2023-08-07 12:50:09 ET
Summary
- DraftKings Inc. reported its first-ever profit in its Q2 2023 earnings release, prompting a spike in shares.
- The company's profitability is good news, but some of its gains came from lucky play, raising concerns about sustainability.
- FanDuel, a top competitor, is already profitable and could pose a challenge to DraftKings' market share.
The DraftKings Inc. ( DKNG ) Q2 2023 earnings release had good news for investors. Sales growth continued robust and, even happier news, the company turned its first profit. The results deservedly prompted a spike in the shares but also bull scenarios by many analysts that began to sound like the dreamland numbers that had brought the stock to the $70s from 2021.
For context, Alpha Spread calculates the latest discounted cash flow ("DCF") valuation of DKNG at Base case: $15.72, Worse case: $7.76, Best case $72.
Many were the same analysts who had watched the stock skyrocket in 2021 and tank as low as $11 as the company continued to grow sales, but at the same time, bleed billions in excessive bonuses to build new play and hold onto mature market shares. So, beside the aforementioned solid performance settled into context in 2Q23, we are already seeing signs of a repeat performance of a roller coaster ride to nowhere among some of the stock’s fans.
At the same time, we want to note that DKNG becoming profitable is really great news—but it is not alone. And some of its gains have just come out of lucky play. In its report it notes that $40m of its profit was related to lucky play, ~10% or 3% above historic mathematically proven odds 7%.
Top Competitor the FanDuel unit of Flutter Entertainment ( PDYPY ) is already profitable, and is trading at ~$96, up 3.5% since the DKNG earnings release. The market share dominance of the two top players in the space essentially leaves crumbs for all other competitors. What is totally understandable is investor thinking that the price differentials between Flutter and itself is far wider than the shares of market.
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Does that provide a valid thesis to see DKNG, even at $31, as a screaming buy by comparison? But it is also a bit of a false flag. Investors need to take a deep breath before igniting a rocket ride on the stock all over again. DKNG also shows an intrinsic value of $18.50,which would make it 42% overvalued at its current price. Take your pick.
So, there is our mixed red and green light signals. DKNG has happily entered the realm of profitability with revenue guidance by management raised again to $3.4b to $3.6b$ for 2023. Yet by many calculations and trading history already known, the stock may well have reached its apogee and could be headed south from here until it reaches somewhere around its real world value.
It is wise to remember that the stock market has a heartbeat. Employ the best analytics available to the best minds on Wall Street and you are still in a realm where analytics in the end are only as good as their data points. And it is human beings with all their flaws who interpret the data points that comprise algorithms.
For that reason, our conviction about a forward valuation of DKNG depends entirely on whether they can continue to stay profitable in the next 2 or 3 forward quarters as so many what ifs migrate into the sports betting sector. Our overall sense is bullish for the next quarter figured on the base reality that Q3 brings the NFL season. With the NFC and AFC East competitive battles likely to be fierce, and such a heavy weighting of betting rich states involved, we like DKNG to bring in a nice quarter. Yet we still caution the pom pom twirlers.
Shares of Market estimated as of this writing:
DKNG
Fan Duel: 45%
DKNG: 32%
Combined, the two top performers take a total of 77% of all US GGR revenue. On a market by market basis, one or the other may lead in share, but that may vary by month as well
BetMGM: ~10%, but 27% of the IGaming (casino) subsector.
Caesars SportsBook: 5%
Barstool: 1.9%
All other of the some 60 odd operators in the sports betting space, are in hand-to-hand combat over what constitutes the crumbs. Including the five noted above, there are only two more that scratch shares of market at or below 1%.
So, while DKNG’s #2 position is excellent, the likelihood is that it sustaining its strong sales growth cycle ahead will become tougher. It would have to poach share from FanDuel first, and stop any growth spurt by BetMGM (MGM) further. The reasoning here is the arrival of ants at the sports betting picnic.
Enter Fanatics
The sports merchandise leader has long cast a covetous eye on the obvious migration possibilities of its presumed data base of 82m buyers of team merchandise, pro and collegiate. Fanatics claims its sales during the covid crisis reached $4.5b from a pre-covid $2.5b. CEO Rubin boasted that the singular market advantage of Fanatics would bring it to the #1 market leader position once it got into sports betting. Bloviating further, this was one of several factors that triggered some analysts to value the sports gear business at $31b—before it dipped its toe into day to day sports betting. It did a $700m capital raise to finance its entry into the sports betting sector.
Fanatics organized a Fanatics Betting business but quickly realized that bettors weren’t waiting for this merchandiser of hats and jerseys to take their money. So they wisely bought the U.S. site of Australia-based PointsBet for $225m after a short-lived competitive toe dip from DKNG raised the stakes.
