DraftKings: The Marauding Is Over - At Near-Term Bottom

Summary

• DraftKings stock's growth premium has been destroyed by the bears, as it revisited its all-time lows recently. The bears were in complete control.
• Management reiterated its guidance to achieve adjusted EBITDA profitability by Q4'23. Therefore, investors must carefully monitor management's commentary and insights on its path to profitability.
• However, we believe that it must also communicate its path toward GAAP and free cash flow profitability eventually. That should lift investors' sentiments remarkably and help the stock re-rate.
• We discuss why DKNG stock remains a Buy. It seems to be at a near-term technical bottom, and the stock could consolidate here.
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Investment Thesis

DraftKings Inc. (NASDAQ:DKNG) investors have been "strangled" into submission as the stock re-tested its all-time lows before reversing. Therefore, investors who bought into its "story" thesis have been marauded by the short-sellers and bearish investors. It was a deliberate and carefully calibrated move to force DKNG stock to its recent bottom.

As a result, only the "long-term" investors are left holding DKNG stock. We are also one of the bagholders left. But, we have appropriately sized our exposure to the unprofitable online sports betting (OSB) leader, and DKNG stock accounted for just 1% of our average portfolio cost. Therefore, we did not find the impact meaningful and would continue to hold it for the long term.

As DraftKings reported its Q1 release recently, we discuss why investors need to look past FY22 for momentum to return to DKNG stock. Notably, as topline growth is expected to slow in its earlier vintage states, the company will need to demonstrate a clear path to GAAP EPS and eventually free cash flow (FCF) profitability.

Its Lack Of Profitability Destroyed Its Growth Premium

DraftKings revenue and adjusted EBITDA margins % consensus estimates (S&P Capital IQ)

DraftKings reported revenue of $417M, up 33.7% in FQ1. It also posted an adjusted EBITDA margin of -69.4%, and both metrics outperformed the consensus estimates.

However, investors must note that adjusted EBITDA metrics are different from GAAP profitability metrics and shouldn't confuse between the two. DraftKings also reiterated its guidance on achieving adjusted EBITDA profitability exiting FQ4'23. However, investors have given little notice to its guidance since its FQ4 update, as the market continued to pummel its growth premium.

Notably, DraftKings' revenue growth is expected to moderate through FY23, even as its adjusted profitability is estimated to improve. Therefore, it's critical that DraftKings deliver improved cost efficiencies to drive operating leverage. Consequently, we are pleased that CFO Jason Park discussed a series of critical management decisions at a May 18 conference helping lift its profitability outlook. Park articulated (edited):

We have a plan where we would meaningfully slow down our fixed costs growth in 2023. We are doing a couple of those things now. And that's something we should do in response to the external environment. And I had mentioned some of those areas, including localized to national spending, and some vendor renegotiation. It's something we are focused on and we'll update investors as they bear more fruit. (MoffettNathanson Annual Media & Communications Summit)

DraftKings revenue and adjusted EBITDA margins % consensus estimates by FY (S&P Capital IQ)

DraftKings GAAP EPS and FCF margins % consensus estimates by FY (S&P Capital IQ)

Consequently, investors must focus on its path towards profitability very closely. As its topline growth slows, its ability to drive operating leverage becomes critical, especially when deeply unprofitable on GAAP EPS and FCF terms. Management also articulated that it might share deeper insights on its profitability metrics in its earlier states, where it expects FCF profitability in at least 10 states in FY23. Therefore, we look forward to these insights, as we believe it helps anchor investors' confidence in management's ability to execute.

We believe more insights are significant because of the burn rate and investors' pessimistic sentiments over the long-term viability of DraftKings' OSB and iGaming model without profitable legacy assets.

Price Action Is At A Near-Term Bottom, But Some Caveats

DKNG stock price chart (TradingView)

The market makers have astutely digested DKNG stock's massive gains from 2020, as the stock hit rock bottom recently. As seen above, a series of enormous bull traps lured in dip buyers and breakout traders/investors.

And once it broke down its critical support of $40, the bears were in complete control as the market continued its distribution phase.

However, we observed a near-term technical bottom predicated on a reversal from its all-time lows. However, we do not observe a bear trap or capitulation signal that could help lift its momentum adequately above its short-term resistance levels. The $15 and $25 levels will continue to be critical near-term resistance zone that the bulls must prove their worth against.

Is DKNG Stock A Buy, Sell, Or Hold?

Notwithstanding, speculative investors keen to ride the near-term bottom can consider adding exposure here. Otherwise, bagholders inclined to layer in can also think about dollar-cost averaging here as we think it could consolidate in the near term.

Accordingly, we reiterate our Buy rating on DKNG stock, with a target price of $20 (implied upside of 41%).

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.