DraftKings (DKNG -1.35%) has been facing challenging times as the coronavirus pandemic led sports leagues to pause their seasons. Since the company derives most of its revenue from offering contests that depend on the results of sporting events, the lack of sports is hurting the company significantly.
The company has enough cash to survive in the near term, and sports leagues will eventually return to normal operations. When that time comes, the company has the potential to reach robust growth. That's because it shares a competitive advantage that Facebook (META 1.54%) also has. Let's take a closer look.
One out of three people on the planet use Facebook. Image source: Getty images.
DraftKings is harnessing the network effect used by Facebook
Facebook has a total of 2.6 billion monthly active users worldwide. The total population of the planet is 7.8 billion people. Remarkably, one out of every three people in the world is on Facebook. Thus, it is a single online community where people can join and communicate with family, friends, and colleagues even if they're a continent away. Facebook's massive reach is a classic example of a network effect -- its platform becomes more valuable as more people join it.
That same force is on the side of DraftKings. Its daily fantasy sports contests provide more value to users as the number of registrants grows. A $25 entry-fee event with 50,000 signups can garner a $1 million first-place prize. The larger the top prize, the more it entices new people to register, thus feeding a positive feedback loop.
Further, the more users signing up to participate in a daily fantasy contest, the more reason major sports leagues have to partner with DraftKings and sustain that partnership. A person who has skin in the game by wagering in a daily fantasy contest is more likely to watch the sport. By promoting DraftKings, major sports organizations would be increasing viewership and engagement from their fans.
DraftKings has already amassed 565,000 monthly active users, up from 485,000 in the year prior. It was able to achieve this even though its product is only available in select U.S. states and countries. Its growth and profitability are significantly dependent on the pace of legalization of daily fantasy sports betting across the U.S. Crucially, momentum is growing for increased legislation for its products. It will be interesting to see whether the post-pandemic environment will lead to an acceleration of that trend.
What this means for investors
Nevertheless, the company continues to spend to acquire more customers and believes it still has a long way before it reaches its peak level of users. Customer acquisition costs, while higher to begin with, will decrease as it grows its number of users. The cost saving will increase even more when it can advertise nationally and achieve better economies of scale.
DraftKings provides investors an avenue to benefit from the valuable network effect. Still, there is an added layer of risk to this stock because of the legislative requirements needed for the company to access more users.
