A starting shot signaled the beginning of a long race on May 14, 2018. This was the day the U.S. Supreme Court ended the federal ban on sports gambling, allowing states to decide for themselves whether to make sports gambling legal for their residents. Five years later, the market has exploded in the U.S. Over 20 states have legalized online sports betting with tens of billions of dollars spent yearly by gamblers betting on football, basketball, and more through these online portals.
But how can investors take advantage of this rapidly growing industry? One popular stock in this sector is DraftKings (DKNG 4.96%), a leading online sports betting platform. Shares of the stock are up 215% year to date after showing continued strong growth and improving profitability. Let's see if this party will continue in 2024, and whether DraftKings is a stock to buy for the long haul.
Aggressive growth, increasing market share
Companies like DraftKings have spent aggressively to attract people to their online betting portals. First-time bettors get attractive promotions that can give them hundreds of dollars in wagers just for signing up with DraftKings. These are heavy subsidies that DraftKings has to finance, but management believes it is worthwhile over the long haul due to the lifetime value a gambling customer.
So far it looks like this aggressive strategy is paying off. DraftKings recently passed competitor FanDuel to take the market share lead for gross gaming revenue in the United States. It now has a 31% share vs. FanDuel at 30%. This includes more than just sports betting, but it shows a leader like DraftKings can press its advantage in order to consolidate more and more customers on its platform. At the end of Q3, the company had over $1 billion in cash on its balance sheet, giving it plenty of firepower to continue offering attractive promos to new bettors.
This is showing up in DraftKings' revenue. The company's trailing-12-month revenue is up over 856% since going public just a few years ago, making it one of the fastest-growing public companies in the world. Last quarter, revenue was still growing quickly, up 57% year over year to $790 million.
Can DraftKings generate a profit?
Revenue growth at DraftKings has been phenomenal. But if you're a skeptic, you'd say this growth isn't sustainable due to the losses the company has incurred. There's no disputing that DraftKings is losing a lot of money. Last quarter, the company had an operating loss of $287 million. Over the last twelve months, its operating margin was around negative 30%.
However, bulls would argue management is correct in going for a land grab in this young industry, which will lead to more profits over the long run. There are still tons of customers to win in existing states, and plenty of other states -- including Texas and California -- that may legalize sports betting within a few years.
Profit margins have started to move in the right direction too. A few quarters back, DraftKings was running at an operating margin of negative 100%. It has shown major profitability improvements in recent quarters without taking a hit to growth. In fact, as I mentioned above, it has gained market share over this time period. If these margin improvements continue, the company will be generating a profit within a few years, if not sooner.
Data by YCharts.
The valuation isn't crazy if you believe long-term guidance
From just its existing states, DraftKings believes it can grow its revenue at a 14% compound annual growth rate (CAGR) through 2026 and start generating $6.2 billion in annual revenue. Management is guiding for adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) to reach $1.4 billion by 2026 as well, though investors should remember this is not a true measure of profitability. Despite this, given the asset-light nature of online sports betting, it's likely DraftKings can generate a healthy profit margin once its business starts maturing.
At a 15% profit margin on this 2026 revenue figure, that would equate to $930 million in annual earnings. As of this writing, DraftKings has a market cap of $16.5 billion, which would be a price-to-earnings ratio (P/E) of 17.7 based on that 2026 outlook. This looks relatively cheap for a business that should be growing revenue in the double-digits for many years.
These numbers don't factor in momentum around sports betting legalization in new markets either. If this happens, DraftKings will be in a strong position to attract new customers from these states given its brand ubiquity and market share lead. Add these factors into the mix, and DraftKings stock is still a good bet after its stellar showing in 2023.
