The stock of DraftKings (DKNG 0.18%) certainly divides investors. The online sports betting company has been a favorite of "disruptive growth" investors like Cathie Wood, but it also once garnered the skepticism of short-sellers like Jim Chanos.
While the stock is still more than 50% below its 2021 all-time highs, 2023 was a year for the DraftKings bulls, with the stock soaring over 209% and becoming one of the best stocks in the market last year.
The question now is: What accounts for DraftKings' improvement, and is the stock still a buy?
NASDAQ: DKNG
Key Data Points
Why DraftKings soared in 2023
It wasn't just speculative investors bidding up DraftKings stock in 2023. The company actually posted rapidly improving financials, even if it hasn't hit profitability yet.
Looking back, there were two main reasons for DraftKings' improved financial performance: Increased industry consolidation, and more parlay betting.
In 2023, Fox quit the online sports betting business and DraftKings took share
On industry consolidation, it appears as though DraftKings' first-mover position in legal U.S. states, combined with a large marketing budget, has forced many of the smaller players out of the industry. Even large, public companies hoping to get into this newly legal industry have bowed out, with Fox Corporation (FOX 1.87%) being the latest casualty.
In August 2023, this potentially formidable competitor decided to shut down its Fox Bet online sports betting (OSB) operations, clearing the way for DraftKings and existing companies to retain or take even more market share. The Fox shutdown followed those of other smaller hopefuls, including MaximBet, Fubo Sportsbook, Churchill Downs, and theScore, over the last couple of years.
Fox still owns 2.5% of Flutter Entertainment (PDYP.Y +0.00%), the parent of FanDuel. FanDuel, along with DraftKings, now forms an oligopoly that shares just over 70% of the online sports betting market today. Fox also has an option to acquire 18.6% of FanDuel at a valuation of $20 billion. So, it appears Fox is just choosing to accede to the leader, in which it already has a stake.
DraftKings spent big, and competitors went home
Fox's move revealed that the massive investments DraftKings has made over the last few years seem to have succeeded in crowding out hope for smaller entrants.
That journey of aggressive spending began even from DraftKings' first days as a public company, when it simultaneously merged with its technology provider SBTech, during its three-way merger with special purpose acquisition company (SPAC) Diamond Eagle Acquisition Corp.
Management believed that vertical integration would give DraftKings' app an advantage over smaller players that had to outsource their technology, and that a superior product would make for stickier customers. That seems to have been accurate; a recent industry poll showed DraftKings as the top choice among customers for "most intuitive interface" and "most betting options." That "stickier" customer then allows for more aggressive marketing above what most other competitors could afford, providing a nice network effect.
That all seemed to pay off in 2023, as DraftKings saw revenue surge 75.7% through the first nine months of 2023 to $2.43 billion, with adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) losses falling by more than half, from ($671.9 million) to ($302.1 million) during the first nine months of 2022 and 2023, respectively.
Image source: Getty Images.
DraftKings' "hold" is steadily increasing, thanks to parlays
Another reason behind 2023's excellent performance is that online gamblers are playing more "parlays," or multi-part bets that come with smaller odds but a bigger payoff. These types of bets typically increase the amount of revenue DraftKings earns relative to the total amount of money wagered, called the "hold." In fact, the trend toward more profitable parlays and in-game bets, as opposed to typical pre-game bets, was one of the main reasons Jim Chanos covered his short bet against DraftKings in 2022.
As a result of increased parlays, in-game bets, and better-optimized trading and analytics, DraftKings' hold increased from 6.5% in 2021 to 7.7% in 2022, and is projected to reach 9.5% in 2023, according to the company's November analyst day. This phenomenon of rising hold percentages obviously boosts revenue but also increases margins.
Expect positive EBITDA in 2024 and beyond
As a result of industry consolidation and improving hold rates, DraftKings projects it will see revenue surge to between $4.5 billion and $4.8 billion in 2024. But more importantly, EBITDA is projected to flip to the positive and rise to between $350 million and $400 million, improving by more than $500 million over the full-year 2023.
At its analyst day, DraftKings also mentioned that it expects to reach $2.1 billion in EBITDA by 2028 from existing states alone, which only accounts for 50% of the U.S. population of online sports betting (OSB) and just 11% of the country for iGaming. But if other states where legislation has been introduced eventually pass their bills and legalize both OSB and iGaming, that paves the way for another $1.5 billion in EBITDA. And if the remaining U.S. states all legalize both OSB and iGaming, that could mean an additional $6.2 billion in EBITDA by 2028. Combined with the $2.1 billion from existing states, that could mean an EBITDA market potential of $8.3 billion.
So while DraftKings looks expensive based on trailing numbers, its $15.3 billion market cap doesn't look that expensive, as long as margins continue to inflect higher, and a few more states legalize OSB and iGaming. Given that many large states such as California haven't yet legalized and are dealing with large budget deficits now, I'd say there's a good chance of some upside surprises here.
While this investor had dismissed DraftKings a couple of years ago as a hyped-up overvalued SPAC, there does seem to be a pathway to value and profits now, as DraftKings has solidified itself as one of the last OSB platforms left standing.
Interested investors should continue monitoring the key state legalization initiatives, and be prepared to pounce on any drawdowns after the stock's big 2023.
