Gambling is becoming more common in the sports world. There are specific shows dedicated to discussing lines and odds on major television, a massive departure from how sports gambling used to be thought of. One of the most prominent players in this industry is DraftKings (DKNG -1.53%), whose sportsbook is legal in 22 states.
Even with the wind prevailing in DraftKing's favor, the stock has had a tumultuous life as a public company after being brought to the markets through a special purpose acquisition company. At its peak, the stock traded above $70 per share, but it now sits at about 18% of that high, down to just $13 per share. Despite this fall, Wall Street analysts have a median 12-month price target of $19, indicating about 45% upside from the current price.
So should you follow these analysts' lead and purchase shares, or is this a bad bet? Let's find out.
DraftKings has a massive audience it can't legally reach
DraftKings has multiple ways it plays in the betting world. What put it on the map was its daily fantasy games, where users can play different games with friends or strangers to win cash prizes. It also has a typical sportsbook and an online casino.
Overall, the company has consistently grown revenue and isn't close to maxing out its audience either.
Data by YCharts.
With plenty of states still holding out on legalizing sports betting (including three huge markets: Florida, Texas, and California), DraftKings has a massive audience it hasn't reached. However, the company is at the mercy of politics as these states may never legalize sports betting. Still, the prevailing trend is that more and more states are opening themselves up to the industry.
The future remains bright for DraftKings, at least from a revenue potential standpoint. But it has an incredible amount of work to do to generate profits.
DraftKings' operating margin is abysmal
If you've never looked at DraftKings' income statement, you'll have to brace yourself -- it's a rollercoaster. Here is a snippet from its third-quarter last year:
| Line Item | Amount | YOY Change | Margin |
|---|---|---|---|
| Revenue | $502 Million | 136% | |
| Cost of revenue | $373 Million | 118% | |
| Gross margin | 26% | ||
| Sales and marketing | $322 Million | 6% | |
| Product and technology | $76 Million | 17% | |
| General and administrative | $186 Million | (15%) | |
| Operating margin | (91%) |
Source: DraftKings. YOY = year over year.
So essentially, you have a company that is more than doubling its revenue, increasing its gross margin, and barely growing its operating expenses. Under normal circumstances, this would be an impressive feat that would have investors rushing to purchase the stock. However, the company is so far in the hole already that investors are instead concerned the company will never be able to dig itself out.
Wall Street expects much slower revenue growth next year too with the consensus estimate calling for 35% growth. If DraftKings does manage to expand its top line at precisely that pace in the third quarter of 2023 -- and none of its expenses grow at all -- DraftKings would still have a negative 42% operating margin.
With that large of a profitability gap to close, it's no wonder investors don't have a premium valuation on the stock anymore.
Data by YCharts.
While DraftKings may seem to have considerable upside based on Wall Street's price targets, there are too many questions marks for the company. Throw in the fact that DraftKings' cash balance has decreased from $2.15 billion as of the end of 2021 to $1.38 billion on Sept. 30, 2022, and investors should have a reason to worry.
Even if the big three markets legalize gambling in the near term, it will take time before the infrastructure is put in place, and DraftKings may have a tough time waiting it out. There are just too many other good investments to take on the risk that comes with DraftKings stock.
