DraftKings (NASDAQ:DKNG) is a fantastic microcosm of the greater stock market trends we’ve seen recently The Covid-19 impact on the stock market started two years ago February. And DKNG stock’s roller coaster ride launched at the same time.
The betting firm, you may recall, was one of the first big special purpose acquisition companies (SPACs) that served as a precursor to the upcoming mania. DKNG stock jumped to $17 in February 2020 before sliding with Covid-19.
By October 2020, however, DKNG stock topped $60. It was the perfect SPAC. It played into the stay-at-home trend as folks looked for new hobbies they could engage with from their phones. DraftKings benefitted from the stimulus checks as well; sending people $1,200 certainly was a boost for online gaming firms. And, more broadly, online gaming itself is a burgeoning industry, and thus attracted thematic investors such as Ark Invest’s Cathie Wood.
Like with the growth and SPAC booms more broadly, however, DraftKing’s great time would soon end. DKNG stock peaked at $74 in 2021, but would tumble under the $30 mark by year-end. Investors stopped focusing on the upside in DraftKings’ long-term market and instead fretted about the massive amounts of red ink that the company is generating today. That’s a totally valid concern. However, here’s why DraftKings still has a serious bull case.
First, The Bad News
We’ll get to reasons for optimism in a moment. But let’s tackle the bearish concerns head-on.
An issue with this sort of business is how much of its revenues come due to player incentives. In a highly-competitive market such as this one, players often have half a dozen or more apps with which they can bet on a big game. What keeps a player loyal to Draftkings amid myriad alternatives?
Oftentimes, the answer is player incentives. Betting sites will offer folks teaser lines, unusually generous parlays, matching bets, or other such perks to bet the game on their app instead of a rival. As long as venture capitalists are pumping billions of dollars into online gaming, expect there to be a proverbial race-to-the-bottom as sites rush to offer the most generous perks to grow their share of the player pool.
The question is, however, how much loyalty will there be if and when the larger player incentives are removed? In some cases, people might even leave the sports betting ecosystem entirely; there are a lot of things to gamble on, after all.
Right now, a lot of players feel they can obtain a positive expected value on their bets because there are so many gaming promos out there. If sports betting returns to more normal conditions where the house does have a large edge once again, activity in the ecosystem may decline.
Blood Red Financial Results
For the quarter ending September 30, 2021, DraftKings reported $213 million of revenues. That was up sharply from $133 million for the same period of 2020. So far so good.
The rest of the income statement is a big mess, though. DraftKings had to pay out $171 million of direct costs to earn those $213 million in revenues. That’s before you get to sales and marketing, which incredibly topped $300 million this past quarter. Just from those two line items alone, it cost DraftKings more than $500 million to produce $213 million of sales. Throw in its product development and administrative costs, and DraftKings somehow did even worse.
All told, the firm lost more than $546 million last quarter, or nearly three dollars of losses for every dollar of revenues. Also, DraftKings’ loss was much larger in 2021 than for the same period of 2020. While DraftKings still has an ample supply of cash for now, if it keeps losing half a billion dollars every quarter, that would soon put a strain on its balance sheet.
Competition Should Finally Start To Diminish
We’re finally seeing signs that gaming companies are getting tired of running massive losses to establish market share. One prominent example of this just came with Wynn Resorts (NASDAQ:WYNN).
In 2021, Wynn announced that it’s online gaming division would be merging with Austerlitz Acquisition Corp. I (NYSE:AUS), which is a SPAC. This deal would have valued its online betting business at $3.2 billion.
However, in November, Wynn announced that it had canceled the proposed SPAC transaction. Presumably, given the large drops in share prices of other gaming companies, the market would not have adequately supported the proposed SPAC merger. Additionally — and this is the really interesting part — Wynn stated that it wouldn’t need as much capital for online gaming thus reducing the need for a public stock offering.
Wynn CEO Craig Billings said, “We expect the capital intensity of the business to decline meaningfully beginning in the first quarter of 2022.” In English, that means that Wynn will be using far less cash to operate its gaming division. That’s fantastic news for Draftkings and other gaming firms; as competitors cut their marketing spend, it should allow Draftkings to lower its expenses as well.
Ironically, one of the reasons that tobacco is such a profitable business is that it isn’t allowed to market its products. Regulations have prohibited cigarette companies from pitching their products in places such as TV or magazine ads. In doing so, it has greatly improved profitability for tobacco as compared to other goods such as soft drinks and alcohol which remain highly-competitive markets. With a vice such as gaming, the product can often sell itself regardless of marketing budgets.
DKNG Stock Verdict
DraftKings was the perfect stock to sum up the Covid-19 landscape. It was a SPAC that rose to incredible and arguably unjustified heights thanks to a confluence of unusual events. Now that the economy is normalizing, pandemic beneficiaries such as DraftKings have seen their stock prices collapse.
And there remains an open question. Is DraftKings the future leader of a booming industry? Or is it simply an app that developed its user base by paying players massive amounts of incentives to stay on its site? Only time will tell.
With other online gaming companies starting to lower their ambitions, however, the opportunity is there for DraftKings to start consolidating its industry position. DKNG stock is still risky, but it’s certainly a more plausible buy at $23 than it was last year above $50.
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.