DraftKings (NASDAQ:DKNG) is set to turn around later this year and next. A sports gambling and online gambling gain approval in a number of states, the total market for DraftKings will increase, allowing its revenue to keep growing at high double-digits. This will help push DKNG stock up to its former heights.
The stock is off from $71.98 on March 19 to $44.50 as of May 20. That represents a drop of 38.8% over just 2 months and has given DKNG stock a slightly negative performance for the year-to-date (-3.59%). However, in the last year, it is still up more than 77%. I believe DKNG stock will return to its former heights. Here’s why.
DraftKings’ Expected Growth
On May 7, DraftKings released its Q1 earnings report showing that revenue rose 253% over Q1 2020. More importantly, the company pointed that the average revenue per customer had risen 48% for the same period last year, meaning customers are more engaged.
On top of this, the company expects that more states will continue to legalize online gambling, bringing in more customers and revenue. There has been a huge shift in states’ attitudes towards sports betting since the U.S. Supreme Court made it legal in 2018.
According to Morgan Stanley analyst Thomas Allen, sports betting could reach $15 billion in 2025, way up from $3 billion in 2020. And that doesn’t even include other gaming activities that could expand the online gambling market even further
DraftKings raised its revenue to over $1 billion, giving it at least a one-third market share in the U.S. We can use this to estimate revenue growth by 2025.
If DraftKings attains 20% market share by 2025, revenue would be $3 billion. This works out to an average annual growth rate of 73.2 % per year on a compound basis. It would likely make $1 billion in other online gambling revenue.
DraftKings is currently unprofitable, losing 36 cents per share on a non-GAAP basis in Q1. But this is mainly due to much higher marketing expenses, which rose from 60.6% of sales in Q1 2020 to 73.2% of sales in Q1 2021 on much higher revenue (see page 10).
As a result, by 2025 I expect that marketing expenses will be much lower as a percent of sales. I estimate that adjusted EBITDA margins will be at least 40% by then. This would put it at $1.6 billion (i.e., 40% x $4 billion).
What DKNG Stock is Worth
Assuming DKNG stock reaches an EV-to-EBITDA ratio of 15 times, its enterprise value would be worth $24 billion. In addition, assuming it had $2 billion in cash by then its market cap would be $26 billion.
Given that the company has 429 million shares outstanding now (see the last page of its Q1 presentation) that puts its value at $60.61 per share. This represents a potential gain of 36.2% over the next four years. That would be a compounded annual growth rate of 8.02%.
That’s a good return but not a great one. But investors shouldn’t forget that my EBITDA margin assumptions are not that high. They could turn out much higher, well over 50%. (And I also lowered its market share penetration from 33% to just 20%.)
For example, based on a 50% margin assumption, DKNG stock would be worth $74.59, or 67.6% higher than today. That represents a CAGR of 13.8% each year.
So you can see that just a 25% higher margin assumption results in a potentially 73% higher CAGR (i.e., 13.8% vs. 8%). This shows the huge operating leverage that the company has.
Bottom line: expect to see DKNG stock much higher over the next several years. This is based on both the huge growth in its market and a higher overall profit margin.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.
