The last time I wrote about DraftKings (NASDAQ:DKNG) was in a June 2 column. At the time, I argued that DraftKings stock was the poster child for special-purpose acquisition companies or SPACs.
I’m enthusiastic about DraftKings’ potential to grab a significant share of the American sports betting market. The only problem at the moment, with a few exceptions, is that professional sports remain on the sidelines.
So, the return of the PGA Tour this past week with the Charles Schwab Challenge was a sign that the world is slowly getting back to where it needs to be for DraftKings to benefit from sports betting.
DraftKings Stock Has Come a Long Way
Pro sports have a long way to go, but they’re back on course, and that’s excellent news for those who own DraftKings stock.
As I said in my previous article, the fact that the company was able to grow its revenue in the first quarter by 30% year-over-year despite the novel coronavirus pandemic suggests that its business has more going for it than just a global thirst for sports betting.
With the shares up 80% since they opened for trading under the DraftKings name on April 24, a lot of people, including some InvestorPlace contributors, are betting that DraftKings stock has peaked because of its current valuation.
I think Covid-19 will have a large part to play in DraftKings’ future trajectory. However, if the world is able to avoid a second wave of the virus that’s as lethal as the first, I think the stock could potentially reach $50 per share by the end of 2020.
But, before I make my case, I will note that there are some negative aspects of DraftKings. They’re essential to consider before placing a bet on DraftKings stock.
Growing Pains and an Elevated Valuation
While the company’s 30% Q1 revenue growth is impressive, one can’t overlook the fact that its operating loss was $66.1 million, more than double its $30.2 million loss during the same period a year earlier.
The company is growing to meet the increasing number of states legalizing sports betting. In May, Forbes sports business columnist Kurt Badenhausen pointed out that 22 states have legalized sports betting, with another 14 in the process of doing so.
DraftKings’ operating expenses are going to climb as its sports-betting business grows. That’s a good problem to have. But the company will have to execute well and establish strong financial controls to ensure that it can profitably expand its business.
InvestorPlace’s Mark Hake recently suggested that DraftKings’ valuation is based on profits that it could generate well into the future.
“For example, the company projects it can reach $1 billion in EBITDA. But, according to Barron’s, management has not yet said when that could be attained. Barron’s says analysts generally agree that it won’t be until the end of 2025. That is effectively five and a half years from now,” Hake wrote in his column which was published on June 9.
Fundamentally, Hake believes that investors are currently paying 12 times EBITDA for the shares, based on cash flow that might not appear until 2025. In his view, that’s a massive leap of faith, one that isn’t justified, since the company, whose business has traditionally been centered on fantasy sports, has only recently moved into sports betting.
Hake, rightly, argues that intelligent investors (by intelligent, he means those who are willing to pay only a reasonable price for growth) should look elsewhere.
Here’s Where I Stand
I think Covid-19 has proven one thing about Americans: They like to bet on things. While sports are on hiatus, retail investors have been placing big bets on stocks. And they are winning.
According to Goldman Sachs’ data, retail investors have done a good job recently.
“A basket of equities that have been eagerly bought by individual investors since the depths of the coronavirus-induced selloff on March 23 has returned 61%, compared with returns of 45% for a portfolio of investments owned by mutual funds and hedge funds, according to Goldman Sachs data,” MarketWatch’s Mark DeCambre reported in a June 15 article.
“The Wall Street pros, who have consistently lagged behind the overall market since the last crisis in 12 years ago, now may find themselves lagging behind mom-and-pop investors by a whopping 16 percentage points, according to the bank’s research.”
Now, there are two ways to look at this revelation.
The first way is that we’ve come to a point where stocks have gotten ahead of themselves because retail investors have more time on their hands to place bets. The second way is to consider that retail investors have actually been paying attention to what’s happening in the world and placing bets that things will return to normal. And when things do return to normal, some of the companies whose stocks had been beaten down during the early days of the crisis will start to make money again.
When it comes to DraftKings, I think the average sports fan sitting at home can see the writing on the wall. As states legalize sports betting, many sports fans will start gambling on games. And the number of states in which DraftKings facilitates sports betting will grow exponentially, leading to higher sales, and ultimately, profits for the company.
For some growth investors, betting on DraftKings stock at 12 times EBITDA is not a silly notion, but a bet on the future of America.
And that’s one bet I think they will win 99% of the time.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.