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It pays to invest in businesses that are well poised to benefit from rapidly expanding markets and secular growth trends. As companies part of megatrends have the opportunity to grow revenue and earnings at an enviable rate over time, it should also translate into handsome stock market returns.
One such company is DraftKings (DKNG) which is an online sports betting platform, valued at a market cap of $24.6 billion. DKNG is trading 61% below all-time highs, set in March of 2021. Despite the pullback in share prices, at its current price, DraftKings has almost tripled investor returns since it was listed as a SPAC (special purpose acquisition company) in early 2020.
DraftKings is among the largest players in the U.S. online gambling market, which is forecast to grow from $5.6 billion in 2022 to $14.44 billion in 2027, indicating an annual growth rate of over 17%.
Let’s see if DraftKings should be part of your equity portfolio right now.
The Bullish Case for DraftKings
DraftKings has increased sales from $323 million in 2019 to $2.24 billion in 2022. This stellar growth rate continued in Q1 of 2023 as revenue surged by 84% to $770 million. DraftKings' enticing top-line expansion was fueled by the launch of its digital sportsbook in legalized U.S. markets.
The number of monthly paying customers grew by 29% to 2.8 million, while average revenue per user was up 35% at $92 in the March quarter. Moreover, the company emphasized its acquisitions costs fell by 27%, narrowing its losses in the process.
DraftKings offers its online betting platform in 21 states that account for 44% of the U.S. population. Its iGaming platform is live in five states which represent 11% of the country’s population.
Further, the company’s Sportsbook and iGaming products are available in Ontario, which is Canada’s largest province, representing 40% of its population. Kentucky and Puerto Rico have authorized mobile sports betting, allowing DraftKings to further enhance its presence and gain market share in the near term.
In its Q1 press release, DraftKings stated 12 U.S. states have either introduced legislation to legalize mobile sports betting or introduced bills that may result in sports wagering referendums in upcoming elections.
According to DraftKings, it has successfully increased hold rates for its sportsbook due to lower promotional activity. A hold rate can be defined as the percentage of sales earned on every dollar bet on its platform.
DraftKings has showcased its resiliency despite a tough macro environment. It is a non-cyclical company that should thrive even during market downturns.
The Bearish Case for DraftKings
However, while the addressable market for DraftKings is expanding at a fast clip, entering new markets comes at a cost. The company will have to spend heavily on marketing to acquire customers. It will also have to allocate resources toward legal and regulatory expenses.
Between 2017 and 2022, DraftKings’ operating losses have widened from $73 million to $1.5 billion. In Q1 of 2023, its operating loss stood at $390 million, compared to $516 million in the year-ago period. DraftKings ended Q1 with $1.1 billion in cash and $1.32 billion in debt, which suggests it should turn profitable soon. If not, the company will have to raise equity capital and dilute existing shareholder wealth or increase debt, further straining its balance sheet.
Priced at more than four times forward sales, I believe DKNG stock is currently fairly valued, given its top-line growth estimates. But similar to other growth stocks, DKNG remains vulnerable in a broader market sell-off due to its weak balance sheet. For instance, share prices fell from $72 in March 2021 to $10.70 in December 2022, wiping off significant investor wealth.
The Final Takeaway
Despite its losses, DraftKings is efficiently acquiring and engaging customers on its platform. It expects to end Q4 of 2023 with an adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) of $150 million. Further, DraftKings is optimistic about posting a full-year positive EBITDA in 2024.
Online gaming and sports betting is a lucrative business. Once it turns profitable, DraftKings will expand profit margins at an astronomical pace due to its asset-light business model.
Right now, sports betting is legal in 33 states in the U.S., and DraftKings should continue its expansion plans in the upcoming decade. On the flip side, an expanding market will attract competition resulting in a deceleration in sales growth.
Last week, Oppenheimer raised its price target for DKNG stock to $36 from $30, indicating an upside potential of 20% from current levels. According to Oppenheimer, DraftKings should benefit from product improvements, a positive operating backdrop, and improved efficiency.
Wall Street expects DraftKings to end 2027 with sales of $6 billion. At its current valuation, shares should surge over 80% in the next four years. Out of the 26 analysts covering DraftKings stock, 15 rate the stock a “strong buy”, 2 a “moderate buy”, 7 a “hold,” and 2 “strong sell”. The mean price target for the stock is $27.84, which is currently about 3% higher than where the stock is currently trading.
On the date of publication, Aditya Raghunath did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
