DraftKings: Scaling Nicely

Summary

• Shares of DraftKings are in rebound mode, though the stock is still down more than 30% over the past year.
• Despite being a household name already, DraftKings still only operates in one-third of the U.S., and revenue growth is north of 2x y/y.
• Player engagement has been incredibly high as sportsbook offerings have brought in more revenue per player.
• DraftKings is also slowly closing the profitability gap. It has large cash reserves to cover losses as it scales.

Scott Olson

It's a great time to be taking on risk again, especially as tech and growth stocks are rebounding from last year's painful stinging losses. Though investors are still generally cautious, we've seen a resurgence in small and mid-cap tech stocks that are driven by "stories" rather than current earnings.

Look no further than DraftKings (NASDAQ:DKNG) for an excellent rebound play. This sports-betting app, well on its way to expanding throughout the United States, has continued to post giant growth rates as the company boots up operations in new states while also increasing player engagement. Up ~25% since the start of January in a furious rebound, shares of DraftKings are still down more than 30% over the past year and down 80% from all-time highs above $70 notched in mid-2021. It's a great time, in my view, for investors to reassess the bull case for this name.

Data by YCharts

DraftKings remains a core holding in my portfolio that I am bullish on. It takes a lot of faith to more or less ignore near-term valuation multiples and financials and focus on the fact that DraftKings is still only allowed to operate its lucrative sportsbook in roughly only one-third of the U.S. population. In other words, there's a massive market of sports and gambling enthusiasts out there who are waiting for sports betting to become legal in their state (many residents of these states have accounts anyway, and play when they are away from home).

And while DraftKings and investors wait for the legislative process to move along, the company continues to make upgrades to its product that drive substantial engagement boosts and wagers.

The slide below, taken from DraftKings' latest shareholder presentation, showcases recent updates to its app, including head to head matchups:

DraftKings product updates (DraftKings Q3 shareholder deck)

Here is my full bullish thesis for DraftKings:

• The tide is shifting in favor of sports betting legalization. In early 2022, DraftKings landed its "white whale" among state legalizations - New York State. Now, the company's sports betting is live in 37% of the U.S. population. Other major states like California and Texas are still major holdouts. The key observations here: A) the benefits from the New York launch still haven't impacted DraftKings' financials yet, and B) more momentum is underfoot, with ten additional state legislatures having introduced legalization bills in 2022 alone.
• Superb velocity once legal. Given that it's already a known national brand with fantasy sports operations live in most states, DraftKings isn't starting from scratch every single time it launches in a new state. Data from recent state launches shows that sign-ups and betting activity immediately ramp from the time DraftKings launches.
• Variety of sports and formats leads to a broad market. DraftKings has something for everyone. Though anchored by big sports like football, DraftKings also has other sports, including golf, NASCAR, basketball, and MMA. DraftKings also has fantasy formats as well as direct online sports betting where legal, as well as offerings in casino gaming.
• Additional monetization opportunities beyond sports betting and fantasy sports. DraftKings has designs on diversifying itself beyond simply sports. Through acquisitions, the company is now a casino gaming operator, and its new marketplace business has tossed DraftKings into the high-growth arena of NFTs. DraftKings notes that recent NFT offerings have been over-subscribed.

The bottom line here: DraftKings is still years away from reaching anywhere close to its eventual scale, but it has plenty of momentum in its favor. Stay long here and continue to ride the recent rebound upward.

Player engagement remains furiously strong

In September, the company launched its sportsbook in its eighteenth state: Kansas. Management reported that Kansas was the fastest player acquisition that the company had ever experienced in a new state launch, per the chart below:

DraftKings Kansas launch (DraftKings Q3 shareholder deck)

The company also launched its sportsbook in Maryland in November and Ohio in January (though we have no reported metrics on these launches yet).

But it's not just new states that are helping to boost DraftKings' book of revenue. As seen in the chart below, average monthly revenue per player has increased more than 2x y/y to $100, helped in part by the company's continued innovation and feature expansion:

DraftKings player metrics (DraftKings Q3 shareholder deck)

The company notes that it has been able to build up its player base even while decreasing its reliance on promotions. Per CFO Jason Park's prepared remarks on the Q3 earnings call:

Net revenue growth also benefited from a less promotional environment than in Q3 of 2021. For the industry as a whole, we saw more rational behavior, which we expect to persist. And within the DraftKings business, we deployed more surgical promotions based on player-specific gross profit profile and as we have consistently reiterated are reinvesting less as cohorts mature.

We had 1.6 million monthly unique payers in Q3, which is 22% higher than the prior year period. It's important to remember that Q3 2021 included the conclusion of the NBA playoffs, while the NBA playoffs were completed before Q3 in 2022. Notably, in September alone, MUPs increased 27% year-over-year to 2.7 million, which is typically our seasonally strongest month of the year for MUPs due to the kickoff of the NFL season. Average revenue per monthly unique payer or ARPMUP more than doubled on a year-over-year basis to $100 with solid gross margin flow-through. This balance of player growth and revenue per player growth is very healthy as promotional intensity naturally declines as states mature."

Inching toward profitability

DraftKings' losses have always made more conservative investors nervous, but the good news is that the company is marching toward improved profitability.

Q3 adjusted EBITDA losses shrunk -16% y/y to $264.2 million (even as revenue more than doubled); with adjusted EBITDA margins improving to -53% from -147% in the year-ago quarter.

DraftKings adjusted EBITDA (DraftKings Q3 shareholder deck)

Reminder that DraftKings expects new customer cohorts to be profitable 2-3 years from point of acquisition, so the company's recent velocity in state launches has weighed on profitability. The company expects 10 of the 18 states it operates in to be profitable on a contribution margin basis for the full year FY22.

For FY23, the company introduced adjusted EBITDA loss guidance of -$575 to -$475 million, representing a 34% loss reduction at the midpoint relative to FY22's adjusted EBITDA guidance of -$790 million:

DraftKings 2023 outlook (DraftKings Q3 earnings release)

Management expects DraftKings to hit breakeven adjusted EBITDA profitability for the full year FY24. And until then, we note that DraftKings is well-funded with ~$1.4 billion of cash on its balance sheet:

DraftKings balance sheet (DraftKings Q3 10-Q)

Key takeaways

DraftKings has a bright future ahead of it: the company continues to expect that roughly 65% of the U.S. population will have legalized sports betting, or double the company's current operations. That's on top of DraftKings' other revenue streams, from iGaming to NFTs and global expansion. In my view, the tide will turn in favor of DraftKings once it starts to show meaningful profitability boosts in FY24, but right now investors still have a chance to buy the stock cheaply while it's still shaking off its 2022 correction.

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.