DraftKings Has Declined More Than 50% in Three Months; Valuation Still Looks Extended on Basis of Future Cash Flows

After the market action over the last two to three months during which high multiple stocks have suffered significant corrections, investors are faced with the choice of whether or not to buy the previous high fliers at discounted prices. One such name is DraftKings Inc. (NASDAQ: DKNG), a U.S. online betting company, which is viewed as one of the few available large cap pure plays on the strong expected growth in global sports betting. 

Indeed, the consulting firm Market Research Future estimates that the global online sports betting market could reach nearly US$60 billion in 2026, up from around US$25 billion in 2019, equivalent to a compounded annual growth rate of 13%-14%.

At its recent share price of US$28.37 (down from low-US$60’s in early September), DraftKing’s stock market capitalization is around US$12.2 billion, and, after factoring in its net cash position of about US$1.1 billion, its enterprise value (EV) is roughly US$11.1 billion.

DraftKings has issued revenue guidance for 2021 and 2022 of US$1.24-US$1.28 billion and US$1.7-US$1.9 billion, respectively. This implies the stock has an EV-to-2022E revenue multiple of about 6.2x, a high figure during most market times but not an outrageous current multiple given present market conditions (near zero interest rates, there is no alternative, etc.).

However, the company’s valuation based on cash flow is more problematic. Its adjusted EBITDA over the last twelve months is a loss of about US$636 million. A large part of this loss stems from heavy sales and marketing expenses of around US$895 million over the same 12-month period. These promotional costs, which are essential both to retain and gain customers, amounted to 78% of DraftKings’ revenue over the year ended September 30, 2021.

(in thousands of U.S. dollars, except for shares outstanding)3Q 20212Q 20211Q 20214Q 2020
Sales and Marketing Expense$303,658$170,712$228,686$191,959
Adjusted EBITDA($313,658)($95,302)($139,262)($87,884)
Adjusted EBITDA Margin-147%-32%-45%-27%
Operating Income($546,516)($321,554)($153,108)($268,338)
Operating Cash Flow($70,886)($98,624)($77,751)($96,584)
Cash – Period End$2,394,985$2,646,500$2,818,128$1,817,258
Debt – Period End$1,247,785$1,324,442$1,327,294$81,612
Fully Diluted Shares Outstanding (Millions)433.1430.3429.0427.8

Even if the company’s revenue were to grow ~40% in 2022, its EBITDA losses would likely remain very high for at least the intermediate term. Simply put, in order to gain revenue and market share in the sports gambling business, a high level of promotional spending is required. If such spending were to slow materially, revenue would likely moderate as well.    

A short-term positive development for DraftKings — at least in terms of avoiding near-term dilution — is that it has decided not to bid a reported US$22 billion (20%-25% in cash and the balance in stock) for the British gambling firm Entain plc. DraftKings announced it would not make a firm offer in late October. Such a bid would have represented an approximate doubling of a proposal made by MGM Resorts International in early 2021.

Another positive factor for DraftKings is the structure of its August 2021 agreement to acquire Golden Nugget Online Gaming. Under that deal, which is expected to close in 1Q 2022, DraftKings will exchange 0.365 shares of DraftKings Class A common stock for each Golden Nugget Online Gaming share. In total, DraftKings will issue around 30 million shares. At the time the transaction was announced, the value of those shares was around US$1.56 billion. Now, they are worth around US$850 million. Since the exchange ratio in the merger agreement is fixed and does not vary based on DraftKing’s share price, DraftKings will not have to make up this difference. 

Even after losing more than half its value in about three months, DraftKings’ valuation still looks extended. On the basis of projected revenue alone, the company’s EV may not be at a discounted level, but it does not appear extremely expensive. Conversely, DraftKings’ operating cash flow is unlikely to turn positive for some time based on necessary promotional spending, and the company’s US$11.1 billion EV is difficult to justify on this measure.  

DraftKings Inc. last traded at US$30.44 on the NASDAQ.

Information for this briefing was found via Edgar and the companies mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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