DraftKings (DKNG) is an online sports betting company that offers daily fantasy matches and online wagers for most major US sports leagues such as NFL, NBA, NHL, MLB, PGA, college basketball, college football, and NASCAR. Also, the company offers wagers on some exceptional international leagues such as the Canadian Football League and EuroLeague.
DraftKings set out on an IPO offering of $19 per share earlier this year. The public offering came to by merging with Diamond Eagle Acquisition Corporation, a special purpose acquisition company (SPAC), in a reverse merger valued at $3.3 billion. The market capitalization of the company came to $6.75Bn in April 2020, however, with the fallout in most sports due to the pandemic one would have expected a reverse in demand for the stock due to the ambiguity of future earnings as the new normal certainly shook the sports arena as we have come to know it. However, surprisingly, DraftKings stock soared to an all-time high of $63.78 in October 2020 that valued the company at a whopping $25 billion within just 6 months from its trading debut. Fundamentally, the company certainly has some grey areas to cover. One major constructive aspect of DKNG, however, would be its debt-free balance sheet.
Why does DKNG stock keep rallying forward?
During the height of the lockdown period, major sporting events were not held, however, DraftKings utilized this time to keep customers engaged. They introduced new product offerings such as fantasy sports and betting on eNASCAR, Counter Strike, and Rocket League. DraftKings also launched a series of pop culture free-to-play pools contests that cover topics from democratic debates to reality competition TV shows. The company’s agile turn to shifting its focus to e-sports resulted in a strategic move that also embraced a fast-growing niche. In support of this dynamic shift, the stay-at-home nature of COVID drove an increased response rate for the advertising cost incurred by DKNG along with the pent-up demand from the suspension of major sports events. These were key drivers of a unique customer acquisition opportunity.
Jason Robins, CEO and Chairman, recently said:
“The resumption of major sports such as the NBA, MLB and the NHL in the third quarter, as well as the start of the NFL season, generated tremendous customer engagement”.
During a time period that is tumultuous for most companies, DraftKings exhibits some major upside potential. The company continues to become stronger in local markets with room to grow as more states legalize sports betting.
So, what are the major concerns?
Despite strong revenues and a turnaround in user engagement, the company is making substantial losses. The Boston-based gambling company posted a third-quarter loss of $347.8 million, or 98 cents per share, compared to a loss of $55.9 million, or 30 cents per share, the same quarter last year. Sales and marketing expenditure persist to eat into revenue. For instance, the third-quarter sales and marketing expenses were up by 248% to a record $203Mn compared to $58Mn reported in the previous comparative quarter.
The management supports this strategy of allocating high expenditure for sales and marketing which they claim is pivotal to achieve their first-mover advantage when a particular state opens up as it enables them to grab market share. This will be the strategy adopted along with the legislation that’s opening more states to legalize sports betting.
Adding to the woes would be the guidance issued by the IRS stipulating that daily fantasy contests be subjected to a federal excise tax of 0.25% on an already deteriorating bottom line. The silver-lining remains the fact that DraftKings ended the quarter with $1.1Bn in cash and no debt on its balance sheet.
Though the stock has tripled in value since its debut on the Nasdaq, a primary source of concern would be the impact of Covid-19 pressuring professional and college sports leagues to cancel their 2020 seasons. On the contrary, some positive momentum in the sporting arena is witnessed with the return of MLB, the NBA, WNBA, the NHL, and MLS, and DraftKings claimed to witness an increase in user engagement on their platform towards the end of the quarter.
Admittedly, DraftKings is a high-risk growth stock. Even though the NBA and MLB have resumed their seasons, there is no guarantee they will be able to complete the season without further shutdowns and DraftKings needs more states to legalize sports betting before it has access to more customers and can reach better economies of scale. At present, sports betting is currently legal in 20 US states, with another 11 implementing or considering legislation on the practice, according to the American Gaming Association. DraftKings’ sportsbook is available in 11 states at the moment.
MJ places bets with DKNG in September
Michael Jordan, the basketball Hall of Fame member, is taking an equity interest in the American fantasy sports outfit DraftKings, joining the company’s board as a special adviser as more US states adopt legalized sports betting. MJ will serve as an adviser to the board on several initiatives, including strategy, product development, marketing, and inclusion efforts. The size of his stake in the Boston-based group was not disclosed yet.
DraftKings is a rookie to the stock market. For the gambler, it is a stock to raise his stakes and for the fundamentalist, the stock needs more of a cooling-off period. There are concerns over greater accessibility for a wider customer base and a comprehensive regulatory framework in states is pivotal to gain market share in this industry.
I believe the prudent approach regardless of the risk appetite would be to keep an eye peeled on post virus momentum and how the playoffs and resumption of sporting activities take on as that is where the core revenue stream is generated and what will avoid DraftKings from cash burn owing to financing operational losses. If major sporting events take place as mentioned in the H2 sports calendar, the pent-up customer demand will bring forth substantial revenue streams.
The author does not have a personal interest in any shares mentioned in this article.
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