Shares of DraftKings (DKNG -4.26%) have fallen 35% from their all-time high earlier this year, and are down over 25% in the last few weeks alone. The stock is down in part because growth stocks are falling as interest rates rise, but investors also haven't been pleased with DraftKings' very aggressive acquisition strategy.
An offer to Entain (LSE: ENT) for $22 billion, more than DraftKings' valuation today, has caused the latest consternation for investors. Is this growth stock a buy, or is it one to avoid in the competitive online gambling market? Let's take a look.
A growth machine
DraftKings is absolutely a growth machine. The company grew revenue 73% in the past year, and expects to generate $1.21 billion to $1.29 billion in revenue this year.
Revenue growth doesn't come without a price, though. You can see above that the company also burned $425 million in cash over the past year, and that cash burn rate is growing as DraftKings spends on sales and marketing and expansion into new territories.
DraftKings had $1.7 billion of net cash on the balance sheet at the end of the second quarter, so cash isn't running out soon -- but at the current burn rate, the company only has a few years of cash to fund its growth.
DraftKings' stock price is important
The falling stock price is important for a couple of reasons. First, stock sales can be used to fund organic growth initiatives, like spending on sales and marketing, as DraftKings has been doing. Given the cash burn rate above, DraftKings could use stock sales to fund further growth as more states open up sports betting and iGaming.
A high stock price can also allow a company to use stock as an acquisition tool. DraftKings did that when it agreed to acquire Golden Nugget Online Gaming (NASDAQ: GNOG) for $1.56 billion in stock. We don't know exactly the terms that DraftKings offered for Entain, but given that the offer was for $22 billion, it's safe to say a large percentage of the offer was in the form of stock. As the stock price falls, so does the effective offer DraftKings is making.
Confidence in DraftKings is key
Investor confidence in a company like DraftKings is key for the company long-term, because it allows management to grow and acquire competitors without having to worry about being profitable or cash-flow positive. The stock can be a piggy bank to be used when needed.
If investors lose confidence in DraftKings and the stock falls, it can be a downward spiral. Suddenly the cash burn is more important, and management may pull back on growth spending, which leads to slower revenue growth, which hurts confidence even more.
On the acquisition side, DraftKings is trying to scoop up competitors to build a large market share, hoping that will lead to economies of scale long-term. If it can't use stock to acquire companies, scale will be harder to build.
DraftKings is on a slippery slope
Despite being a major player in online gambling in the U.S., DraftKings needs to perform flawlessly and keep investor confidence to reach its potential. After the Entain offer, we're starting to see some cracks in the company's acquisition strategy and the stock is falling as a result. If the drop continues, it may not be able to close the Golden Nugget Online Gaming transaction -- which can be rejected by Golden Nugget Online Gaming shareholders -- and the Entain deal could be in question.
DraftKings is making a big bet on itself and the future of online gambling, but it may be extending itself too far, and that's why I'm staying out of the stock right now.