This move gives Fanatics immediate platforms into 15 legal states where they can begin firing competitive guns with a big fat war chest. It is to be noted that the reason PointsBet sold was a realization that this low margin, high capital burn business was a dead end street for low share operator.
The Australian PB company confesses it has sold its U.S. operation at a loss but says the 4.9% share of its global business equity will remain with U.S. partner NBC.
Now just as the sector leaders are turning profitable, comes Fanatics, willing to pour out whatever it takes to poach share for a seat at the table. It won’t be easy. Fanatics top guy, veteran sports betting exec Matt King has said, “it’s a ten year journey.” He’s right on the money. But year one is underway.
No one expects a major breech into the citadel shares of the two market leaders by Fanatics. Yet we cannot discount the entry of a deep pocketed competitor into a business whose fuel has been bonuses and giveaways will chip away at leaders.
FoxBet, following Churchill, waves bye bye to the sector
FoxBet, a unit of Fox ( FOXA ) has left the field of play, another victim of its own hubris when it entered the game in 2019 with its initial buy in to the Stars Group, later acquired by Flutter. Statements of its singular entry points due to its big sports media footprint flooded the financial pages. Part of its original deal was an option to buy 18.6% of the Fan Unit unit then valued at $11b, Fox claimed it could exercise its deal against an $11b valuation. FanDuel said no.
They went to arbitration seeking to value their option at the original price. The panel ruled against them, confirming the valuation had gone up to $22b for the company and hence their option was worth $3.72b. An accelerator clause in the decision subjects Fox’s option to a 5% hike based on performance. So that its piece must now fetch $4b if they exercise.
Also back in early 2022, Churchill Downs ( CHDN ), the racing and gaming operator, announced it was leaving the online betting business, closing down its Twin Spires site. So here was another company, presuming solid DNA and database bettors waving bye bye because it could not see its way how to ever make money or build customers on a profitable basis. It was another smoke signal to investors that spelled caution ahead—even if you see a solid performer like DKNG turning profitable.
That brings us to the next ant in the picnic. Flutter has long announced its intention to do a NASDAQ-traded U.S. IPO for FanDuel. What held the process up was the uncertainties of the arbitration case noted above. That was solved, and now we have FoxBet, leaving the field but still holding the FanDuel option. This helps clear another pothole facing Flutter.
We can expect speeded up moves ahead for the Fan Duel IPO. Whether they go the SPAC route or merely list the existing Flutter securities on the NASDAQ means that investors will now have a shot at another pure play in the sports betting space. Much of the original trading up of DKNG in the 2020/1 period was driven by its status as the only true pure play in the sector.
Within the next year or less, I believe we will see a FanDuel IPO on the NASDAQ that will compete for investor interest with DKNG. Does the question of owning both have an easy answer? Probably not now. Both are sector leaders, both excellent marketers with dominant shares, both have the resource base to maintain share and fight for new markets. So it may well become a conundrum here: Will DKNG’s trading range rise to meet somewhere closer to FanDuel when it goes public, or will the reverse happen: Will FanDuel shares descend down to meet DKNG valuations as investors pair trades?
And the biggest question in the room, the 600lb gorilla question: “Will DKNG and FanDuel eventually get married?”
And let’s not forget that the feisty 50% BetMGM owner site backed up by its parent’s near $11b cash hoard is going nowhere. It has, in fact, set goals for dramatic growth of its digital businesses that put a drive to building market share within its grasp over whatever time and capital it may take.
Conclusion
There are many more ants coming to the sports betting picnic than those biggies we have noted here. This is not a business with barriers to entry for companies already holding gaming licenses. Note that the WynnBet site owned by that eponymous company Wynn Resorts ( WYNN ) had been put on the sale block for $500m and without takers they liked, decided to continue fighting it out and doubling down on marketing. So we have marginal players holding on, small players leaving the field and market share leaders beginning to turn profitable.
What it all adds up to is a very tricky sector upon which to allow the DKNG results for the quarter as an omen of glory days ahead. We like their Q2 2023 a lot, but will reserve judgment as to a price target that is too dreamy as those which accompanied the stock in its first run higher during 2020-2021.
We think the stock feels more comfortable anywhere between $23 and its current high of $31. Some analyst price targets, or PTs, have it at $27, which I find reasonable. Others are looking for $37, which sounds a bit toppy on the basis of a single quarter.
Overall, we like DraftKings Inc.’s sold #2 market share. We like their getting religion by tamping down their giveaways. Their site is among the most player-friendly. Their sales growth could slow, but if we get the handful of new states now nearing going legal, DKNG will get a hefty share. They appear able to hold share in mature markets, and lead in others.
We’re calling DraftKings Inc. stock a HOLD , assuming it could move up to the mid-thirties or just as easily erode down to the mid to lower twenties any time before the next quarter. Let’s see where the ants crawl first.
For further details see:
DraftKings: Beware Of An Empty Calorie Run All Over Again