antasyDuel (FD) has proposed to acquire DraftingKings (DK). FD and DK compete by offering daily fantasy sports (DFS) contests. You are an FTC lawyer in the Bureau of Competition assigned to review FD’s proposed acquisition of DK and make a recommendation to the Commission. The FTC investigation revealed the following facts. DFS contests were introduced in 2006. DFS providers provide a software platform that allows users to participate in "fantasy sports." DFS involves users participating in contests in which they pay for the right to "draft" teams consisting of athletes in a particular sport (e.g., football) and earning points associated with the performance of those athletes. The key defining feature of DFS contests is that they occur, as the name implies, on a daily basis. There are other types of fantasy sports contests. Prior to the introduction of DFS, the dominant platform for the provision of fantasy sports contests was “season long fantasy sports” (SFLS) contests. In SLFS contests, users draft teams and earn points for their performance over an entire season. DFS was designed at least in part with the intention of attracting disenchanted SLFS users – who often lose interest in lengthy season-long contests. From 2006 to 2010, the period when DFS first came into being, fantasy sports saw tremendous growth, with participation rates in the U.S. growing by 65%. A July 2015 survey of DFS players indicated that “nearly half of all survey participants said they’ve significantly reduced their season-long fantasy activity (after they started playing DFS).” The Companies (FD and DK) also discovered the opposite to be true: a significant percentage of players that stopped playing DFS did so to increase playing time on SLFS. The DFS ecosystem brings together users of wide-ranging skill, interest, and motivation to compete against each other in fantasy sports contests. DFS providers like FD and DK create the contests and supplies the infrastructure necessary to support the contests. Users provide the liquidity – through payment of contest entry fees submitted to enter the contests -- that enables the DFS provider to pay out prizes and offer more contests while also generating revenue for the provider. DFS providers like FD and DK generate revenue by taking a percentage commission on entry fees. As a result, nearly everything a DFS provider does in terms of contest creation, product development, and marketing is focused on a single goal: growing total entry fees (and in turn total revenues). DFS players have different levels of commitment to DFS and play for different reasons. At one end of the skill spectrum are “professional” players. Professional players generally fall into two loosely defined groups: (1) net winners (DFS providers often refer to these users as “sharks”); and (2) net losers (i.e., DFS providers often refer to these users as “whales”). Though both groups play at large volumes, each group tends to have slightly different reasons for playing DFS. Net winners tend to focus almost exclusively on financial gain and often evaluate DFS’s relative rate of return against other activities, such as sports betting, online poker and other games of skill, as well as participation in financial markets. Net winners tend to employ a range of sophisticated strategies to win, from developing lineup algorithms to submitting multiple lineups to hedge against potential flaws. Importantly, net winners rely on the participation of whales and smaller volume “casual” players against whom to compete. In DFS generally, and in the experience of FD and DK, professional players make up a very small percentage of total users in the ecosystem but contribute a very large percentage of total entry fees. Casual users make up the largest percentage of total users but contribute significantly lower entry fees per user than the professional group of players. About 70 percent of active users do not generate a positive financial return on their DFS entry fees. A balanced DFS ecosystem means more players entering contests, more money circulating through the system (i.e., more entry fees), and more revenue for the Companies (because they generate revenue based on entry fee commissions). Attracting and retaining new users is critically important because it starts the cycle of growth, driving overall user engagement (especially among professionals), which leads to higher prize pools, thereby attracting more casuals. The DFS industry faces the challenge of and maintaining new, casual users without significantly impacting the return on investment (ROI) of legacy users, especially the professionals, such that they substitute to other activities. Neither FD or DK has ever had a year in which it reported positive accounting profits. The accounting losses were particularly large in 2015, with FD and DK reporting losses of nearly $300 million and over $500 million, respectively. In 2016, the losses dropped to approximately $60 million and $90 million. FD was among the first DFS sites when it launched in 2009 and quickly became the industry’s most popular DFS provider. Through 2014, however, FD continued to have at least a 65% share of DFS measured by dollar entry fees. DK launched a massive advertising and marketing campaign in 2014 and reached entry fee parity with FD in 2015. Other DFS sites exist. Most notably, Yahoo!, one of the largest providers of season-long fantasy sports, has started offering DFS. But today, two roughly equal-sized firms (FD and DK) have by far the largest share of DFS entry fees. DFS providers compete largely to increase the number of overall users, attracting them from SLFS and elsewhere. In 2008, the number of DFS players was 0. In 2013, it was under 400,000. From 2014 to 2015, it grew from 1.6 million to 4.7 million. In 2016 it dropped to 3.4 million. The future of the industry depends in large part upon whether the number of DFS players falls to zero or grows substantially. Both outcomes are possible. Focusing on 2015, both companies had entry fees of approximately $1.4 billion, which generated slightly over $100 million of gross revenue. With only about $100 million in gross revenue (and well under $100 million in net revenue), FD spent over $300 million on marketing while DK spent over $500 million. In 2016, both companies substantially reduced their marketing expenditures. That reduction slowed the rate at which the companies were “burning” through their cash, but the meteoric growth from the previous years stopped as well. FD’s entry fees actually shrunk. DK’ entry fees did grow, but only modestly. A striking feature of DFS is the large fraction of entry fees accounted for by a small fraction of the players. Approximately 1% of the players account for over 60% of entry fees on both sites, and approximately 5% of the players account for 80% of entry fees. A small number of players win consistently, and their likely motive for playing is to make money. Roughly 20% of players on both sites lose 100% of their entry fees, meaning that they did not receive a prize in any contest. These players only account, however, for about 1% of entry fees. On the other