For over a hundred years, betting on sporting events has been a popular pastime. The bookies who handled these bets could never imagine their job would be at risk someday as consumers can now make sports bets on their smart phones. Online sports betting is now a $7 billion to $8 billion industry, and one of the leaders in that field is DraftKings Inc. (DKNG, Financial).
The company is a digital sports entertainment and gaming company and provides online sports betting on a global basis. It is believed to be the only U.S.-based vertically integrated sports betting operator. DraftKings currently operates retail sports betting in 23 states and certain regions in Canada. Its daily fantasy sports product is available in 44 states, certain Canadian provinces and the U.K. The company partners with major sports brands, such as the NFL, NHL, PGA Tour, UFC, NASCAR and the NBA. DraftKings also owns and operates Vegas Sports Information Network, a multi-platform broadcast and content company.
Founded in 2012, the company currently has a market capitalization of $14.4 billion.
Online gaming industry
The legalization of online sports betting occurs on a state-by-state basis and the trends continue to be positive. Vermont, Kentucky and North Carolina have been the latest to legalize sports betting.
Almost every state has considered legalizing sports betting, however political opposition and complex tribal relationships will likely prevent more than a dozen from going online for years to come. Early on, companies like FanDuel, DraftKings and BetMGM became the early leaders. Just a few years later, a newer player, Fanatics Sportsbook, entered the space in 2023 and is expected to gain market share in certain states.
Financial review
The company reported first-quarter results in May, which showed strong revenue but continued operating losses.
Revenue increased 84.5% to $769.7 million and monthly unique payers increased to 2.8 million, which was an increase of 39% compared to the first quarter of 2022. Average revenue per user was $92 in the first quarter, representing a 35% increase compared to the prior-year period. But that’s about where the good news ends.
The company continues to lose money on a massive scale and reported an operating loss of $389.9 million. Even eliminating the large amount of stock compensation, which totaled $117.4 million in the quarter, the company still reported large operating losses. The cash burn rate was $222.80 in the quarter.
The company is able to absorb these losses, at least for now, as cash on the balance sheet stands at $1.1 billion. One of the last capital raises was convertible notes totaling $1.25 billion. Fortunately, this was a speculative bull market transaction that carries a zero-coupon and is convertible at $94.85 per share. The company has a net debt position at the end of the quarter and will only get bigger this year.
Valuation
DraftKings is a long way away from net profitability and currently does not generate positive Ebitda, so current valuation metrics will not work. According to analysts, net profitability may not occur until 2025, but the company is expected to generate positive Ebitda in 2024 in the $170 million to $180 million range.
Based on those estimates, DraftKings is selling at 84 times 2024 Ebitda and perhaps 22 times 2025 Ebitda. These crazy overvaluations prompted an insane buy rating recently by Bank of America securities analyst Shaun Kelley. With the stock trading at 52-week highs, negative free cash flow, a net debt position and crazy dot-com valuations – this particular analyst thinks it is good time to buy the stock. Luckily, he does not carry the prestigious charter financial analyst designation, or it might be revoked. And of course, reading the fine print on this analyst report shows the company has an investment banking relationship with DraftKings. Finally, the analyst projects a price target of $35 per share, only 12% above today's price.
The good news is that most Wall Street analyst recognize the enormous amount of risk in the stock and, of the 26 analyst that cover the company, the average price target is $30.64, which is below current prices. The price target is wide with a high target of $39 and a low target of $18.
Guru trades
Gurus who have purchased DraftKings stock recently include Ron Baron (Trades, Portfolio) and Chuck Royce (Trades, Portfolio). Investors who have reduced or sold out of their positions include Catherine Wood (Trades, Portfolio) and Jefferies Group (Trades, Portfolio).
Summary
There is a bull case for the stock, which includes new state launches of online sports betting as well as structural cost improvements as the company reaches national scale. New product development is a focus for the company, which will also drive growth.
However, DraftKings operates in a very competitive environment. Not only are physical casino’s staging a big post-pandemic comeback, but there are numerous gaming apps available now. Colorado alone has 25 betting apps and New Jersey has over 18. The online competition will likely intensify as building a physical casino is far more difficult than building a digital app.
In addition, this is one of the most highly regulated industries in the U.S., which is always an issue. The success of DraftKings is not guaranteed and, with no tangible book value to backstop the company if free cash flow does not become a reality, equity shareholders could be wiped out.
This remains a speculative stock and only appropriate for investors willing to accept extreme levels of risk.
