about where we will be in six months and a year from now.

Our next question comes from Joe Greff with JPMorgan.

Do you guys have minimum investments for advertising on ESPN beyond $150 million per year? And is there anything that precludes ESPN from taking advertising across its platforms from your OSB competitors?

There’s no obligations other than the $150 million a year. We can choose to do more than that. We may if we’re seeing great results, but that is the obligation. They have the ability, of course, if they want to, to take advertising dollars during commercial breaks from competitors, and that’s really ESPN’s call on if they do it and how much of that they do. I’m not worried about that. I think it’s going to be very clear if you’re tuned into ESPN programming that they are fully behind ESPN Bet.

Great. And I’m not sure if you answered it exactly, and maybe you don’t want to. But the provision where both parties can terminate the agreement, assuming a certain market share threshold, did you actually give a specific threshold?

We did not, Joe. I mentioned earlier that we’re not going to. But we’re not doing this deal to be 4% or 5% market share players. That’s not going to be acceptable for us. It’s not going to be acceptable for ESPN. And so, you should assume if those are the ranges you’re in, that’s not going to work out long term. But we think we’re going to be certainly within the range that we provided here on slide 9 in our investor presentation, and we think we can go beyond there, long term.

Our next question comes from Ryan Sigdahl with Craig-Hallum Capital.

Curious, will ESPN Bet offer iGaming in states where legal to leverage that OSB/iGaming cross-sell that peers have had so much success with?

We will have a Hollywood-branded iCasino offering integrated with our ESPN Bet sports betting platform in all states where online casino gaming is permitted. We firmly believe that we have the strongest brand in the world to spearhead this initiative. Regarding online casinos, we share the general belief that multiple brands will be essential in the long run. Some brands may appeal more to slot players, while others may better attract table game players. Therefore, we decided it was the right moment to concentrate on the Hollywood Casino brand. This brand represents about two-thirds of our physical properties. We have made significant capital investments across our portfolio, and we take pride in the Hollywood brand, which establishes a strong connection to digital online casino offerings. Currently, we are active in five markets, and we anticipate this will expand over time. Additionally, in markets where we operate land-based casinos under the Hollywood brand, we see excellent cross-selling opportunities both online and in our physical locations.

Jay, just to clarify, I have a separate follow-up. You mentioned something about whether it will be a cohesive experience within the apps, or will they be separate apps?

No, no. I mean, we will have at some point a standalone Hollywood Casino app. We’re not there yet. But it will be integrated. So if you’re in the state of Pennsylvania, for example, and you’re within ESPN Bet betting on sports, you’ll be able to wager by clicking on the Casino icon and go to Hollywood Casino seamlessly within the same app and platform the way that you can today between Barstool Sportsbook and Barstool iCasino.

Our next question comes from Shaun Kelley with Bank of America.

Jay, I’d like to revisit some of the financial aspects. Specifically, can we discuss your initial plans for Barstool and whether the initial budgets included any marketing and preparations for 2023, especially considering the transition back to your tech platform? I'm trying to understand how much of the total $300 million, particularly the significant expenditures in the fourth quarter, was already anticipated. How much of that is additional spending, and how much was factored into your expectations from the start?

Yes. I would say a good portion of it is incremental, although we did have a pretty solid marketing plan for launch this football season, if we hadn’t gotten to the finish line with ESPN for ESPN Bet. So I don’t know, maybe one-third of it was already built in and two-thirds of it now incremental when you consider the ESPN investment and some of the additional off-channel marketing investments, something like that.

That's helpful. As we look ahead to 2024 and beyond, you've mentioned your long-term commitment and significant efforts. Could you clarify the depth and duration of your plans? Specifically, regarding the five times parameter, which I believe refers to lease-adjusted net debt, will that remain consistent throughout 2024? Additionally, how long do you think it will take to start seeing cost leverage? Historically, we've observed paybacks ranging from 12 to 24 months, and there seems to be a trend of acceleration in promotions in more recent cohorts of states. How do you perceive this, and when do you anticipate making significant progress toward your business goals?

Yes, it’s a great question. We’ll cover a lot of that, Shaun, in our Investor Day before the end of the year. But I think at a high level, sort of think about where we are in the journey versus maybe the other top players is we’re probably with this announcement today a yearish behind in terms of that inflection point. Others are sort of getting there soon in the fourth quarter. And I think second quarter was profitable for a lot of operators, not a ton of money but profitable. But I think you’re going to see people, at least based on what they’ve committed to, show some real profit in the fourth quarter of this year. We obviously will not as we’re launching the product this year. And we’re going to be really focused on customer acquisition and retention and cross-sell over the course of the next 12 months. And I think going into football season next year, we want to make sure we feel like we’ve left anything out there on the acquisition side. We’re continuing to be aggressive going into football season given that we’re going to miss the first couple of months of football season this year. But I think things will start to settle out for us, and we’ll have a good handle on how things are going to look in 2025 and beyond from a profitability standpoint. But they will certainly be profitable. And I think it depends on what level of scale and where we are on the podium as to what ‘25 and beyond look like, but that will certainly be the year where you really start to see the returns starting to come through the P&L.

