DraftKings (DKNG 0.09%) has been a strong performer over the past five years with the stock up over 250% during that stretch. However, the stock's momentum has stalled in 2024 with shares down slightly year to date.
Nonetheless, the online sports betting operator continues to have a bright future in front of it. Let's look at three things investors should know about the company before buying the stock.
NASDAQ: DKNG
Key Data Points
How DraftKings makes money
In simplest terms, DraftKings' revenue comes from bringing in more money from the bets that are placed than it pays out in winnings. This is called the "hold" in the gaming industry.
The company's biggest source of revenue comes from online sports betting and running a sportsbook. In order to make money from online betting, it takes a cut of the bets it brings in (commonly known as the "vig"). It then looks to get to as close as possible to an equal amount of wagers on both sides of a bet so as not to take a side. Its sportsbook does this by creating odds and then moving the odds to try to even out the betting action.
DraftKings has been able to increase its hold by promoting more parlay bets, including same-game parlays. Parlays are when a bettor combines multiple bets into one wager to get better odds, but they must see all of them win to get paid. However, the hold rate is much higher on these bets as the odds favor the gaming operators.
Next year, meanwhile, the company has floated the idea it will add a surcharge to payouts from winning bets in states that have high sports betting tax rates. The move is considered a bit controversial, and industry experts are waiting to see how major sportsbook operators respond to any potential backlash.
For its daily fantasy business, meanwhile, it simply collects more money than it pays out to the contest winners in prizes. Basically, users are playing against themselves, and DraftKings is just getting a fee to create and run the games.
Its app also offers online casino games in several states, such as blackjack, craps, baccarat, roulette, and slot machines. For some games like live dealer roulette and blackjack, the company benefits from the traditional odds built into the games that favor the casino, while others use random number generators that give a set return to player (RTP) payout.
Riding the wave of legalized online sports betting
Over the years, DraftKings has benefited as more states have legalized online sports betting. It had been illegal outside of a few states until 2018, when the Supreme Court struck down the Professional and Amateur Sports Protection Act (PASPA) as being unconstitutional after the state of New Jersey challenged the mandate.
New Jersey legalized online sports betting after winning its case, while several other states quickly followed suit. While DraftKings had established a presence in many states with its Daily Fantasy offering, New Jersey and these states would be the first markets it entered with its online sports betting product. Last year, Ohio and Massachusetts legalized online sports betting, while North Carolina and Vermont legalized it this year.
Entering each new market has led to strong revenue growth for DraftKings. The company traditionally spends a lot of money on marketing and promotions to acquire customers when it enters a new state. However, with brand recognition now pretty high on a national level, newer states have seen more rapid customer acquisition and are becoming profitable more quickly.
As the company begins to reduce marketing and promotions in established markets, DraftKings should see profits begin to soar.
Image source: Getty Images.
DraftKings is currently not in three very large U.S. states
DraftKings currently offers sports betting in 25 states and Washington D.C., covering about 49% of the U.S. population. It is also in Ontario, Canada, home to 40% of Canada's population.
However, it is not in the three largest U.S. states: California, Texas, and Florida.
Florida has legalized online sports betting but only through the Seminole Tribe, which owns Hard Rock Bet. With the Supreme Court recently declining to hear a case challenging this arrangement and the Seminole Tribe being required to take 60% of all revenue in any commercial agreement, the odds of the company entering Florida are small.
California, meanwhile, voted against two ballot initiatives to legalize online sports betting in 2022. The state could look to involve tribes to try to eventually get it passed, although there are 100 tribes in California that would need to be part of a revenue-sharing agreement. DraftKings rival FanDuel, for its part, has talked of commercial companies and tribes working together to help legalize online sports betting in the state. However, the process will likely take several years to play out.
While getting into Florida seems remote and California appears a ways off, Texas could be the biggest near-term opportunity for the company. The state proposed legalizing online sports betting in 2023, but after The Texas House of Representatives passed the legislation, it didn't make it past the Senate. However, the issue will likely be brought up again next year with the expectation that it will pass.
With over 30 million residents, Texas is the second-largest state in the U.S. and represents about 9% of the country's population. It is also a huge sports state. As such, there will be a big opportunity for DraftKings when the state finally legalizes online sports betting.
Should investors buy the stock?
DraftKings continues to grow rapidly, and at the same time, it is seeing a lot of operating leverage as many of its markets mature. It's getting better economics and returns as it enters new states, and it is seeing better hold rates as it promotes and directs users to place more parlay bets.
With Texas potentially legalizing online sports betting next year and a potential boost from its winner's surcharge, now looks like a good time to buy the stock ahead of these potential tailwinds.
