DraftKings: Monstrous Revenue-Generating Potential

Summary

• The online gambling market is set to grow rapidly over the next decade or so. Given its substantial market share, DraftKings is well-positioned for long-term success.
• DraftKings is seemingly expensive relative to other casino and gaming stocks.  Whether you want to argue the company is deserving of a higher valuation is up to you.
• The stock is down ~22% over the last six months, and with expectations for increased market turbulence moving forward, investors could take advantage of a low buy-in price.
• By virtue of our long-term investing approach, we believe DraftKings is a well-built company with an enormous runway for growth.

Povozniuk/iStock via Getty Images

This article was updated on 10/12/2021 to reflect an updated valuation.

Investment Thesis

DraftKings (NASDAQ: NASDAQ:DKNG) is a leading online sports betting and casino operator in the United States. In recent years, the industry has experienced wider mainstream adoption and legislative approval. DraftKings, which is a top participant in the arena, is set to benefit from more states continuing to legalize online sports betting and casino games. There has been an enormous amount of hype around the online gambling market. While this may have led to higher-than-deserved valuations, online gambling is certainly not a fad. We view the online gambling market as a secular growth industry, and DraftKings is a top contender in the area. As legislative expansion continues, more competition will enter the field, which will help spark more innovation and drive further growth. Our base case FY25 price target for DKNG is $131/share, offering investors a 164% upside (22% annualized return).

Untapped Potential

The global online gambling market is forecasted to reach $112.1B in 2025, up from $64.1B in 2020 (75% increase). The online gambling market, which consists of sports betting, casinos, poker, and other types of remote gaming activities, was favorably impacted by the COVID-19 pandemic. The graph below, which illustrates the forecasted market size through 2027, indicates that online sports betting (OSB) is the primary driver of the industry. Currently, the top three states for online sports betting are New Jersey, Pennsylvania, and Michigan. Flutter Entertainment (OTCPK:PDYPY) is the parent company of FanDuel, which is the clear leader in those three states, boasting a 40% overall OSB market share. DraftKings is your runner-up with a 29% market share. Although FanDuel is the frontrunner in terms of market share, it is evident that FanDuel and DraftKings are dominating the U.S. online sports betting market. Competition for DraftKings is certainly not something to be fearful of. The industry is large enough for many players to succeed, and increased competition will likely lead to more innovation on DraftKings' front.

Grand View Research

Sports betting is legal in more than two dozen states; however, many only have in-person betting. Budget shortfalls have several states reassessing sports betting, but there is a chance that some states will not allow online sports betting due to political opposition or tribal relationships. Per the image below, DraftKings' mobile live betting in only available in 13 states as of today. DraftKings is not live in several other states despite sports betting being legal, and the rest have not legalized sports betting up to this point.

Draftkings.com

The image below provides a snapshot of each state's current legal status in regards to sports betting. Sports betting is pending legal in Washington, Florida, Louisiana, South Dakota, Maryland, and Connecticut, and most other states have some type of bill to legalize sports gambling introduced. The legislation process will take certain states longer than others; however, the mainstream acceptance of sports betting, both retail and online, is heading in a positive direction.

usbets.com

The legalization of online casino gaming is lagging behind online sports betting. Only five states, New Jersey, Michigan, Pennsylvania, Nevada, and West Virginia, have legalized both online casinos and online sports betting. Thus, the online casino area appears to be on the onset of its journey when comparing it to the OSB space.

Tax Benefit Incentive For States

Tax revenues realized by the state of Michigan during the first few days after legalizing internet gambling was upwards of $4.4M. The overwhelming majority of that income was generated via online casino games, rather than sports betting. States are realizing that by taxing and regulating online gambling, more money is conserved within the local economy. Conclusively, online casinos are a win-win for states and their residents, leaving legalization much more attractive than the alternatives. Online gambling also can serve as increased protection in the case of down years. A surge in online gambling in the state of New Jersey throughout the pandemic helped bring relief to the state during a budget crunch. The increase in revenue from online wagers did not make up for all losses in physical casinos; however, the tax collections were greater because online revenue is taxed at higher rates. Traditional casinos are taxed at 8% of revenue, whereas online casinos have a tax rate of 15%. Similarly, sports betting in-house is taxed at 8.5% compared to the 13% for sports betting online.

Exciting Innovation Awaits

Technologies like blockchain, IoT, and VR are being introduced to the online gambling space. Virtual reality headsets could revolutionize the online gambling experience. Imagine being able to enter into a virtual casino without having to travel, or wagering money on a basketball game while feeling like you are courtside, but in reality, you are sitting on your couch. Likewise, many online gambling companies have been accused of not being transparent in the methods of their online games, which can be addressed via blockchain. Blockchain would allow everyone to know what is going on behind the scenes, which would increase transparency and likely result in more consumers willing to participate in the online games.

