DraftKings Investors Need to Be Aware of These Major Risks

Sports betting company DraftKings (DKNG 2.85%) went public via a special purpose acquisition company (SPAC) in 2020. If you're thinking about buying this stock, there are some key risks that long-term investors need to weigh first. 

In this segment of Backstage Pass, recorded on Nov. 1, a few days before the company's earnings releases, Fool contributors Jose Najarro, Danny Vena, and Toby Bordelon explain.

Days later, the company reported its earnings for the third quarter on Nov. 5. During the three-month period, its revenue surged 60% year over year, while monthly unique payers and average revenue per monthly unique payers increased 31% and 38%, respectively.  

Jose Najarro: I do want to say there's definitely some risks with the company. I talked about all the good stuff, but first, this is a competitive market. We've definitely seen a lot of casino companies out there. A lot of people are going into that online betting. A lot of states are still being approved. So it'a still a competitive market.

Second risk, I want to say it's some regulatory market. You have to make sure things get approved by the state, by the government. Who knows, out of nowhere they could be like: "We're not going to approve. This is going to take a little bit longer," so that growth can slow down. So, the regulatory market, I do believe comes with some risk as well.

The other thing I do want to say, this is priced for growth. Right now we're definitely seeing that growth incoming. Price-to-sales ratio might not be as crazy as the rest of the market before, prices-to-sales ratio is about 11. This company is still not profitable in GAAP earnings, but like I mentioned, they're definitely growing at strong levels.

Next, I just want to share some recent news, pushing back into the NFT [non-fungible token] market. DraftKings recently, like I mentioned, they've only been working with athletes, but during the Halloween season, they actually partnered up with Saw, if you guys remember Saw, it was like a scary movie collection.

They sold some NFTs based on that movie Saw. If you collected the full set, which included one trap, one schematic, and one key, you were also able to get some more stuff from the Saw itself. This is the first season, I wonder, if there's going to be anything during the Christmas holidays, or during the end-of-the year holidays. Pretty interesting there.

Finally, I just want to mention they do expect to have earnings this upcoming Friday, Nov. 5, before the market opens. That's pretty much all I had to share about DraftKings. If you guys have any questions on the company.

Danny Vena: The only question I had, and I had a little bit of bad taste in my mouth over DraftKings at the very beginning, because as an accountant, one of the things that concerns me is whenever you have a company that issues something called a "going concern" disclosure.

Essentially that's something in the accounting field that says, if there's any possibility that the company wouldn't be able to continue its business and its operations for the period of the next 12 months, the company is required to disclose that.

One of the things early on, actually, even before the SPAC merger was completed, was that the company said that they might have some going-concern issues. Now, that obviously has rectified itself since then, but do you see any other risks of the business continuing?

Najarro: In forms of financial, Danny, I would say not much right now, especially since most of the purchases it's doing is either in form of stock purchased or stock-based.

They do have a decent amount of cash at hand right now as well. Financials now, mainly more in the other risks like, maybe a little bit highly valued, maybe a little bit dependent on regulatory approvals. But as a business, in financials I don't really see much risk at the moment.

Toby Bordelon: I know, Jose, we talked about this company a little bit ago on the M&A Show when they were doing some of these deals. I had not realized the Entain (ENT 0.31%) deal had been called off, so that's interesting.

I know we had a concern, and I think we talked about this, they had this Golden Nugget deal. Now they're trying to go to this, is that too much? Yeah, it's a land grab, and you want it to expand.

But there was some concern that, "Can you really handle all this at the same time?" Maybe in some way I'm glad to see them step back a little bit. Then we're focused on getting that Golden Nugget stuff wrapped up and integrated before they start going crazy again with some more acquisitions.

Najarro: It seems investors agreed with you there, Toby, because after they mentioned that, hey, we're not going to follow through with that acquisition. The stock price rallied about 4, 5%. I'm guessing it's similar concerns, that acquisition was almost going to be like a one-to-one ratio.

The market cap of Entain was going to be very similar to just the market gap of DraftKings itself. I think a lot of investors share that similar concern. Hey, you just made an acquisition, you're buying another company similar to your size, slow it down for a second there.

Bordelon: Yeah. I mean, you can get too big too quickly and if you bite off more than you can chew, because we have integration issues and things can go south pretty quickly. But definitely a fascinating company in the space.

I think it's one that if you're interested in online gaming, you've got to take a look at it. I think with FanDuel, they're probably one in two in the market right now, I would say.

Vena: Certainly, as this really is an emerging market right now, if you think about the online gaming space, it has really only emerged in the last couple of years. I think it's definitely worth a look.

It may not be for everybody, and it might be a little bit risky there. But I think with any early stage company, you're going to have a certain level of risks and just whether or not you can get a risk level that you're comfortable with and you can still sleep at night. Good, definitely interesting.