Major League Baseball may very well not play any games in 2020, and it’s possible that the NBA will not finish its season. Those developments are extremely negative for DraftKings (NASDAQ:DKNG). As a result, DraftKings stock looks too risky at this point.
In my previous column on DraftKings, published on May 29, I wrote that the company “which is one-half of a duopoly in the fantasy sports sector, should benefit tremendously from the return of all three major American professional sports leagues at around the same time.” I predicted that the leagues’ return would boost DraftKings’ shares in the medium term.
But now it looks like both the NBA and the MLB may not return this year. That’s because a meaningful number of the players of both leagues seem reluctant to play any games in 2020.
Some NBA players say that resuming the season could undermine the protests against racism that are taking place around the country. Other players think that playing during the pandemic will not be safe.
One NBA coach, who preferred to remain anonymous, apparently believes that the season could be canceled; he speculated that, if the league’s season does not resume, “there will be a lockout” of the players by the owners.
The situation looks more grim for MLB, as its players and owners can’t agree on how much the players will be paid if the season is resumed.
Although DraftKings is enabling consumers to bet on casino games in a number of states, I believe that its bread-and-butter business remains sports fantasy leagues, where it is one half of a duopoly, while its main growth opportunity lies in sports betting.
I hold that view for a few reasons. First, Barron’s recently reported that the company’s share of the online casino games market is less than 20%, while its share of the sports betting market is slightly over 30%. Secondly, the publication noted that only a handful of states have legalized online betting on casino games. New Jersey, not exactly a large state, is the biggest market in the U.S. for such betting.
Further, only 15 states have legalized online sports betting. Finally, DraftKings, on its first-quarter earnings conference call last month, estimated that, while the major sports leagues are shut down, it will burn $15 million to $20 million of cash per month.
The bottom line is that fantasy sports are legal in every state, while online betting is illegal in most states and almost every large state. Further, DraftKings’ market share is much larger in fantasy sports and sports betting than in online casino-game betting.
Finally, while the major sports leagues are on hiatus, the company is burning a large amount of cash.
The Valuation and Outlook of DraftKings Stock
DraftKings has a large market cap of $12.5 billion. Analysts. on average, expect its sales next year to come in at $754 million. That means the shares are trading at a pretty huge price-sales ratio of 16.6.
When I wrote the previous column on DraftKings, all the sports leagues looked poised to resume action at about the same time, likely creating a huge windfall for the company in the third quarter. I thought that medium-term catalyst, along with the company’s gigantic, longer-term opportunity in online sports betting, made the shares worth buying, despite their large market cap and high valuation.
But now the MLB and NBA may not return to action this year, and many investors may fear that the NFL will follow suit. As a result, the Street may focus on the $15 million to $20 million of cash that the company says it will burn each month if none of the leagues returns to action.
In that environment, DraftKings stock is likely to fall meaningfully below its current levels. Consequently, I would advise investors to sell the shares and buy them back if and when it looks as though the NBA and/or MLB will return to action this year.
As of this writing, Larry Ramer did not own shares of any of the aforementioned securities. Larry has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been airline stocks, oil stocks and Snap. You can reach him on StockTwits at @larryramer.