Online gambling has gained substantial popularity in recent years. And while the pandemic expedited the shift toward online betting, the gambling industry as a whole is expected to become increasingly digital moving forward. Convenience is key today, and companies like DraftKings (DKNG 0.59%) allow people to wager money on sports and casino games from the comfort of their own homes.
As of the beginning of 2022, 18 states allow online sports wagering, and only six states permit mobile casino games. As more states continue to push legislation, the addressable market for companies like DraftKings will grow drastically. No one doubts the market potential -- global online gambling wagers reached nearly $1 trillion in 2021. That said, the industry is still in its early innings, and given that online betting is a state-by-state issue, it'll be very interesting to watch the industry play out. With plenty awaiting in the internet gambling arena, let's discuss whether or not investors should buy DraftKings shares today.
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A rough year for the online gambling stock
To say it's been a rough year for DraftKings would be an understatement. The stock soared above $60 per share in September of last year before heading into a downward spiral. Throughout the past year, shares of the online gambling company are down 68%. Broad scale headwinds like rising interest rates and the Russia-Ukraine crisis have been unkind to high-growth tech stocks like DraftKings. Generally speaking, growth stocks tend to take the largest hit during times of uncertainty. This is because many of these companies are more expensive, less established, and unprofitable, which in turn makes them riskier investments.
DraftKings' pullback also stems from investor concerns over the company's financial situation, mainly its future path to profitability. In its most recent quarter, the company's management stated that it expects an adjusted net loss between $825 million and $925 million in 2022, notably higher than what analysts initially modeled. While other elements of the company's recent earnings announcement weren't ideal, investors were primarily concerned with DraftKings' lack of progress on the profitability front.
The bull case
Starting with the industry alone, there's plenty to like about DraftKings. According to Grand View Research, the online gambling market is set to grow at a compound annual growth rate (CAGR) of 12% through 2027, up to $127.3 billion. Given DraftKings' 36% share of the U.S. online sports betting market, the company is well-positioned to benefit from the secular growth trend.
DraftKings also continues to grow its top-line at a rapid pace. In 2021, the company grew revenue by 111%, up to $1.3 billion. In its previous earnings announcement, management raised its fiscal year 2022 revenue guidance from $1.7 billion to $1.9 billion to a range of $1.9 billion to $2 billion, representing year-over-year growth between 43% and 54%. By 2025, analysts are forecasting DraftKings' top-line to reach $3.9 billion, translating to an average annualized growth of 25% from 2021 revenue.
I'm impressed with DraftKings' sales growth, both historically and projected. As an industry leader, the company is in an advantageous position compared to most of its peers. Continued mainstream adoption and legalization will only benefit DraftKings in the years ahead.
The bear case
There is one major caveat to DraftKings' impressive growth -- the company's operating expenses continue to rise, resulting in an unclear path to profitability. In 2021, DraftKings' total operating costs increased 85%, up to $1.6 billion. As a result, the company's EBITDA loss expanded to $1.4 billion, significantly greater than the $729 million EBITDA loss in 2020.
The company's aggressive spending -- although contributing to robust growth -- comes at a price for investors. Wall Street analysts aren't forecasting DraftKings to reach a full-year of profitability until fiscal year 2026, meaning investors will likely have to wait nearly half a decade before profitability is achieved. There's no guarantee either that DraftKings will ever generate a positive bottom-line. The online gambling market is becoming more and more crowded, which could impede the company's growth and cut into its top-line moving forward.
And while the company's valuation has normalized, it's still not at ideal levels when comparing it to competition. Today, DraftKings is trading at 5.8 times sales -- this is significantly higher than industry peers Flutter Entertainment (PDYP.Y), Penn National Gaming (PENN -3.64%), and MGM Resorts (MGM -1.24%), which carry price-to-sales multiples of 2.4, 1.2, and 2.1, respectively.
DKNG PS Ratio data by YCharts
The company's valuation is more reasonable than it was a few months ago, but that doesn't make the stock cheap. In fact, I would argue that DraftKings is still expensive today and would need to fall even further before reaching reasonable levels to buy.
Am I buying DraftKings?
It's tempting to want to buy into DraftKings' ongoing crash, but there are more actionable opportunities available on the market today. The company's runway for growth is massive, but I think this is largely offset by its sky-high operating expenses and indefinite path to profitability. As a long-term investor, I'm willing to wait several years for a company to generate a positive bottom-line. That said, it's necessary that the company demonstrates meaningful progress on a year-over-year basis.
In DraftKings' case, I don't think the company has provided enough evidence that it will become profitable down the road. Combine this with its lofty price-to-sales multiple relative to its peers, and I'm unmoved by DraftKings stock as of today. Investors should remain on the sidelines for now and look to deploy their capital elsewhere for the time being.
