When famed short-seller Jim Chanos disclosed a short position on DraftKings (NASDAQ:DKNG), the stock fell from $35 to $28.37 at the end of last week. How valid are Chanos’s calls that valuations on DKNG stock and others justify a short call?
Excessive valuations alone are not a good enough reason to bet against a company. Investors can only guess if Chanos’ overvaluation bet will pay off. He bet for years against Tesla (NASDAQ:TSLA) did not pan out. Shareholders need to re-evaluate the growth prospects of online sports betting and DraftKings’ position in the market.
Gambling Legalization Matters for DKNG Stock
Legal Sports Report said a federal court decision will cease sports betting in Florida. This ruling adds uncertainty to DraftKings in the near term. Investors are skittish in holding DKNG stock because of its valuation. At over 20 times sales, five times book, and a debt/equity of 0.68 times, the company’s growth prospects cannot weaken. Court rulings that slow sports betting legalization will delay DraftKings’ business momentum in 2022.
In Nevada, DraftKings and FanDuel already applied for gaming licenses on March 11, 2020. Those applications are still pending. The more delays it faces, the more shareholders realize the company will not post strong growth in the short term.
Modest Third-Quarter Results
In the third quarter, DraftKings posted revenue growing by 60%. Its monthly unique payers (MUPs) grew by 31%. Monthly unique paying customers averaged 1.3 million. The company benefited from strong unique payer retention. It added users through its iGaming and Sportsbook products. Its expansion of both products also lifted MUPs.
DraftKings increased its Average Revenue per MUP (ARPMUP) to $47, up by 38% from last year.
The company raised the midpoint of its revenue guidance to $1.26 billion. This reflects new state launches and its proven ability to add users and keep them engaged. Despite the strong outlook, DKNG shares slipped in November, losing around 40% of their value.
On Nov. 1, DraftKings ended its $22 billion deal to buy Entain. Its decision not to proceed is a positive development for shareholders. The firm would have paid a premium to grab a company with a solid record of accomplishment of growth. This comes at an expensive price target.
DraftKings may focus on lowering its cost of revenue and spending effectively on sales and marketing in 2022. Competition for acquiring customers will heat up. As long as it stays ahead by growing faster than the market average, investors will hold the stock for the long term. In New Jersey, Pennsylvania, and Indiana, the firm sustained its lead. It did not benefit from a Daily Fantasy Sports for Cash database on those states.
DraftKings is depending on getting licenses in states like New York to reach profitability. It will adjust its marketing efforts depending on when a state rewards it a license. Its business model targets a path to profitability in two or three years. When the company posts quarterly results, investors must watch the gross margin levels.
Besides an initial lift in the first 30 days of launching in Wyoming and Arizona, DraftKings has product innovations to drive growth. For example, Rocket (on slide 4) and NFL Flash Bet will lift their gross margins. The company is in the early phases of growing DraftKings Marketplace. It launched the marketplace on Aug. 11 and posted over $20 million of gross merchandise volume in the third quarter.
The company has the flexibility to adjust its product mix to increase new customer acquisition rates. It demonstrated good customer retention. This allows DraftKings to cross-sell Autograph from the marketplace to existing customers.
Fair Value and Your Takeaway
On Wall Street, analysts have a price target that ranges from $34 to as high as $105. On Stock Rover, a stock scoring service, DKNG shares have weak grades. The stock suffers from a poor valuation and quality score.
The value score will rise should the stock continue to dip further. Investors are no longer paying as big a premium for DraftKing winning online sports betting licenses.
Markets started to shy away from sports gambling stocks a few months ago. DraftKings is the leader in the space. FuboTV (NYSE:FUBO) may look cheaper as it trades at a smaller market capitalization. Investors should stick with companies with a strong brand name and an aggressive growth strategy.
DraftKings is a stock that growth investors should consider from here. Have a timeframe of at least three or more years for holding the stock. The sector faces increasing volatility but it has a bright future.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.