DraftKings Stock: Take Money Off the Table (NASDAQ:DKNG)

gorodenkoff

By all accounts, DraftKings (NASDAQ: DKNG) is the good news bad news of its sector. Steadfast bulls on the stock, including a bluelist of institutions, have one mantra: quarter-over-quarter revenue growth is outstanding. We agree – with one caveat. DKNG revenue growth reached 47% year-on-year. But it begs this question: Are the massive marketing and promotional expenses that are creating this growth producing real muscle in the database or empty calories? This reminds me of a long-lasting, but still questionable, marketing ploy in the casino industry:

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DKNG data by YCharts

Above: An NFL spike is possible, be prepared to sell at least half of your holdings when the time comes – if you have any gains.

If in doubt about foot traffic, hold a raffle. In short, it consisted of giving away a fancy car, or cars usually hoisted above slot carousels on the casino floor. The idea was a simple draw. Free entry. All you have to do is fill out a card and throw it in a plexiglass bin. The promotion has reliably attracted thousands of entries from drive-by visitors to our casinos as well as established customers. But the object has always been to glean justification for entering and collecting names for future promotions.

To some extent, the standard promotional offers that all sports betting platforms currently use are sweepstakes. The hook is x amount of free play for those who wish to register and join the database. What lottery promotions have taught us is that you always get ten tons of chaff for every grain of wheat in the entries. So DKNG’s massive promotions to get tempting new games for free money have their value, but I also suspect they’re weeding out tons of empty low calorie registrants.

So yes, promos do have some value in inflating “sales growth” quarter by quarter, which may or may not last.

So if the most compelling, if not the only, reason to own DKNG is its impressive sales growth as it bleeds hundreds of millions, we have to wonder when will all this investment pay off? We have looked at DKNG and its major competitors to date and have come to the inevitable conclusion that at best we might be looking at 2025/7 before the business becomes profitable. So if earnings and very positive EBITDA end up driving valuations maybe five years from now, why would anyone continue to sit on their positions?

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Eilers & Krejcik Gaming LLC

Above: This is a realistic case, but we are more optimistic, looking for $25 billion by 2025/7. But the $200 billion projected by some analysts is dream country.

A revenue story can only go so far in building a long-term belief. But call it recency bias if you will, but here are some ugly facts:

MTT:

Revenue: $1.57 billion. Promised: 2 billion dollars in 2023. Doable.

Profit margin: — 9.9%

Operating margin: — 108%

EBITDA: — (1,568 billion)

DILUTED BPA: — (4.05)

EV/EBITDA: — (4.22)

Earnings Estimates: Analyst Consensus

2022: — ($3.21)

2023: — (2.26)

At this rate of shrinking losses, our view that DKNG is far from profitable appears to be realistic.

Cash: $1.57 billion. Fine, but unless revenue growth continues to generate more cash at an increasing rate as new expensive launch states come on board, the nice prize pool will shrink and force either more debt or watered down equity.

Cash per share: $3.78, okay but not great.

Current ratio (mrq) 2.35. A bit high but comfortable, so no problem there as long as revenue increases can generate cash inflows to support cash outflows. DKNG said it was cutting promotions. However, Massachusetts is coming soon and DKNG and others are spending tons lobbying in California as that state nears referendums, which doesn’t bode any more fruitfully than many think. Both proposals put tribal casinos in the driving seat. Regardless of the volumes, the margins there will be anemic if and when.

So what about DKNG shares now?

Editor’s price: $15.49. The stock recently spiked to around $21 and pulled back. Analysts’ targets hover around $25.

I reiterate my previous advice: DKNG has advantages no doubt, but the only reason to hold it back is to wait for either an activist to stir the pot or a business buyer to arrive.

But after reconsidering that view, it occurred to me that if there weren’t even tire kick rumors we could find, there was no appetite for the when to jump on a deal even with the possibility of attaching a real nice bonus to holders.

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Grand View Search

Above: This prediction seems reasonable when it comes to CAGR, but like most, it’s an educated guess at best, as it doesn’t factor in big new entrants like ESPN and Fanatics when they come in. finally move. The dilution will hurt.