Our next question comes from Steve Wieczynski with Stifel.

So, Jay, you briefly addressed my first question, but one of the inquiries we've received from investors in the last 16 or 18 hours is whether you are late to the market. If you don’t launch until the middle of the NFL season, how challenging will it be for you to capture market share? This may not be an immediate concern this year, but looking ahead, many potential customers may already be committed to other platforms.

Yes. We faced this question frequently before launching Barstool Sportsbook in October 2020, and we achieved over 10% market share early on, which we maintained for nearly a year. While we've been on this path for a while, active involvement in the online sports betting realm is relatively recent, and we see a significant opportunity to become a major player. I believe that launching in November is advantageous since it won't coincide with the busy football season, where competition for customer acquisition becomes intense. Our decision to launch with ESPN Bet in November is product-focused, and strategically, it positions us well as other companies may have already exhausted their promotional budgets on new customers. We plan to introduce something unique mid-season that other competitors may not offer anymore. We’re comfortable with taking our time to demonstrate our potential and will share our progress in real-time during November and December as we move toward 2024. We feel positive about the timing of our launch.

Okay. I understand. Jay, if we go back to when you first invested in Barstool, I recall you mentioned how promising that partnership would be. I'm trying to grasp why this deal differs so much from Barstool. I get that ESPN operates differently, but perhaps I can ask what aspects of Barstool you may have overestimated or misjudged. I'm trying to phrase this as kindly as possible while reflecting on that deal, and I realize you might have some limitations in how you can respond.

Well, I guess the way I would answer it is that we felt great at the time that we were partnering and launching with Barstool. And we’ve had a great 3.5-year run with our partners at Barstool. And I’m sure most, if not all of you, watched Dave’s emergency press conference on this last night. I thought he summed it up really well. It just became obvious to both parties that there’s probably long-term only one natural owner of Barstool Sports, and that’s Dave Portnoy and Barstool Sports. And being part of a publicly held, highly regulated, licensed gaming company, it became clear that we were an unnatural owner. And so, I think today is a great day. It’s great for Dave and Barstool Sports. It’s great for Stoolies. It’s great for PENN, and it’s great for ESPN. Everyone’s feeling great about the future and where we’re headed. And we’re not really focused or going to spend too much time talking about the past. We’re going to really stay focused on where we’re headed.

Our next question comes from Joe Stauff with Susquehanna.

Jay, I was wondering if you could maybe just touch on a few things. In terms of your new tech stack and the product offering, question is largely about kind of just how stress-tested and kind of ready for prime time and higher levels of capacity going into the football season is. Can you talk about your Parlay product? Is that product something that you are pricing? Or do you outsource certain pieces of it? And maybe some of the plans that you have in terms of maybe getting into New York, or how far or how long it will take if you were able to integrate ESPN’s maybe streaming signal within the app, things like that?

Yes, there’s a lot to address, Joe. I’ll do my best to cover everything, and please feel free to jump back in if I miss something. We’re launching in November to ensure we have enough time to not only rebrand the app to ESPN Bet but also to enhance its user interface and experience. Additionally, we want to ensure that we can handle a significantly increased volume as we grow. This is a key reason for the November launch. We already have some hardware, but we'll be ordering more servers to support this increased capacity, which is a positive situation to be in. We’ve successfully operated in Ontario for a full year, including during the Super Bowl, and have a top-notch technology and engineering team in our Penn Interactive unit. We are confident in our ability to manage greater volumes when we launch in November. Regarding our approach to risk and trading services, our strategy remains unchanged. We have a dedicated risk and trading team that has demonstrated its effectiveness. We are pleased with the progress made in Ontario and in the U.S. after migration. Having our own risk and trading team has already presented numerous advantages in pricing Parlays and managing VIP bets at the appropriate levels. While we do utilize some external feeds, owning our risk and trading team enables us to make impactful decisions regarding our overall hold percentage and pricing strategies for both in-game and general Parlays. We're continuously improving and seeing positive trends in our overall hold percentages. Now, concerning access to other states, as Dave mentioned in his emergency press conference, entering the market with ESPN Bet positions us well for access in many areas. Some states have limited licenses, but we believe that where there's a will, there's a way. We are exploring creative avenues to enter states where we are not currently operating, which remains a top priority for both us and ESPN.

