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DraftKings: Don’t Chase The Post-Earnings Rally

By Vincent MartinStock MarketsAug 08, 2022 16:57
uk.investing.com/analysis/draftkings-dont-chase-the-postearnings-rally-200530542
DraftKings: Don’t Chase The Post-Earnings Rally
By Vincent Martin   |  Aug 08, 2022 16:57
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  • The big crash in DraftKings stock has been driven by the market’s errors last year, rather than an overreaction this year
  • A $7 billion market cap still seems high relative to current revenue and big losses
  • Long term, DraftKings needs to improve execution and management

Trading in DraftKings (NASDAQ:DKNG) stock during 2020 and 2021 was a case of the market simply losing its moorings. The bull case for DKNG too often seemed to rest solely on steady legalization of sports betting and iGaming in the U.S., while it ignored all-too-real risks surrounding valuation, competition, and execution.

DKNG closed Friday down 75% from a record high reached in March of last year, so clearly, the market has recalibrated its expectations. But despite a bounce of late, each of those risks remains. There’s an intriguing story here, certainly, but up 83% from the lows, there’s no need to rush into DraftKings stock.

DraftKings Weekly Chart.
DraftKings Weekly Chart.

Source: Investing.com

DraftKings Stock Rallies

On Friday, DKNG gained 10% after releasing second quarter earnings before the open. At first glance, the rally does make some sense. Revenue handily topped analyst consensus. Full-year revenue guidance was raised; the expected loss for the year was narrowed relatively significantly.

But looking closer, the news might not be quite that good. For one, DKNG had rallied sharply into the report, which, in theory, would suggest a higher bar for the company to clear. And while the full-year outlook looks solid, essentially all of the improvement came from Q2 performance. DraftKings topped its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) guidance for Q2 by $72 million — and raised the full-year outlook by $60 million. A similar trend holds in terms of revenue.

Even with higher expectations, it’s not like the outlook is that impressive. DraftKings still expects that adjusted EBITDA will be a loss of $765 million to $835 million. At the midpoint, that’s almost 40% of revenue. There is a long, long way to go to profitability, even ignoring stock-based compensation that totaled a stunning $322 million in the first half of the year.

Investors last week bid up a number of struggling speculative stocks after earnings, including Coinbase (NASDAQ:COIN) and Carvana (NYSE:CVNA). DKNG may have benefited more from that risk-on appetite than from any real change to the broader story here.

The Valuation Problem

Again, DKNG has bounced nicely from May lows. It’s possible that given the steep decline from the highs, investors see the stock as cheap.

Over time, it could be. DraftKings is burning cash heavily at the moment, but it’s spending up to acquire new customers in new states like as New York. Management said after Q2 that losses would peak this year, and early markets, like New Jersey, already have turned profitable.

Long-term, DraftKings sees significant profitability. At its Investor Day in 2022, the company raised its long-term EBITDA target to $2.1 billion from $1.7 billion the year before (and “$1 billion-plus when the company, in late 2019, announced plans to merge with special purpose acquisition company Diamond Eagle Acquisition).

The company’s current market capitalization is roughly 3.5x that figure. There’s a reasonable argument that should DraftKings hit that target, DKNG stock could quadruple. Mature European iGaming providers historically traded at a mid-teens multiple to EBITDA

There is a catch, however. That $2.1 billion target is for five years after 65% of the U.S. population lives in states with legalized sports betting — and 30% live in states with legalized iGaming. Including pending launches, the figures are 44% and 13%, respectively.

California, with 12% of the U.S. population, could get the sports betting industry near DraftKings’ targeted reach. But that state has been a minefield for gambling interests: online poker legalization has been discussed there for more than a decade. Movement in terms of iGaming appears relatively stalled at the moment.

And again, DraftKings is targeting that $2.1 billion figure five years after that level of legalization is accomplished (not to mention further growth in Canada). At the earliest, then, that target is 10 years out.

Returns of 300% over 10 years are nothing to sneeze at, certainly. But, of course, those returns rest not only on legislators cooperating, but DraftKings actually hitting that target.

The Management Question

And there should be some skepticism on that front. To put it bluntly, this does not look like a particularly well-managed company.

DraftKings clearly has ceded top market share in the U.S. to FanDuel, a unit of Flutter Entertainment (OTC:PDYPY). BetMGM, a joint venture between MGM Resorts International (NYSE:MGM), and Entain (OTC:GMVHY), is not far behind.

Yet, DraftKings was, and remains, the unquestioned leader in daily fantasy sports. DFS was supposed to give the company a huge base of easy-to-acquire sports betting customers and an early head start in the industry. The company hasn’t capitalized, and the huge losses of late are being driven in part by marketing spend DraftKings wasn’t supposed to need.

There are capital allocation questions as well. The acquisition of Golden Nugget Online Gaming, which closed this year, was clearly an overpay. DraftKings then aggressively tried to buy Entain, even raising its bid. Fortunately for DraftKings, given that Entain now is valued at less than half the $22.4 billion DraftKings was willing to spend, the deal fell through.

Investors now should know that sports betting and iGaming alone don’t make a bull case. DraftKings needs to recapture market share, control its spending and deliver on its promise. To this point, it hasn’t done any of those things. It’s going to take a lot more than one quarter for the company to prove that it can.

Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.

DraftKings: Don’t Chase The Post-Earnings Rally
 

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DraftKings: Don’t Chase The Post-Earnings Rally

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