Legendary short-seller Jim Chanos has revealed that he is short shares of DraftKings (DKNG -0.32%). Note, shorting a stock means you are betting that its shares will go down in value. In other words, you make money when the stock price falls.
Chanos cites DraftKings' aggressive spending on marketing and the stock's rich valuation as the main reasons he is short the stock. Is he right? Let's dig into the facts and determine if investors should follow Chanos' lead and sell DraftKings stock.
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Marketing spending is getting results
DraftKings offers several online activities, including fantasy sports, sports betting (known as sportsbooks), and gaming (known as iGaming). The latter two are the company's faster-growing segments, but DraftKings must get state-by-state authorization before it can offer sportsbooks or iGaming in a jurisdiction.
Recently, states have shown an increasing appetite for online gaming, viewing it as a lucrative source of tax revenue without having unsightly brick-and-mortar casinos that can also be too far away for some residents. Indeed, DraftKings is now live in 15 states for mobile sportsbooks and five for iGaming. With the launch of each new jurisdiction, DraftKings spends on advertising and promotion to get the word out to folks in the state.
And this is where Chanos' concerns about spending come in. For the nine months ended Sept. 30, DraftKings spent $703 million on sales and marketing -- thus, generating $823 million in revenue. While that's an impressive amount, it hasn't been enough to offset the company's overall costs and has led to a massive $1.2 billion loss on the bottom line. So Chanos is not wrong about high marketing spending.
However, in DraftKings' defense, that spending is producing results with the number of monthly unique players nearly doubling in the past year from 679,000 to 1.3 million. Compare that to another gaming company, Skillz, which spent 112% of revenue on marketing in its most recent quarter while growing monthly active users by less than 50%. Admittedly, the two companies are not exactly the same, but it highlights DraftKings' encouraging results.
Further, the company has achieved a 33% market share in the mobile sportsbook category and 17% in iGaming -- showing it to be a strong competitor.
The premium valuation could be justified
Chanos' other criticism is DraftKings' expensive valuation. As of this writing, the stock was trading at a price-to-sales ratio of 10.6, near its lowest level all year but a slight premium to Skillz's ratio of 8.9.
That said, DraftKings is growing revenue rapidly. Management is looking for sales to surge between 93% to 99% in fiscal 2021. While it is estimated to decelerate to 43% next year, that does not include the potential benefits of DraftKings' entry into new states. For instance, DraftKings was recently approved as an operator in New York, a market that could generate $1 billion in annual gross gaming revenue.
Overall, Chanos makes good points on aggressive marketing spending and an expensive valuation. However, in my opinion, it's no reason for investors to panic and sell DraftKings stock.
