Patience Is Still Advised With DraftKings Stock

I believe online sports betting and internet gambling both will be big markets in the U.S. I think DraftKings (NASDAQ:DKNG) will prove to be a winner in at least one, and maybe both, of those markets. But, at this point, that’s not enough to turn bullish on DraftKings stock.

DraftKings (DKNG) logo, magnified, on its app.
Source: Lori Butcher/Shutterstock.com

Obviously, many investors disagree. DKNG has soared nicely of late: it’s already rallied 35% in 2021. State-level revenue looks solid so far. And while the novel coronavirus pandemic created a negative short-term impact by pausing professional and college sports, it should have a beneficial long-term effect.

For now, and likely for the foreseeable future, it’s state governments that will determine the legalization of sports betting and online gambling. Those state governments are facing a double whammy: lower tax revenues and higher costs. Multi-year budget holes need to be filled, and gambling taxes will be a popular method of raising the required revenue.

One strategist has even made the argument that sports gambling firms like DraftKings could benefit from the action in the stock market. We’ve seen a lot of what looks like gambling in U.S. equities. As that strategist put it, many of those traders will “go back to what they know better: sports gambling.”

There’s a ton to like here. But there’s one big concern as well. That concern suggests investors would do well to wait for a pullback in DraftKings stock.

$1 Billion in EBITDA

DraftKings is targeting $1 billion in annual EBITDA (earnings before interest, taxes, depreciation and amortization). It expects to hit that profit level when about 30% of the U.S. population has access to legalized online gambling, and 65% live in states with legalized sports betting.

We’re not there yet. None of the four most populous states — California, Texas, Florida, and New York — have legalized online sports betting, which is the real moneymaker. (New York has legalized on-premise sportsbooks at its tribal and commercial casinos.) Those four states account for roughly one-third of the country’s total population.

Only three states allow a full suite of iGaming options that are run by private companies like DraftKings. Those three states (Michigan, New Jersey, and Pennsylvania) account for roughly 10% of the country’s populations.

In other words, we’re a long way from the industry conditions that would underpin DraftKings’ profit target. DraftKings itself isn’t close. Pro forma for the merger between DraftKings, SPAC (special purpose acquisition company) Diamond Eagle Acquisition, and back-end provider SBTech, Adjusted EBITDA was a loss of $308 million in the first nine months of 2020.

Now, those upfront losses aren’t necessarily a problem. DraftKings is aggressively acquiring users, who should be profitable over the long haul.

But those losses, and DraftKings’ long-term target, both highlight the core concern here: the price of DraftKings stock.

DraftKings Stock at the Highs

At the current price of $64, DraftKings has a market capitalization over $25 billion. In other words, DraftKings is valued in the range of 25x its targeted EBITDA. Not its EBITDA for 2021, or 2022, but several years out.

The problem is that even the best European iGaming companies don’t get much more than that. Now, the U.S. market might well be better than that of Europe. Certainly, it will have more growth potential even five years from now. But, again, the roughly 25x figure is based on potential profits that are still away.

And, of course, those profits haven’t been generated yet. I do believe DraftKings will be a winner, but competition is going to be intense. In Michigan, which went live for iGaming and online sports betting last month, there already are 15 different licensed operators. 15!

DraftKings stock is pricing in significant success in a market whose eventual direction remains unclear. DKNG even looks expensive relative to a key transaction elsewhere in the industry.

A stake in its biggest rival sold in December. It values that entire company at about $11.2 billion — less than half DraftKings’ current enterprise value.

We have some data that suggests that the current valuation is stretched. That’s not to say that DraftKings stock is a bubble, or that the stock should be shorted. Rather, at a certain point, projected returns begin to narrow based on the current price.

Indeed, it may not be a coincidence that DKNG reversed at roughly the same price in early October. DraftKings is a great company, but DraftKings stock has legitimate valuation concerns.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.


Article printed from InvestorPlace Media, https://investorplace.com/2021/02/patience-still-advised-draftkings-stock-highs/.

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