DraftKings: Why This Is A Mixed Bag Investment
Summary
- DraftKings is expected to grow its top-line by more than 55% y/y in 2021.
- Will DraftKings be able to reduce its customer acquisition costs and still sustain its solid growth rate profile?
- Investors are already paying more than 23x forward sales, which is a large premium for too much uncertainty.
- Looking for more investing ideas like this one? Get them exclusively at Deep Value Returns. Learn More »
Investment Thesis
DraftKings (NASDAQ:DKNG) was a very rewarding stock early in 2020. However, right now, its performance has been somewhat dissatisfying.
Investors will have to justify paying more than 23x forward sales until DraftKings can demonstrate it can stop burning cash flows on its steadfast path towards customer acquisition.
Ultimately, there are better investments elsewhere.
Revenue Growth Rate and Market Sentiment
Highlighted above, we can see that DraftKings has lost momentum these past few months, where it has essentially matched the Nasdaq (NDAQ). Indeed, there are several reasons for this performance, which I now put a spotlight on below.
Source: author's work
The big question that investors are facing is why is there such a material deceleration from Q4 2020 into 2021?
Obviously, investors are to a large extent expecting that management is being highly conservative with its 2021 guidance, however looking beyond that, there are additional questions that need to be addressed.
What level of revenue growth rate beat are investors largely hoping for 2021? Let's assume, for our purposes, that 2021 reaches a 60% y/y growth rate. In fact, whether it's a 55% y/y revenue growth rate or even 60% y/y, it's truly nowhere near to approximately triple digits revenue growth rates that DraftKings reported during both Q3 2020 and Q4 2020.
Could it be argued that the competition is now starting to bite away at DraftKings prospects? Successfully answering this question will pay dividends down the road.
Customer Retention? Does it Matter?
Next, a lot of attention has been put on whether or not New York will allow for online sports betting. Presently, it appears that New York will allow, although the full details are still being ironed out, such as just how much will DraftKings and other operators ultimately have to share New York state.
However, I believe that the bulk of the bullish thesis here should be more squarely focused on whether DraftKings has sufficiently strong profitable revenue growth?
Source: Investor Presentation March 2021
During their investors' day last month, DraftKings attempted to appease investors by noting that they have very strong customer retention metrics on their platform.
Furthermore, as we get slightly more granular, we can see below that DraftKings' customer retention cohort metrics remain consistently high into year 2:
Source: Investor Presentation March 2021
DraftKings charges that their customer acquisition costs are balanced and that their retained customers increase their spending on the platform in their second year on the platform, as they increase familiarity and trust with the platform.
Moreover, their key performance indicators note that total revenue retention increases to 108% by the cohort's second year on the platform (see above, orange).
And while I know that, when it comes to growth investing, the absolute last thing you want to do in the middle of a soaring bull market is start questioning a company's path to profits, I nevertheless feel compelled to do this ugly task.
Source: SEC Filings, 10-K
As you can see above, once we add back all the non-cash stock-based compensation ($326 million), more than $330 million was used in cash flows from operations.
Please note that I haven't dared to mention the capitalized software costs or capex requirements, as that would be a truly bad taste article to write in the middle of a bull market.
But just taking that $330 million used in cash flows, it appears that for DraftKings to grow its top line by $615 million, it certainly uses up a lot of investors' capital.
Valuation - To a Large Extent, Upside is Already Priced In
As a back-of-the-envelope calculation, let's assume that DraftKings' revenue reaches $1.1 billion in 2021. That's more than approximately a 73% y/y growth rate, compared with management's own guided 55% y/y for 2021. In that event, investors are right now paying more than 23x forward sales.
Now, allow me to throw a comparison into the mix. This company I'm going to bring in, is also very controversial, and also has its own issues, so if readers wish to disregard the comparison, please feel no misgivings about doing so.
However, fuboTV (FUBO) is expected to roll out its own sports betting platform in Q4 2021 called Sportsbook. For now, these operations haven't been factored into its guidance, as they are yet to be rolled out, and their success still has a lot of question marks. However, fuboTV is priced at less than 7x forward sales, despite it also guiding for 75% y/y growth rates for 2021.
So why should DraftKings be priced at more than 23x forward sales, while another peer, that's also expected to have a similar offering priced at less than 7x forward sales?
The Bottom Line
DraftKings shareholders are arguably making a substantial assumption that, as DraftKings takes its foot off the peddle with fewer gambling incentives, its customer acquisition costs will reduce and that DraftKings will imminently start to cut out a clear path to profits.
I am unsure of whether DraftKings will succeed on its trajectory. What I will declare is that, more likely than not, investors are already paying a very large premium for a lot of future uncertainty. In sum, there are better stock picks elsewhere.
Strong Investment Potential
My Marketplace highlights a portfolio of undervalued investment opportunities - stocks with rapid growth potential, driven by top quality management, while these stocks are cheaply valued.
I follow countless companies and select for you the most attractive investments. I do all the work of picking the most attractive stocks.
Investing Made EASY
As an experienced professional, I highlight the best stocks to grow your savings: stocks that deliver strong gains.
- Honest and reliable service.
- Hand-holding service provided.
- Very simply explained stock picks. Helping you get the most out of investing.
- Balanced arguments.
- Long track record.
This article was written by
Michael Wiggins De Oliveira is an energy specialist whose primary focus is capitalizing on “the Great Energy Transition” - the confluence of decarbonization, digitalization with AI, and deglobalization - to achieve greater investment returns. Through his 9+ years analyzing countless companies, Michael has accumulated outstanding professional experience in the energy sector and a following of over 40K on Seeking Alpha.
Michael is the leader of the investing group Deep Value Returns. Features of the group include: Insights through his concentrated portfolio of value stocks, timely updates on stock picks, a weekly webinar for live advice, and "hand-holding" as-needed for new and experienced investors alike. Deep Value Returns also has an active, vibrant, and kind community easily accessible via chat. Learn more.Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
The author is long FUBO.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (20)