We also have to consider that DKNG’s board may not have ruled out such a deal for reasons of its own. After all, they are hardly fans of the ways and means of growing their nests of personal equity without loud interrogations from parent companies. Watch the company’s key people have built a formidable entry into the sports betting space and are happily trotting along with their bobbed-twirling shareholder executives in the retail and institutional segments (DKNG is owned by over 60 institutionals).

So it’s quite clear by now that a number of would-be acquirers or activist troublemakers have looked at the business and, at least for now, have taken a pass before moving on. a phonecall. Their reasoning takes this standard type of weighing the bad and the beautiful.

We urge readers of this space to don their banker’s caps and follow the bouncing ball, like it or not.

Benefits

DKNG is a leading company in terms of market share and should remain so for the long term. Together with FanDuel (DUEL) and BetMGM (MGM), they currently control 60% of the total market revenue. A reasonable projection of the sports betting market by 2025 is that it will be a $25-30 billion industry. Expect DKNG to hold a 20% worst-case share among leaders, which translates to at least $5 billion in revenue.

If we can attribute a 30% operating margin with promotional expenses fully under control, you have a pre-tax generator of $1.5 billion in operating profit. By most measures of a well-managed parent company, this would be highly accretive to group EBITDA.

Finances: DKNG currently appears to have enough cash to fund its ongoing operations without having to resort to major refinancing or additional debt. Its long-term debt of $1.3 billion should be enough to keep it easily solvent.

Brand value is strong among gamers and it is poised to increase its revenue stream from iGaming and maintain its leadership in DFS. Can we assume that launching an offering would be an attractive enough premium to lure retail and institutional investors into the tent? We think the discounted cash flow valuation is a good reference here. We consider a bid of $24.50 to $28 very attractive if the stock remains in the mid-teens during the NFL season. An agreement brings a fully developed market leader into a family of companies. Synergies and cost disciplines can help expand operating margins.

The inconvenients

A review of the competitive set reveals that DKNG competes in most states with up to 10 rival platforms. Although consolidation is inevitable, it may be too remote to be considered an overall advantage for all competitors. Two potential giant competitors loom. One of them, open and private, Fanatics, the $27 billion sportswear merchant, filed trademarks for Betfanatics. They claim to have 82 million active customers. An IPO is likely, possibly a SPAC. The second is of course ESPN. Disney (DIS) feels pressure to create a platform.

While we believe that neither of these two companies with immense access to millions upon millions of sports fans faces tougher roads in establishing a betting platform that would hit DKNG hard, it is still a factor. as a potential valuation buffer. There is no moat of any kind in this sector and the entry of these two large entities is likely to dilute, but not destroy, the market share position of the leaders.

The main contingency here in evaluating a bid for the company is the intense state-to-state competition that puts pressure on marketing spend, regardless of platform discipline. Even at greatly reduced promotion costs, new states will still arrive. Each of these will require launch programs. Additionally, the nature of loyalty comes into play if and when new entries decide to overwhelm players with ultra-rich offerings.

Conclusion

Our standing advice on DKNG was a “Hold” primarily due to our belief that sooner or later a private investor or activist would see the true value of the company within its recent trading range. It could add a nifty premium while taking the business to a price that would provide a relatively cheap entry into what will be a very good business operating at generous digital margins in the future.

So far, we don’t see any takers. But we’re not ruling it out entirely either. It’s also the start of the NFL season where management reports are bound to be exuberant and sentiment across all online sportsbook stocks will improve – at least if comps through 2021 are strong.

Yet we are concerned that so far, what we can see is that DKNG management has yet to demonstrate a level of spending discipline and operational creativity that would inspire us to guide “buy” on the security, even if the price seems attractive at the time.

I don’t think we’ll ever see this sector trading at the levels it reached in 2021 when the enthusiasm was unbridled. At the time, some analysts predicted a market growth of $200 billion by 2025, which we thought was way out of the realm of reality.

It’s time to take some money off the table if you are ahead of the current trade. And save the rest in case the tire kickers show up.

So I think a sell of anywhere between 30% and 50% of an existing position on DKNG makes sense under the idea that NFL pop can bring in a nice spike and the idea that a company or an activist may soon come out of the woodwork is not to be dismissed entirely.

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