DraftKings has done a tremendous job investing in innovation. Recently, the company acquired Golden Nugget Online Gaming. Adding Golden Nugget to the company's portfolio improves DKNG's iGaming market share potential. DraftKings expects EBITDA synergies of $300M+ from revenue uplift, COGS improvement, marketing efficiency, and corporate overhead scale. Not only will Golden Nugget increase DraftKings' iGaming market share, it will bring live dealer capabilities in-house, in addition to facilitating more efficient marketing and a strong digital DNA. DraftKings also announced the launch of a new NFT marketplace, which provides the company exposure to a fast-growing, high margin market. DraftKings Marketplace is a digital collectibles ecosystem and exchange and is expected to be accretive to LTV (life-time value of customer) and CAC (customer acquisition cost) for the company's core OSB and iGaming business. In the second quarter of 2021, the largest NFT marketplace generated $382M in transaction volume. Sports NFTs play a significant role in the space, which makes this move by DraftKings a fantastic standalone high margin opportunity.

Valuation

When looking at the chart below, which compares DraftKings to its peers, you can see that DKNG is more expensive (on a price/sales & EV/sales basis) than its top competitors. DraftKings' TTM price/sales ratio is 18x compared to its peer average of 6x. We believe that this significant difference stems from the fact that DraftKings is much better positioned in the online gambling space than any other company on the list. For that reason, we are not entirely concerned with comparing DraftKings to the overall industry. The company's price/sales ratio since its IPO has been on average 28x, so as of today, DraftKings is actually trading below its historical average. Most of the company's competition is not as far along in the online gambling space, therefore helping to justify DraftKings' higher trading multiples. With the exception of FanDuel, which is under the Flutter Entertainment umbrella, DraftKings encompasses the most runway for growth in the online gambling market.

Loft Capital Mgmt. & Seeking Alpha

Base Case

Price/Sales: 12x | FY25 Price Target: $131

According to our base case, we forecasted FY25 revenue to be $4.4B compared to consensus estimates of $3.9B. We used a price/sales ratio of 12x, which we derived via analyzing DKNG's peer average price/sales ratio and the company's individual historical average price/sales ratio. We think a 12x multiple is justifiable given the company's market share, runway for growth, and historical metrics. Using a price/sales valuation approach, we arrived at a price target of $131/share, offering 164% upside.

Loft Capital Mgmt.

Bullish Case

Price/Sales: 12x | FY25 Price Target: $142

According to our bullish case, we forecasted FY25 revenue to be $4.7B compared to consensus estimates of $3.9B. Again, using a price/sales multiple of 12x, we arrived at a price target of $177/share, suggesting a 187% upside.

Loft Capital Mgmt.

Bearish Case

Price/Sales: 10x | FY25 Price Target: $79

According to our bearish case, we forecasted FY25 revenue to be $3.2B compared to consensus estimates of $3.9B. Using a price/sales ratio of 10x, we arrived at a price target of $79/share, offering a 59% upside.

Loft Capital Mgmt.

The table below outlines our revenue and adjusted EPS forecasts through the fiscal year 2025. As you can see, we do not believe DraftKings will be profitable until 2024, and in our bearish case, 2025.

Loft Capital Mgmt.

Favorable Risk-Reward Profile

The three main risks we associate with investing in DraftKings are regulation concerns, increased competition, and high valuation. Compliance to online sports betting and casino laws is a state-by-state issue. Some states will take much longer than others to approve legislation that legalizes online gambling, and there is certainly a chance that other states will never comply. The lack of mainstream acceptance would drastically impair DraftKings' chances in becoming profitable, which most analysts believe will not happen until 2024 at the earliest. In terms of competition, it is inevitable that more companies expand their digital footprint as the online gambling market progresses. DraftKings operates its mobile platform in less than 15 states, and again, the ability for this number to grow relies significantly on legislative expansion. As new states continue to adopt sports betting and gambling legislation, casinos will work to bolster their reach. For many people, there is a social aspect to casino gaming, so investors should take into consideration the amount of market share online platforms can realistically seize (if it is even legal at all for companies like DKNG to operate). Lastly, the high valuation of DraftKings is heavily reliant on the growth runway for the company. That said, slow legislative expansion would reduce growth prospects, which in turn would diminish the value of online gambling stocks to investors.

We have evaluated all the risks associated with DraftKings, and we believe the stock still offers a favorable risk-reward scenario to investors. Recent legislative trends demonstrate wider mainstream acceptance of online sports betting and casinos, and while it would be ideal for every state to legalize online gambling, it is not necessary in order for DraftKings to become profitable. Over a dozen states have some type of legislative bill introduced as of today, and we expect that states will continue to prioritize their attention to the space. As we mentioned above, online gambling can be a great source of tax revenue for states, which further incentivizes them to push for legalization. Much like a domino effect, as more and more states legalize online gambling, others will follow suit with less resistance. We strongly believe that competition in the arena, especially from the likes of FanDuel, will only help to improve DraftKings' national footprint. The company already has a comfortable market share, and we believe increased competition will lead to sound strategic moves for DraftKings, such as their recent decision to establish DraftKings Marketplace. Lastly, we are not too captivated by DraftKings' current valuation. While we think it is fair to argue that the company deserves to trade at higher valuation multiples given its runway for growth, our long-term approach eliminates much of the valuation criticism that the company often receives.

