Gambling goes back to the earliest years of humanity, yet is a growth market today. With legal restrictions loosening in North America, digital gambling company DraftKings (NASDAQ:DKNG) is in a race with competitors to claim its stake as king of the gambling mountain.
DraftKings is losing a lot of money right now, but should that keep investors away? Let's dive into what is really going on and see whether DraftKings' potential reward outweighs the risk.
Legalized betting is a big opportunity
The U.S. has gradually moved toward legalized gambling, with sports betting now legal (or in the process of becoming legal) in 34 out of 50 states. Not quite as far along, "iGaming," or online casino games, is now live in four states with several more reviewing legislation to legalize it.
DraftKings estimates these two gambling categories are worth more than $60 billion in the U.S. alone once all 50 states legalize. DraftKings offers daily fantasy sports, online sports betting, and iGaming all on one app, making it easy for users to fund their accounts and cross-play different gambling segments.
DraftKings is in a race to grab market share against competitors, including FanDuel (owned by Flutter Entertainment), Penn National Gaming, and a long list of brick-and-mortar casinos looking to protect their existing business. DraftKings has aggressively partnered with a variety of companies in the digital sports space, including:
- Leagues: NFL, NBA, UFC, NASCAR, MLB.
- Teams: New York Giants, New York Rangers, New England Patriots, Dallas Cowboys.
- Media Channels: ESPN, Bleacher Report, Dish Network, Uber Technologies.https://draftkings.gcs-web.com/static-files/bf17c9d2-f5a4-4a37-a8f9-00a13234b211
These partnerships have earned DraftKings market share, which the company estimates to be 30% nationwide in online sports betting and 19% in iGaming. DraftKings is also expanding outside of U.S. borders, with potential legalization in Canada adding another $8 billion in addressable market. Eventually, DraftKings could continue to expand internationally; the global sports betting market is estimated to grow as large as $134 billion by 2024.
Are DraftKings' financials a problem?
DraftKings is not a profitable company, posting a $1.2 billion loss in 2020. Its sales and marketing expenses for that year were $495 million, almost as much as its $614 million in revenue. The steep losses have continued in the company's first quarter, where it posted a net loss of $346 million. Sales and marketing expenses continued to nearly eclipse revenue, amounting to $228 million versus $312 million.
DraftKings did grow revenue 175% year over year in Q1, but sales and marketing grew along with it, which makes one wonder whether DraftKings ever become profitable. It's certainly unlikely to turn a profit while sales and marketing consume almost three-quarters of revenue.
DraftKings spends its marketing dollars on advertising and giving players promotional cash to lure them onto the app. Typically, a player will become a user and, after promotional cash is spent, will use their own funds to continue playing. Because the market is so new in the United States, most users gambling on DraftKings are new users spending promotional cash.
DraftKings expects that as its user base begins to mature over the next few years, the customer mix will shift from most users playing with promotional cash to using their own money, reducing the amount spent on sales and marketing. Only time will tell whether management is right or not, but it's important to understand the "why" behind the company's financials.
Is DraftKings a buy?
DraftKings stock has pulled back from its highs after a multi-month stretch where growth stocks have generally fallen out of favor with investors. The business is losing money right now, so earnings-based ratios won't work to value the stock. Instead, we will use the price-to-sales (P/S) ratio.
DraftKings is expected to grow revenue 88% in 2021 to $1.16 billion, which values the stock at a P/S of 17. Other stocks in the market with similar revenue growth rates are trading at higher P/S ratios, but DraftKings could be discounted because of its steep financial losses.
The remaining market opportunities in the U.S. gambling markets are still not fully tapped, so DraftKings could continue to grow rapidly while losing money over the next few years. Investors could benefit from this growth, assuming that DraftKings can eventually turn a profit. It will be important for investors to track customers' spending patterns on the platform to show that users stay on the platform long after the promotional cash runs out.