DraftKings (NASDAQ:DKNG) will likely move significantly higher this year, despite its high valuation now. More states are moving to allow online sports betting, which will feed through to higher growth and valuation for DKNG stock.
As of Jan. 8, DNKG stock was at $52.00 and is up over 11% year-to-date and up over 57% in the past six months. As it stands the company now has a market capitalization of $20.37 billion.
In addition, its enterprise value (EV) is $19.16 billion, since as of Sept. 30, its net cash was $1.14 billion. Therefore, we can calculate its EV-to-sales and compare it to other stocks.
For example, analysts estimate that the company will produce $840.8 million in sales this year. This assumes a growth rate of almost 54% over the forecast 2020 sales of $547 million.
Therefore, DKNG stock now trades for on an EV-to-Sales multiple of 22.8 times its sales (i.e., $19,160 million divided by $840.8 million. So far DraftKings has had negative earnings before interest, taxes, depreciation, and amortization (EBITDA), so we cannot use an EV-to-EBITDA ratio.
DKNG Stock and the Compeititon
GNOG stock trades for about 12 times its revenue on an enterprise value basis. This is significantly lower than the 23 times DKNG stock’s multiple. I assume that eventually, GNOG will rise closer to DKNG stock.
I do not necessarily think this means that DKNG stock is too highly valued. For example, if the company continues to grow sales 54% each year over the next five years as more states open up to online sports betting, its revenue will explode.
Just to give you an example, if we compound sales at 50% over five years, sales will be 7.6 times today’s sales. Therefore if we divide back out its EV-to-Sales ratio will be significantly lower.
For example, if we compound DraftKings’ 2020 $547 million in sales by 50% each year for five years, sales will be $4.154 billion by 2025. Therefore, its EV today of $19.16 billion is only 4.6 times 2025 forecast sales. This is quite reasonable and explains why the market has bid up DKNG stock.
Recent Developments in Online Gaming
New York state seems to be getting serious about allowing online sports betting. For example, on Jan. 8 joint bills between the New York statehouse and legislature had been filed to legalize online sports betting in the state. This was a different approach than the way the governor wants to allow online betting.
But the point is now both the governor and the legislature are talking about allowing online sports betting.
The reason this is important is, as Seeking Alpha reports, that this state alone could result in $20 billion per year in online sales. Even if DraftKings got a 10% market share it could raise its sales by $2 billion. That’s four times its present level.
However, an analysis by Barron’s shows that the governor wants the state to have a monopoly over all the online betting. This, of course, is not good news for DraftKings. Moreover, if the other large population states like California, Texas, and Florida follow this lead it could be devastating for DraftKings’ future plans.
Therefore, we can say there is a good deal of risk in the sales projections for DraftKings. This could be a damper on DKNG stock and its upside.
What to Do With DKNG Stock
Given the risks to the upside in DraftKings stock, one might think it is not worth investing in. However, DraftKings and other online sports betting companies might not want to see the states gain a total monopoly.
I am sure that they can influence legislatures to help them see the benefits of private enterprise running the show and the state gaining taxes. But you never know how these things will turn out.
This leaves me with an expected return approach to the upside for DKNG stock. After all, this is how professional gamblers estimate their odds when betting.
For example, let’s say there is a 50% probability of the company actually achieving a 50% compound growth rate over the next five years. That could lead to at least a doubling of the stock over that period, i.e., a gain of 100%.
Let’s assume a 30% chance that most state governments decide to have their own monopolies in sports betting. That could lead to a halving of DKNG stock, a negative 50% return. Lastly, let’s assume there is a 20% probability that things stay the same, and DKNG stock stays flat, or let’s say rises just 5% from here.
All three of these scenario probabilities add up to 100%. But the weighted average expected return is 36%. Here is how that works. In the first scenario, a 50% probability of a 100% return leads to an expected 50% return. Next, we add in a 30% likelihood of a 50% decline. That results in a negative 15% return (i.e., 0.30 times negative 50%).
Now the cumulative expected return is 50% minus 15% or 35%. Lastly, we add in a 20% likelihood of a 5% gain, or a 1% expected return (i.e., 0.20 times 0.5 equals 0.01).
Therefore, the total expected return for all three scenarios is 50% plus -15% plus 1%, or 36% total. That means there the expected return for DKNG stock is at least 36% over the next five years.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.