Conclusion

Our base case FY25 price target for DraftKings is $131/share, offering a 164% upside. As market volatility continues surrounding rising interest rates and debt ceiling matters, investors could be granted a great opportunity to buy DKNG at a lower price. Our model demonstrates enough upside in DraftKings' stock price to account for margin of error and eliminate high valuation skepticism. We believe that DraftKings is a well-run company with a healthy financial position and enormous runway for long-term growth.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of DKNG either through stock ownership, options, or other derivatives. 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.

Comments

[Money&Money,LLC]

It appears that DKNG is following the early AMZN playbook. Just keep pumping money into the build up, dont worry about profits. Eventually the profits will come as you become the dominant player.

[charly333]

Just found out my calculation of the market cap was wrong. The B-Shares have no economic rights, so the market cap of the outstanding shares is "only" $ 19.3 billion.

[glorca]

Per john Keynes, the biggest casino is the stock market, i tend to concur on this from time to time. so,of course to have osb is only an extension of the fear and greed aspects of gambling/ investing/speculation. sheer madness.

[charly333]

Just looked again at this stock. It's on my watchlist for shorts. Market cap $ 38.15 billion (SA is missing the B-Shares), that means a P/S for 2021 of about 29.8 with TTM losses bigger than sales. This is madness. Gamblers in the stock market buying gambling stocks, it seems.

[jared0112]

I own dkng but I own more PENN as they are at least profitable. I’ll take a 10% share in the industry during 2021 while profitable and no big spending on customer acquisition vs waiting for another 3-5 years but I can be wrong which I why again I own many.
Rsi and gan are also interesting.

Good luck to us all.

[kthor]

Several things will happen with DKNG, BetMGM and Entain

1. MGM will buy out the BetMGM USA from Entain/DKNG, probably at MGM advantage
2. MGM will take a position in DKNG after Entain
3. MGM sell betMGM
4. DKNG just drops the bid for entain

2&3 seems unlikely, see what happens

[Turk Malloy]

I want to believe this stock with triple in 5 years. I have used all the major sports apps and believe DraftKings is the best. Right now they seem the have correct partnerships (e.g. NFL). They just had a great story about them on CNBC and all the technology and where they want to go (although the story was about gamification of betting and stock purchases - a negative). But I am concerned it will take another 4 years to be profitable and then at that point the sales growth will have diminished to the point people will be looking at the old school p/e metric to determine value.

Maybe they are sandbagging when they will be profitable so it can surprise analysts.

[Loft Capital Management]

@Turk Malloy Thank you for your comment. It will be interesting to see how investors react to decelerating growth as the company remains unprofitable (until 2024 at the earliest according to most).

[suave0718]

@Loft Capital Management with recent events do you still feel strongly about your 131 price projection?

[Terrymnola]

You estimate the stock trading at 15 times sales in 2021 with a 100% revenue growth, and continue to show it selling at 15 times sales in 2025 when revenue growth has fallen to 22%. In reality, if the revenue growth falls to 22% and is in a declining trend then there is almost no chance the stock will be trading at 15 times sales at the time, especially with no or low profits. It is much more like to be selling at around 4 or 5 times sales as the revenue growth rate decelerates into a more mature company. At some point revenues are going to became almost irrelevant and profit potential all important when valuing the stock. The $163 base case price in 2025 is probably about three times too high for the revenues projected in the model above because of the unrealistic 15 times sales multiple tacked on to what will likely be a maturing company. A $50 stock price in 2025 is much more likely.

[WolfpackCapital]

This is a fantastic article. Thank you Author! Finally an article that’s great

[dinvestf]

They will make a killing with their NFT

[Turk Malloy]

@dinvestf This was an area they brought up in CNBC story last night - certainly a potential big deal.

[jared0112]

I own them all but for this article not to lay out the expenses/financials is just plain irresponsible. Pumper article.

[Bowler162]

If the case was so bullish why do they need to buy Entain's cashflow?

[Market Mason]

@Bowler162 To diversify geographically? To buy their tech stack? To undermine one of their competitors (MGM)? Could be a lot of different reasons.

[cdgingrich]

@Bowler162 I try to only invest in companies that are the leaders and intend to stay the leaders. That is how I see DKNG-GNOG-Entain.

[tenbaggerZ!!]

But a money losing machine with pathetic profit profile that’s monstrously over valued

[WolfpackCapital]

@tenbaggerZ!!
“Money losing machine…..”
Evidently you’ve never heard of… TSLA, AMZN, NFLX, SNAP, SHOP etc etc. every monster stock begins as a “money losing machine.” The war is for market share. Profits come LATER.