DraftKings (NASDAQ:DKNG) is now a public company after merging with an already public shell company in April. Despite the unconventional IPO process, investors have bid up the company's stock price considerably. The market is betting on the immense growth opportunity that may unfold in the coming years as online sports gambling is legalized in several states.

Is Draftkings over-hyped, or could it live up to expectations?

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U.S. online sports gambling

DraftKings was founded in 2012 and has primarily facilitated daily fantasy sports. Daily fantasy sports is an online game where players build hypothetical team rosters and earn points when athletes perform well in their actual games. DraftKings collects revenue from players who pay money to enter contests and from sponsorships. It attracts and retains players by offering cash prizes to those who construct winning teams. 

Daily fantasy sports is a nice business, but a much larger growth opportunity exists for Draftkings and its rivals to operate as bookmakers in the legal sports gambling market in the U.S. Sports gambling has long been illegal, but in 2018 a law changed which enabled states to legalize and regulate their own sports-gambling industries. Since this change, 14 states have already legalized online sports betting, and the industry has already started operating in 9 states. Many more states are expected to join this party in the coming years.

At the time of writing DraftKings operates online sports betting in 7 states and anticipates expanding into more states as regulation passes, and the company is able to secure the appropriate licenses and approvals. In Q1 2020, DraftKings generated $88.5 million in revenue, which amounts to a 12.5% growth rate; however, the growth rate is expected to accelerate as sports gambling ramps up in more states.

Today, online sports gambling in the United States is a fairly small industry, but DraftKings believes the industry could eventually grow to over $20 billion in annual revenue. DraftKings currently splits the market with FanDuel (owned by Flutter Entertainment). If it can maintain market share, it stands to reap billions in future annual revenue -- implying eye-popping growth grow for investors.

Person on a laptop holding casino chips.

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Another growth opportunity: online casino

Online sports betting isn't the only market DraftKings is playing for. The company also has its sights on online casino gambling, which is a virtual version of traditional casino games, such as slots, poker, and blackjack.

Online casino is already legal in U.S. states that account for 10% of the population and is expected to be allowed in several more regions in the not-too-distant future. Many states' need for additional revenue sources is helping to broaden the push for legalization. Ultimately, DraftKings believes the U.S. online casino market could be another $20+ billion annual revenue opportunity.

The company's strategy is to cross-sell existing DraftKings players into its online casino offering. This appears to be working in New Jersey where both online sports betting and online casino are already legal. DraftKings has noted that 50% of the sports-betting users in New Jersey also played the DraftKings casino app. If the company can keep players in its ecosystem, online casino could be another multi-billion dollar revenue opportunity in the not-so-distant future.

Not the only game in town

DraftKings has an exciting growth opportunity for years to come which has been reflected in investor enthusiasm for the stock. However, investors should be cautious not to get overly excited because there are many uncertainties with how the DraftKings growth story could play out.

It is important to note that DraftKing has many competitors. FanDuel is a formidable competitor and is backed by Flutter Entertainment -- a global online gambling company. Penn National Gaming is also worth watching as it recently acquired media company Barstool Sports and has huge ambitions in the online gambling arena. And many other competitors are likely to emerge.

Finally, it is unclear exactly what shape the legalization of online gambling will take and the speed at which it will happen. Online casino may not gain wide adoption, and several large states, such as California, Texas, and Florida, have yet to show signs of legalizing any form of online gambling.

DraftKings may well be a home-run growth stock over the next 5-10 years, but investors should be aware of the risks, especially now that the stock has caught fire.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.