The COVID-19-inspired pauses and delays of major sports leagues were devastating to sports betting company DraftKings (DKNG -0.19%), which derives a significant portion of its revenue from contests that wager on the outcome of sporting events.
Now, with the NBA and MLB seasons set to resume later this month, DraftKings is ready to make up some of its lost ground. Let's take a closer look at three reasons why DraftKings stock is a buy.
1. A large base of users
DraftKings makes the bulk of its revenue on daily fantasy contests. Participants pick a group of players from a specific sport and compete against each other to see whose team scores the most points. The payout is determined by how many people enter the event, and DraftKings takes a percentage of the overall prize pool. For example, 50,000 participants enter a contest paying a $25 entry fee for a total of $1.25 million in entry fees. DraftKings will designate a prize pool of $1 million and keep the difference.
Therein lies the value in DraftKings. The larger the number of players entering an event, the larger the prize that can be awarded. When players see others winning million-dollar payouts, they are persuaded to join the game as well.
The company already has 720,000 monthly unique players, up from 619,000 at the same time last year. What's more, average revenue per user was up to $41 from $37 a year ago, despite the headwinds from the coronavirus. The company has over 12 million registered accounts and 4 million individual payer accounts (users who have deposited money at least once). With so many people staying at home, and the many closures of casinos and card rooms, the company has an opportunity to increase engagement from millions of dormant customers as major sports leagues get going.
2. Opportunity to capitalize on the surge in demand for in-home entertainment
The rise in demand for in-home entertainment is a catalyst that can propel revenue for the company in the near term -- with the opportunity to sustain that activity long after the pandemic has run its course. The NBA and MLB are restarting their seasons later this month, which will likely boost engagement among DraftKings customers. The two leagues are popular on DraftKings because they play multiple games daily, which allows for more variation in team creation, making daily fantasy contests more intriguing and drawing in more entrants. In contrast, the NFL plays games mostly on Sundays, making it challenging to run contests on any other day.
When engaging in games of chance, people prefer to play against each other rather than against the "house." That was one of the main reasons online poker was so popular in the U.S. before legislation crippled the industry. DraftKings has the opportunity to capitalize on that consumer taste with its daily fantasy contests. The value for investors is the possibility that some portion of the users who are attracted to the site during the pandemic stick around long after COVID-19 has ended.
3. Increasing momentum for legalization
DraftKings does not have the approval to operate in all states across the U.S. However, momentum is increasing for legislation that would allow it to have more access. The increase would allow it to attract more players and advertise nationally, increasing revenue and reducing marketing expenses simultaneously. Following the repeal of the Professional and Amateur Sports Protection Act in May 2018, 21 states have legalized sports betting in some form.
What this means for investors
Revenue growth was accelerating for DraftKings from 31% growth in 2018 to 40% growth in 2019. The impact of COVID-19 is expected to reduce growth to 25% in 2020 before accelerating again to 30% in 2021. If it continues to grow at 30% over the next six years, it will have earnings before interest, tax, and depreciation of an estimated $1 billion by 2027 on revenue of $3.6 billion.
Admittedly, DraftKings is a high-risk growth stock. Even though the NBA and MLB will be resuming their seasons, there is no guarantee they will be able to complete the season without further shutdowns. And DraftKings needs more states to legalize sports betting before it has access to more customers and can reach better economies of scale. Still, the potential payoff from this stock makes taking the risk worth it.