Margin Compression and Prediction Markets Drive Downgrades in Turbulent Sports Betting Sector

Bank of America's recent downgrade of DraftKings (DKNG) and Flutter Entertainment (FLUT), parent company of FanDuel, has sent ripples through the sports betting industry, signaling growing concerns over margin volatility, regulatory pressures, and the disruptive rise of prediction markets. The move, led by analyst Shaun Kelley, cut both stocks to "Neutral" from "Buy," with price targets slashed to $35 for DraftKings and $250 for Flutter. Shares of both companies fell sharply following the announcement, with DraftKings dropping 6.4% to a two-year low and Flutter slipping 3.9%, according to CasinoBeats.

Kelley's report highlighted a "perfect storm" of challenges for the sector. Structural hold—the percentage of wagers retained as revenue after paying winners—has eroded due to favorable sports outcomes that have boosted bettor payouts. This margin compression is compounded by rising state taxes, such as Illinois's recent increase, and regulatory scrutiny, particularly in the UK, where Flutter operates, NewsNet5 reported. Kelley warned that these pressures could persist through 2026, with states potentially raising taxes further to offset revenue losses from prediction markets, a nascent but rapidly expanding segment.

Prediction markets, which allow users to bet on outcomes ranging from political events to economic indicators, are increasingly viewed as a credible threat to traditional sportsbooks. Platforms like Kalshi and Polymarket have attracted major partnerships, including deals with the NHL and ICE, the parent of the New York Stock Exchange, according to Business Insider. These markets operate with lower fees and dynamic pricing, diverting betting volume from established operators. DraftKings and Flutter are not standing idle: DraftKings acquired Railbird Technologies, a CFTC-licensed prediction market platform, while FanDuel partnered with CME Group to launch its own event contracts, iGaming Today reported. However, Kelley noted that regulatory uncertainty—some states warn prediction markets could jeopardize gaming licenses—adds complexity to these ventures.

The downgrades also underscore broader industry struggles. DraftKings has seen its U.S. online casino market share drop from 27% to 23% over two years, while Flutter's handle growth has slowed to 5% year-to-date, according to Legal Sports Report. Despite these challenges, both companies remain dominant players. DraftKings recently secured a high-profile partnership with ESPN, becoming the "exclusive Official Sportsbook and Odds Provider" for the network, a move that could bolster visibility ahead of its Q3 earnings report, Barron's noted.

Analysts caution that the path forward is fraught. Kelley estimates a $150 million EBITDA hit for DraftKings in Q3 and Q4 due to margin declines and prediction market investments, while Flutter faces similar pressures. With tax risks escalating and prediction markets maturing, the sector's "structural hold" may no longer be as stable as once assumed, NewsNet5 reported. For now, DraftKings and Flutter are adapting, but the shifting landscape suggests a prolonged period of margin management and regulatory navigation lies ahead.