Last month I wrote that DraftKings (NASDAQ:DKNG) was worth between $60.61 and $74.59 when DKNG stock was at $44.50 on May 20. Since then, as of June 9, it is now at $54.35. The point is that it was undervalued and likely to rise. I still believe that the upper end of the target is very possible. My new valuation is $73 per share, or 34.2% higher than today.
Keep in mind that DKNG stock is well off of its highs. It’s down from $71.98 on March 19 to $54.35. That represents a drop of 24.5% over 3 months. Nevertheless, DKNG stock is now positive for the year (+16.73%), as it closed at $46.56 on Dec. 31. As you can see, my estimate of its value reflects a return to its previous highs.
The rest of this article will explain how I value DKNG stock, so you can have a simple understanding of my working model.
How To Value DKNG Stock
At its core, my model depends on a report by Morgan Stanley analyst Thomas Allen. He argues that sports betting could reach $15 billion in 2025, up from $3 billion in 2020. Moreover, I now believe that that the market is clearly valuing the stock based on its 2025 forecast revenue numbers.
For example, Seeking Alpha indicates that on average analysts estimate revenue will reach $3.58 billion by 2025. That implies that DraftKings’ market share would be slightly less than a quarter by 2025.
That seems like a reasonable number, especially given the company’s existing advantages in the marketplace, which are likely to increase. Moreover, given that estimates for 2021 are for $1.17 billion, this implies a 4-year growth rate of 205.9%. On a compounded basis, that works out to 32.2% average annual growth in sales.
Next, in my model, I assume that the company’s profitability will increase to about 50% EBITDA (earnings before interest, taxes, depreciation, and amortization) margins. This is despite the fact that right now the company is unprofitable.
For example, in its latest quarter (Q1), DraftKings had an adjusted EBITDA loss of $139.3 million on revenues of $312.7 million. But this result reflected marketing expenses of $228.7 million, or 73.2% of sales. That is not normal. Within the next five years, I suspect that those expenses will fall as a percent of sales, allowing the company to start to reap 50% EBITDA margins.
Therefore, assuming 50% margins, EBITDA will reach $1.79 billion by 2025. Next, I multiply the EBITDA number by 15 times to value those earnings. That gives DKNG stock an enterprise value of $26.85 billion.
What To Do with DKNG Stock
I estimate DraftKings will have at least $2 billion in cash by 2025 from profitability and further warrant issues. That gives it an equity market value of $28.85 billion, or 34.2% ahead of today’s price.
This implies that DKNG stock is now worth about $73 per share, or 34% above today’s price. In addition, I don’t think that it matters that much that the estimates I am using relate to 2025.
Here is why. I think the valuation for DKNG stock is always going to be at least 4 to 5 years in the future. This is because the market assumes that the sports betting market will continue to grow dramatically.
Don’t Discount Future Sales and Earnings
After all, right now the stock has a huge price-to-sales ratio. For example, as mentioned analysts expect revenue to reach $1.17 billion this year. But its equity market cap is $21.49 billion. That is a price-to-sales multiple of 19.2 times. This clearly implies that the market is valuing DKNG many years into the future based on its forecast revenue and profitability.
In other words, the market’s outlook on the stock will roll over to the next 4-to-5-year sales and EBITDA forecasts. That is the reason why I don’t feel right now that is important to discount the future sales and EBITDA to the present. However, that changes once the company turns profitable. Once profits can be clearly forecast, the valuation will be based on a discounted measure of their present value.
Therefore, look to make at least 34% on DKNG stock as it moves closer to its inherent value of $73 per share.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.