Sports betting, when there are sports to be wagered on that is, is becoming more mainstream in the U.S. In turn, this reason alone will surely give investors reasons to take a look at newly public DraftKings (NASDAQ:DKNG). And that’s good news for DraftKings stock.
On Friday, April, 24, DraftKings became a public company via a reverse merger with Diamond Eagle Acquisition Corp. (NASDAQ:DEAC) — a special purpose acquisition company (SPAC) — and SBTech, a provider of betting technology and related services. That type of transaction, which was previously rare but is now increasingly common in the initial public offering (IPO) space, was, in the eyes of some critics, interestingly timed.
Why? Because there are no sports happening in the U.S. right now due to the novel coronavirus outbreak.
However, make no bones about it. The transaction valued DraftKings at $3.3 billion, putting in “unicorn” territory; a la, Uber (NYSE:UBER), Lyft (NASDAQ:LYFT) and some others last year.
The final closing price for Diamond Eagle was around $17.50, and DraftKings stock closed at $20.12 last Friday with a market value of $6.29 billion. This means that the upstart daily fantasy sports (DFS) and sportsbook operator is off to a decent start.
What to Know About DraftKings
Chances are even if you’re not a DFS player or sports bettor, you’ve heard of DraftKings and rival FanDuel. That’s how strong the companies’ brand recognition is in DFS circles. In this area, they essentially function as a duopoly, and they’re leveraging that brand recognition in the sports betting space.
One element of DraftKings stock that’s going under-reported is that there’s a dual share class structure here — one that’s popular in Silicon Valley. Hey, even Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook (NASDAQ:FB) do this. However, as Harvard Law School points out, dual share class structures pose risk to common investors and reduce accountability.
That doesn’t mean such issues will play out at DraftKings. But it’s worth pointing out that co-founder Jason Robins controls more than 92% of the voting equity in the company. Said another way, the 6% of DraftKings owned by Disney (NYSE:DIS) doesn’t mean a whole lot to the latter because its shares carry less voting rights.
Of course, an investor that looks to Alphabet and Facebook will say that they’d be just fine with the DraftKings share structure if the stock even sniffs returns that are comparable to those internet giants. And rightfully so.
Speaking of returns, it’s obviously too early in the DraftKings stock story to be passing judgment. However Thomas Allen of Morgan Stanley recently initiated coverage of the name, calling it a “best in breed” idea in the sports wagering space. Allen put a $23 price target on DraftKings, but said in an extremely bullish scenario, it could be a $75 name down the road.
Like the aforementioned unicorns Lyft and Uber, DraftKings loses money. In fact, it’s losses ballooned last year even as revenue surged. What that says is customer acquisition — the lifeblood of a gaming company — isn’t cheap. However, Allen sees a clear path to profitability with DraftKings turning a profit in 2023.
Bottom Line: Lots of Assumptions, Moving Parts
Allen assumes that by 2025, the U.S. sports betting industry — the fastest growing of its type in the world — will be valued at $12 billion. However, the key to that estimate is the assumption that by that year, 36 states will permit the activity.
Currently, the number is 18 with four and Washington, D.C. in the “on deck circle.” However, just because a state allows sports betting doesn’t mean it will award DraftKings or any of its competitors a license to operate there.
Of the 18 states where sports wagering is currently permitted, DraftKings is operational in nine and is able to offer online betting — which is more lucrative because of its higher margins — in seven states.
In other words, politics are very much at play in the domestic sports betting business. And often times, Wall Street forecasts for industry growth don’t take that into account. Let’s examine the situation in the five largest states, working backward from number five Illinois. The Land of Lincoln is allowing sports betting (when sports are being played), but DraftKings and online rivals will have to wait until late 2021 to get in on the action there.
In New York, the company operates a brick-and-mortar sportsbook located nowhere near New York City because the Empire State currently doesn’t allow online wagering.
That gets us to the sports betting holy trinity of California, Texas and Florida. For now and probably a few more years into the future, throw Texas out because there’s essentially no momentum to make sports gambling happen there.
There’s pending legislation in Florida, but it would require amending the constitution. And in 2018, voters there approved a ballot measure to prevent gambling expansion.
That leaves California, where even if sports betting is approved in the currently proposed form, online wouldn’t be allowed. Additionally, the industry there would be controlled by tribal gaming entities — freezing out the likes of DraftKings.
Collectively, those aren’t encouraging factors, but they don’t damn the case for DraftKings, either. First, smaller to medium states, such as Indiana and Iowa where the company operates, have burgeoning sports betting markets. Second, there’s talk that because of the coronavirus sapping state revenue streams, more will embrace the idea of online gaming to bolster coffers following the pandemic.
The bottom line? There’s growth to be had in the sports betting business, regardless of whether the biggest states join the party. That said, it’s up to DraftKings to leverage that growth and become profitable. If it does, the stock is a winner — but patience will be required.
Todd Shriber has been an InvestorPlace contributor since 2014. As of this writing, he did not hold a position in any of the aforementioned securities.