I understand. That clarifies a lot. Again, I suppose it’s something that will happen eventually, but do you have plans to possibly integrate the ESPN signal into your app, maybe in 2024, or how long would that theoretically take?

Yes. I would say that’s a real forward-looking question, Joe. The answer is, of course, those are things that we’re going to prioritize, but I’d rather wait until our Investor Day more toward the end of this year. And we’re really focused on launch and ramping and getting through football season. But we’ll have a lot more to share with you of how we’re thinking about product roadmap and enhancements in media integrations between ESPN and ESPN Bet and feeds and the other questions you have. We’ll be happy to address all of those or as many of those as we can later this year.

Our next question comes from Brandt Montour with Barclays.

So, we covered a lot. My first question is about the retail sportsbook and the Barstool brand that you’ve been rolling out. What will happen to those? Also, do you have access to rebranding those sportsbooks under the ESPN Bet brand?

Yes, that's a great question. We've made significant investments and currently have top-tier retail sportsbooks in our portfolio, which is fantastic. The agreement with Dave and the Barstool team involves a period where they will require our support during the transition. We also need time to launch the ESPN Bet app and remove some Barstool-specific branding from our retail sportsbooks. However, we are collaborating on several transition issues. As for how this will all look in the end, it's still to be determined. The ESPN team has not had the chance to visit our locations yet, so we have a process to go through. There may be some ESPN-branded retail sportsbooks planned, but if that doesn't happen, we believe we still have top-notch retail sports betting destinations and sports bars linked to nearly all of them.

Thank you for that. As a follow-up, you mentioned the additional $150 million for off-channel marketing. I understand this amount is separate from the $150 million commitment to ESPN through a fee. Can you clarify whether this extra amount is completely discretionary or if it’s part of an agreement with ESPN to support the product? Is there potential to use broader Disney assets for this spending? Also, how did you determine that specific amount? What leads you to believe this is the appropriate figure?

Yes. I mean we’ve put a lot of thought into what we believe we’re trying to accomplish, scaling and in addition to the support and marketing service that we’re getting from ESPN, what are we missing. And so, we feel like that level of spend allows you to do really most, if not all, of everything else that you want to do or plan to do. There’s no commitment, to your first part of your question, Brandt, on how much we will or won’t spend in off-channel as part of this deal. This is what we believe is the right level of spend, and our partners at ESPN feel good about it too. So, we’re both excited about marketing spend both within the ESPN ecosystem as well as outside of that.

Our next question comes from John DeCree with CBRE.

I believe you mentioned the additional spending in the fourth quarter in response to Joe’s question. However, I would like to know how the annual marketing spend of $150 million at ESPN and approximately $150 million off-channel compares to what was previously allocated for the Barstool brand. What is the increase in total marketing dollars relative to the last year or two?

Yes, we have discussed this previously, and it's a good question. We have been working on product migration for the past 12 to 18 months, as I mentioned earlier. We were cautious about being aggressive with our marketing spend, focusing mainly on organic integrations with our partners at Barstool. That phase is now complete, and we are very pleased with the products and how the migration went. It was seamless and uneventful, which is impressive considering we converted all 16 of our U.S. markets within 24 hours. Kudos to Benjie and the Penn Interactive team for that. Overall, we feel really positive about our current position. Moving forward, we are flexible and can adapt our strategies as needed, but we feel confident.

Okay, understood. Fair enough. I have a question regarding the ESPN email and the fantasy database subscriber list. Can you directly market to those email addresses, or are there restrictions? Additionally, do you know if the information for ESPN Bet customers is owned by PENN, ESPN, or is it shared?

Anyone involved in the ESPN Bet ecosystem is owned by PENN. It is essential to be fully regulated and licensed to access information on gaming customers. Regarding the emailable database at ESPN, we won't go into too many specifics, but ESPN has been developing a robust and comprehensive plan for some time. Additionally, as highlighted in the release ESPN issued yesterday, we have strong alignment on the importance of responsible gaming. ESPN is establishing a committee that will collaborate closely with our committee at PENN. We believe we have a clear path and roadmap for marketing to the database responsibly, ensuring that we complete age verification and adhere to all necessary considerations on the gaming side.

Our next question comes from Stephen Grambling with Morgan Stanley.

Many of the other media partnerships, I think, ultimately acquired customers that then lost them or we saw them dwindle in year two. How will you measure conversion effectiveness with ESPN and/or track KPIs to ensure that you’re acquiring beyond that kind of first test? And as a related follow-up, how do the CAC assumptions embedded in your market share projections compare to what you provided in the past for the digital business?

