DraftKings (DKNG 0.59%) is falling out of favor with investors. The stock has crashed by 74% from its highs in early 2021. Uncoincidentally, that matches the time when economic reopening gained momentum in the U.S.
During the pandemic, it was a market favorite as investors correctly figured gamblers would flock to the platform as brick-and-mortar casinos were forced to close temporarily. Let's take a closer look at the business and its prospects to determine if the crash in the stock price could be justified.
Image source: Getty Images.
Revenue is exploding for DraftKings
Indeed, revenue exploded for DraftKings in 2020, rising 90% from the year before. The momentum continued into 2021 as it grew 111% from 2020. In all, the company accelerated revenue growth for three consecutive years.
DraftKings is a digitally native gambling company that offers sports betting, iGaming, and daily fantasy sports. As a gambling business, it needs the approval of each state to enter the market. Therefore, revenue growth is closely connected with market access agreements. Fortunately for shareholders, state governments have shown a healthy appetite to legalize the activities. From the perspective of legislatures, it's a way to boost state coffers without directly imposing taxes on constituents.
DraftKings is live in 17 states with mobile sports betting and five with iGaming, representing 39% and 11% of the U.S. population, respectively. Even more states could enter into similar relationships with DraftKings in the next several years.
Early results from existing markets indicate consumers enjoy the services. DraftKings said the total addressable market for sports betting and iGaming in North America is more significant than expected. Now estimated at $80 billion, it's an increase of $13 billion from the previous estimate.
Understandably, folks are taking a liking to online gaming. After all, some people have to drive several hours to reach the closest brick-and-mortar casino. The distance creates friction for folks who would like to gamble from time to time, reducing the frequency of visits. Since some state agreements call for taxes on a percentage of gaming revenue, that is not ideal for them either.
So with all that working in DraftKings favor, why did the stock crash by 74%?
DraftKings stock falls out of the sky
For starters, the stock had gotten expensive. Before the pandemic onset, it was trading at a price-to-sales (P/S) ratio of less than 12; at its peak, it had climbed above 36. Additionally, you almost have to use a P/S ratio to measure valuation for DraftKings because it is negative on most other metrics. It generates negative free cash flow, negative earnings, and negative earnings before interest, taxes, depreciation, and amortization (EBITDA). That could be another explanation for the dramatic stock crash.
Despite revenue rising by 90% in 2020 and 111% in 2021, it still reports massive losses on the bottom line. After the crash, DraftKings is trading at a P/S ratio of 5.9, right about where it was before the outbreak. Did it fall too much? Maybe. But there is certainly reason to justify a fall from its peak valuation.