side of the distribution, only 8.5% of FD players accounting for 36.3% of FD entry fees and 6.9% of DK players accounting for 33.6% of DK entry fees had positive ROI’s in 2015. Players leave DFS providers for a variety of reasons. For example, in a July 2016 survey of lapsed players, FD asked, “Why did you decide to stop playing?” In response, 30% of players agreed with, “I think FD has an unfair playing field with too many experienced players,” 25% agreed with, “It was too hard to win,” 25% agreed with, “I didn’t have any money left in my account and didn’t want to deposit more money,” and 14% agreed with, “I felt like I was losing too much money.” The rate of agreement with this set of answers, all of which fit a common theme, substantially exceeded the rate of agreement with other reasons for stopping. Only 7% agreed with, “I prefer to play season-long football” and only 6% agreed with, “It was too time-consuming to do the research.” One dimension upon which DFS providers compete is the commission rates they offer to users. The commission rate is the percentage of the entry fees kept by the DFS provider – that is, the amount of entry fees that are not paid out to users (e.g., a 10% commission rate means the DFS paid out 90% of entry fees in prizes to users and retained the rest). FD had a commission rate of approximately 10% in each of these years. The exception is 2015, when its commission rate fell to 7.8%. The approximate 10% commission that FD achieved in 2013, 2014, and 2016 reflects the pricing strategy it has generally pursued from the time it started operation. DK’ achieved much lower commission rates in 2013 and 2014 than did FD. In 2015, its 8.8% commission rate was actually above FD’s commission rate for that year, but still below the approximate 10% rate that FD has generally targeted and achieved. In 2016, DK’ commission rate rose to 10.0%. DK’ low commission rates in 2013 and 2014 were the consequence of a conscious strategy to run large prize pool contests that it knew were unlikely to fill. By 2016, there is no detectable enduring effect of the changed market structure on the commission rates. They are about 10%. DK’ strategy for catching up to FD did entail charging a lower price on average, but it did not cut its commission rates across the board. Instead, it offered some games with large prize pools that resulted in overlay. Similarly, FD’s response was both small and temporary. The reduction in its commission rate from 9.5% in 2014 to 7.8% in 2015 in part reflected the lower commission it charges for games with higher entry fees, and any reduction not attributable to the increase in games with high entry fee disappeared in 2016. Similarly, if one compares average ROI’s for FD players in 2014 and 2015, both groups of players received about the same ROI. FD offers contests based on the NFL, NBA, Major League Baseball (MLB), the English Premier League (EPL), and the UEFA Championship League (UCL). It just recently introduced contests based on professional golf. DK offers contests for all the leagues/sports for which FD offers contests. It also introduced golf in 2015, 2 years before FD did. It also offers contests for NASCAR, mixed martial arts (MMA), eSports, and the Canadian Football League (CFL). In the sports where DK is the only DFS provider, DK charges the same entry fees as it does in the sports where both DK and FD offer contents. DFS faces a number of regulatory challenges. Several states have declared DFS a form of gambling and declared DFS contests illegal. In general, when the legal status of DFS in a state has changed, DK and FD have stopped providing service and/or resumed service at the same time. The one exception is Texas, where FD stopped offering service in May 2016 in response to an opinion from Texas Attorney General that DFS likely violates Texas’ anti-gambling statutes. Despite that opinion, DK has to accept entries from Texas. The merging parties’ economic expert witness estimated the extent to which Texans who would have played FD played on DK instead. The expert’s analysis concludes that 35% of the entry fees that FD lost when it shut down entirely – which the expert describes as the equivalent of an infinite price increase -- went to DK, and on that basis concludes that FD and DK are not particularly close substitutes. The expert further contends that the true diversion ratio in response to a “small but significant” price increase would be much smaller than 35%. FD and DK websites have more similarities than differences. Both sites have a lobby that lists games to enter, has tabs for the sports offered, and has banner ads for a few headline contests. Both have to provide the user the ability to enter lineups in a contest. The potential lineups are specific to the day and even the time-slot when the contest will occur because, on a typical day or in a typical time slot, only a fraction of the teams have games. And the lineups have to be limited to players on the teams with games. On both sites, lineups are subject to a salary cap, which means that each player has to be priced; and these prices change daily to reflect factors like injuries and trends in player performance. Both sites provide some information about players including their average performance over the season, their performance in their last game and their performance in recent games as well as information about injuries that might prevent them from playing or limit their effectiveness. Both sites provide live scoring so that a player can track in real time (or nearly real time) how his entries are doing and whether they are “in the money.” Both sites want to provide this functionality on multiple devices – desk tops (pcs, Macs, and Chromebooks) and mobile (iOS and Android) – and available both in an app and through the intermediation of a Web browser. Each element requires effort by the product development team. There is evidence that FD and DK each have a significant backlog of research and development projects that have not been attended to for 12-18 months as resources have been diverted to regulatory and legal challenges. The parties argue that the merger will allow them to reduce duplication in product development and invest in future innovations to improve DFS platforms. The parties’ economic expert estimates that the merger efficiencies specific to the merger will be approximately $12-13 million. The expert has also projected that the combined entity will save $4 million of the $50 million that the two firms would spend separately on legal expenses. The merging parties have made it clear that there is no possible settlement or divestiture if the FTC decides to challenge the merger. Thus, the only two possible outcomes are that the FTC closes the investigation and allows the merger to proceed or the FTC seeks a preliminary injunction to prohibit the merger in federal court under Section 7 of the Clayton Act. Your recommendation should fully analyze whether the proposed merger violates Section 7 of the Clayton Act, and whether the FTC is likely to prevail in litigation against FD and DK in federal court should it decide to bring the case