Good questions, Stephen. Regarding some of the KPIs, we will discuss those more in our investor presentation at the end of the year. Right now, our focus is on the launch. I understand there are many inquiries about other media deals, but I think it's important to recognize the differences. People turn to ESPN every day for sports content—scores, stats, stories. They are unparalleled in this field. We believe we can retain our audience because they have a strong connection to the brand. Our aim is to deliver a top-tier product that provides compelling reasons for users to remain engaged and be treated exceptionally well. Viewers will continually return to ESPN’s media offerings and be reminded of our presence. We are optimistic about our year two retention abilities and cross-sell opportunities given our strong brand. In terms of Customer Acquisition Costs (CAC), we’ve been transparent in thinking that our media relationships allow us to maintain competitive customer acquisition costs. The current environment has been favorable, and previously, we couldn't fully engage due to the lack of a competitive product, but now that we have one, we see positive prospects. Customer acquisition costs are currently around $200 to $300, with some instances being lower, which we consider healthy levels. Assuming the market continues in this direction or improves, we see promising opportunities to invest and feel confident about Lifetime Value (LTV) and the returns from those customer acquisition costs.

On that note, if the return on investment is favorable and the customer acquisition cost is lower, would you be open to exceeding the five turns of leverage, or is there a way to secure additional capital to pursue market share more aggressively?

Yes. I mean, look, let’s wait and see, Stephen. I think right now, we’ve got a really good plan that I’ve laid out for everybody and given you some parameters on how we’re thinking about the business. And by Investor Day, assuming we do that sometime in December, we’ll have been live for, call it, a few weeks, and I think have some really good information to share in how we’re thinking about some of the topics that you’ve raised. But I think it would be premature to get into that now. We feel good about the plan in front of us.

Our next question comes from David Katz with Jefferies.

Congratulations on your deal. I wanted to ask, and Jay, I think you’ve touched on this a bit, but I would like to hear your thoughts on how you are planning to define your product in a unique way. Over the past several months to a year, we've observed various differences in the types of offerings and how apps are positioning themselves to not only gain market share but also do so profitably.

Yes. It’s a good question. I think that really the key differentiation for us medium term, long term, David, is going to be the things that we can do around integration, media integrations, video and maybe potentially live streaming. There’s a lot of things that we can do because of who our partner is here that others won’t be able to do in the same way. I think there’s been a lot of attention, as there should have been, given to same-game Parlays and who’s best at those. And to me, those are going to end up being largely commoditized because they’re betting offerings that we’re all going to be at the same level in a very short period of time. But there are certain things that we’re going to be able to do because of the media partnership and who ESPN is that others just won’t be able to emulate.

Understood. And if I may just follow up quickly. With respect to the cross-selling opportunities here, have you talked about sort of the concentric circles around customers in one database versus the other? Obviously, one is much, much larger than the other. But how many of your PENN people are ESPN people and/or vice versa?

We don’t have a good feel for that today, David. I’d imagine that there’s going to be some overlap but not a lot. I mean, this is a huge opportunity to partner with ESPN. And yes, I think most of it is going to be incremental to what we have today. Frank, if we can maybe just do one question that would be great.

Our next question comes from Jason Tilchen with Canaccord Genuity.

I’m curious about your market access, particularly in Connecticut, considering Rush Street's plans to exit there. Given that this is ESPN’s home state, what do you think your chances are of obtaining the third license, and what is your current status in that process?

Yes. The decision hasn’t been made yet, and we would obviously like to be in Connecticut. We will see when that decision is made and if we are fortunate enough to be a new operator there. We have discussed New York before. While no one is fond of the tax rate in New York, there could be opportunities in the short to medium term to gain access to New York in creative ways. These are efforts we are working on behind the scenes. As I mentioned earlier, it’s crucial to be a scale player to have access to the important states. Currently, I don’t believe anyone is really making money in New York, but from a database cultivation perspective, I hope there will be opportunities down the road to collaborate with the state for a mutually beneficial operating environment. These are initiatives we will continue to pursue behind the scenes, and we will keep everyone updated on our market access strategies. We might have some updates potentially by the time of our Investor Day.

Great. Thank you.

All right. Thank you, everyone, for joining this morning. Very excited. Look forward to continuing to connect with you on this what we view to be such an amazing strategic alliance. And the future looks bright. So, look forward to continuing to talk. Thanks for spending time with us this morning and for all the analysts for having great questions, as always. We’ll talk to you soon.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.