Why Investors Will Have to Be Patient With DraftKings Stock

DraftKings (NASDAQ:DKNG) is one of the leaders of the online betting industry. That sector has rapidly-emerged over the past few years as many states have legalized online gambling. Formerly just the domain of Nevada and New Jersey, online gambling.is now legal in many regions of the country.  Stuck at home during the pandemic and flush with stimulus checks, many Americans were looking for new things to do, enabling online betting to flourish.  Despite that, however, DKNG stock has been a real dud in recent months.

DraftKings (DKNG) logo on a phone

Source: Lori Butcher / Shutterstock.com

But on the positive side for DraftKings, online sports gambling has started to gain mainstream acceptance. The National Football League (NFL), for example, allowed the Raiders to move to Las Vegas. Previously, it had been feared that having a team in a gambling-oriented city would reflect badly on the sport. Those concerns have long been brushed aside; now sports betting websites and apps are some of the leading advertisers on televised sporting events.

The Sector’s Positive Outlook Hasn’t Helped Online Gambling Stocks

In other words, the industry has a great deal of momentum. And, over the next month, the NFL playoffs and Super Bowl will take place. Those events should drive record sports wagering volumes in the United States as viewers in many states will be betting on America’s most popular game

But despite the promising near-term outlook for sports betting, DraftKings and its peers have gotten pummeled. What’s the problem, and can DraftKings get back on track?

Plagued by Excess Competition

When DraftKings went public, it was viewed as an easy way for investors to get exposure to sports betting. At the time, there weren’t very many online sports gambling sites in the U.S. And DraftKings and Penn National Gaming (NASDAQ:PENN) were the sector’s two main publicly traded stocks. As a result, when investors wanted to buy an online sports gambling stock, there was a good chance that they’d  pick DraftKings’ shares.

Now, however, other companies such as FanDuel have carved out a big chunk of the emerging industry. And the traditional casinos aren’t going down without a fight. Longtime casino owners like MGM (NYSE:MGM) and Caesar’s (NYSE:CZR) are making strong moves into online sports betting as well. New, digital-first offerings such as PointsBet are taking market share as well.

All in all, it’s turned into a dogfight. There are winners and leaders in each of the states that have legalized online sports betting.

There are advantages for relatively large firms like DraftKings that can quickly  get a big lead when new states legalize online betting. However, the highly segmented market  also creates a ton of redundant costs, red tape, and compliance concerns for each company.

Gaming Is a Five-to-Ten Year Turf War

DraftKings isn’t too  worried about its 2021 or 2022 financial results. Of course, every publicly-traded company wants to beat analysts’ average estimates each quarter. But the focus of online gambling companies is on gaining market share.

Ultimately, the online gambling industry seems likely to be dominated by a few major players. It’s imperative that DraftKings maintain its market leadership position so that it can make the right moves when the industry’s weaker players step aside. DraftKings needs to have sufficient financial resources and a reputation that’s strong enough to be able to snap up its weaker rivals once they look to sell themselves.

Investors Want Profits Today, Not In 2027

If DraftKings makes the correct moves, it, FanDuel and maybe one or two more gaming companies should dominate the sports betting market by the end of this decade. It’s simply not feasible for more than 12 companies to all advertise and deal with the sector’s risks and compliance issues across dozens of different states. The amount of redundant costs is breath-taking. As a result, mergers and consolidation must happen.

Long-term investors who buy DKNG stock shouldn’t mind waiting for this scenario to play out. All signs  seem to indicate that DraftKings still has one of the sector’s top  brands. As long as that remains true, DraftKings has a good shot at eventually becoming the industry’s leader.

However, the stock market has changed dramatically over the past six months. It’s not enough to have a good story anymore. Now investors are increasingly asking if companies can generate earnings or free cash flow.

And if a firm is not profitable now, investors want them to have a clear path  to profitability. Price-sales ratios have utterly collapsed for firms, including DraftKings, that have rapidly expanding revenues but no clear ability to convert those sales into profits anytime soon.

The Verdict on  DKNG Stock

Over the past 12 months, DraftKings produced $1.1 billion of revenue and turned that into $445 million of gross profit. That’s not bad in theory. However, the company had $1.6 billion of sales, general and administrative (SG&A) costs over the same period. Most of that was spent on marketing which was used to get and retain customers. Those sign-up bonuses aren’t cheap.

Needless to say, if a company has to spend $1.6 billion on marketing and overhead to attract $1.1 billion of revenue, its business model is problematic. Over time, DraftKings should be able to lower its marketing costs as customers become accustomed to the platform and rival gaming companies exit the industry.

Still, that is going to be a multi-year process. Analysts, on average, expect the company to remain firmly unprofitable through at least 2024, if not longer.  As long as the market continues to look for profitable or nearly profitable companies, DKNG stock is going to struggle. For investors willing to play the long game, however, the shares may soon be worth a second look.

On the date of publication, Ian Bezek 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.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a sizable New York City-based hedge fund. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media, https://investorplace.com/2022/01/why-investors-will-have-to-be-patient-with-draftkings-stock/.

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