In April, sports-betting company DraftKings (DKNG 0.59%) went public via a reverse merger. The reverse merger process allows companies to tap the public markets like traditional initial public offerings (IPO) but is often faster and cheaper.
With DraftKings' IPO, this is the only pure-play U.S. stock for sports betting. And Wall Street clearly thinks highly of the opportunity. Shares have more than doubled in 2020, and some analysts think it could go much higher -- even to $75 per share.
Personally, I'm uncomfortable investing in IPOs. I like to wait at least a year, while the company's management establishes a track record of delivering on promises to shareholders. It also gives time to better see the trajectory of the business and the market opportunity, and allows insiders to possibly cash out. While fear of missing out (FOMO) is real, the best investments provide years, if not decades, of growth. If sitting out a year deprives me of all the stock's upside, it didn't belong in my long-term holdings in the first place.
This is my approach to DraftKings stock. But I can't deny its present popularity and its stock return to date. However, after digging into the company's filings, there are a couple of areas of concern investors should be aware of. And if these issues concern you too, here are two better stocks for your investment dollars.
Growing net loss
In the first quarter of 2020, DraftKings reported revenue of $89 million -- good for 30% year-over-year growth. However, its net loss more than doubled to $66 million. Much of this was attributed to marketing expenses. And it's true that sales and marketing was the largest line item at $54 million. But this doesn't entirely account for the loss.
DraftKings' gross profit was only 51% in Q1 compared to 68% last year. This was partly due to expanding into new markets. But the company also disclosed that Sportsbook and iGaming are lower margin businesses than Daily Fantasy Sports. Over time, the former is expected to continue making up a larger percentage of revenue, effecting profitability.
For a stock growing profitability, consider video game company Take-Two Interactive (TTWO 0.42%). From 2017 to 2019, the company grew full-year net revenue by 50%. But net income has nearly quintupled over that time. Much of this outsized growth is due to operating leverage gained from more users. So if the company continues growing revenue at a healthy clip, one would expect the profitability trend to continue.
Take-Two Interactive can certainly grow revenue further in coming years, since its pipeline is full of new games. That should drive further profitability, which will likely reward shareholders with a higher stock price. And considering this company has over $1.5 billion in cash, cash equivalents, and short-term investments, it has plenty of options for rewarding shareholders with prudent capital allocation.
How big is DraftKings' market really? Image source: Getty Images.
Total addressable market
In its analyst day presentation, DraftKings pegged the U.S. total addressable market (TAM) at around $40 billion. From this, it believes it can generate up to $4.7 billion in annual revenue. That's quite a bit higher than DraftKings' $432 million in full-year 2019 revenue, and reason for investor optimism.
However, let's gently tap the brakes. Future revenue projections assume 65% of the U.S. population lives in a state with legalized online sports betting, compared to just 24% today. It also assumes 30% of the population can legally participate in iGaming, compared to just 10% right now. Further, it extrapolated the economics for New Jersey to other states. However, none of these projections are foregone conclusions.
I'm not questioning DraftKings ability to grow -- it's reasonable to assume future growth. I simply question just how large the TAM is. The answer to that question is important because the company's market capitalization is already north of $10 billion (when including already exercised warrants from Old DraftKings).
By contrast, I have no questions with The Trade Desk's (TTD -0.54%) enormous TAM. In its first quarter earnings call, CEO Jeff Green reiterated the size of the market it's going after by saying video advertising will someday be a $500 billion opportunity. The Trade Desk is the largest independent demand-side advertising platform, making it a primary-beneficiary candidate. Yet there was only $3.1 billion spent on its platform in 2019, showing there's still plenty of growth opportunity.
Granted, the programmatic advertising market The Trade Desk addresses was only estimated to be about $34 billion in 2019. But the shift from traditional advertising is happening now, as advertisers look to justify spending with the data analytics digital advertising provides. As change accelerates toward The Trade Desk's strengths, it's easy to see why the stock is a buy.
