Point/Counterpoint: The Case for DraftKings

(C) Reuters.

By Yasin Ebrahim and Christiana Sciaudone

Investing.com — The economic fallout from the pandemic has left some firms fighting for their lives, worrying whether their business models will still be relevant in the “new normal” when the virus is eventually brought under control.

Online sports and betting operators like DraftKings are not among those businesses.

The lifting of gambling restrictions in many states across the U.S. is creating major opportunities for online sportsbooks. But investors aren’t the only ones poised to profit. State regulators, strapped by lost revenue from Covid shutdowns, are eyeing online gambling as a source of tax income. There are risks, too, such as increased competition.

Investing.com’s Yasin Ebrahim argues the bull case for DraftKings Inc (NASDAQ:DKNG), while Christiana Sciaudone argues investors should beware the risks. This is Point/Counterpoint.

The Bull Case

While the bears may point to the company’s lack of trading history given its public market debut via a reverse merger in April, DraftKings is a firm boasting solid fundamentals after the shackles of regulation were lifted two years ago.

In 2018, the U.S. Supreme Court, struck down a 1992 federal law on commercial sports betting in most states, paving the way for 18 states, representing just over 30% of the U.S. population, to launch regulated sports betting markets.

With an eye on a new source of tax revenue, states like Tennessee, Virginia and New Hampshire, traditionally non-gaming states, also legalized mobile sports betting in the first two years since the court ruling. And more are likely to suit, leading to a fertile ground in which sports betting and online gaming operators can thrive.

“When legislatures return in earnest, we firmly believe the number of states ready to consider accelerating mobile sports betting and online gaming legislation to drive tax revenue will expand substantially,” Matt King, CEO of FanDuel, told ESPN.

Morgan Stanley (NYSE:MS) estimated the sports betting industry will be a $7 billion to $8 billion business in the U.S. within five years.

Against this favourable backdrop, sport betting and gambling operators like DraftKings are able to provide what others in industries ravaged by Covid-19 cannot: Visibility.

Following the return of live sports, DraftKings recently reinstated guidance for the year, which is “indicative of its favorable position in leveraging pent-up demand for online sports betting,” Oppenheimer said.

While the bears will be quick to suggest a second wave of Covid could put live sports on the bench once again, and stall momentum in the sports betting industry. DraftKings has already proved its mettle when the first wave of the pandemic struck, with shares up more double its

IPO price of $20.

“Despite the limited event calendar, June revenue was +20% and accelerated in late-July/early August on professional sports returning,” Oppenheimer added. “We see pullbacks around sports disruption serving as buying opportunities and having minimal impact on underlying fundamentals.”

The Bear Case

Investors aren’t the only ones eyeing online sports betting companies like DraftKings. So are governments hungry for fresh tax revenue.

Take New York, for one. Legislators are likely salivating at the prospect of raking in what NY Sports Day projects to be $108 million a year in taxes for the state. A New York Senate bill would authorize the state’s seven retail casinos to operate online with a 12% tax on sales and a licensing fee, according to Casino Beats, to start.

And that’s just one of the risks facing online sports betting, says Barry Jonas, director and senior equity analyst at Truist Securities. He points to Europe, where there was pushback from a social harm perspective and, apparently, children found to be betting online. There’s also growing competition and the question of loyalty, with bettors easily able to jump from one app to another.

Gaming analysts tend to be more conservative when it comes to online sports betting companies, Jonas said. They see the increasing competition and the regulatory risks, including states in fiscal straits that could easily try to tap into company profits with increasing taxes.

Jonas initiated DraftKings at a hold-equivalent rating in early September. While he likes the company and the management team, Jonas believes the market is calculating zero risks and that’s helped spur a valuation that is simply getting out of control. Look no further than that company’s shares having more than doubled since it started trading in April after completing a reverse merger with special purpose acquisition company Diamond Eagle.

Jonas points out that DraftKings’ 10-year forward EBITDA target multiple of 11 is at the higher end of gaming’s one-year multiple of 10 times. DraftKings reported sales of $75 million for the second quarter and is expected to report $130 million for the third quarter, according to data compiled by Investing.com.

“DraftKings has effectively said they’re not making money any time soon,” Jonas said in a phone interview. They are estimating $1.2 billion in Ebitda in 2030. “I don’t see that it’s a given that DraftKings will hit their target.”

It’s hard to argue that DraftKings isn’t on a roll. It’s one of the top 100 most popular stocks among Robinhood investors, something Jonas believes might be among the reasons for the current euphoria. Plus they recently added basketball great Michael Jordan as a special advisor to the board and inked a deal with ESPN.

But the competition is already here.

Penn National Gaming Inc (NASDAQ:PENN) soft-launched its online sportsbook in Pennsylvania this week. Penn bought a 36% stake in Barstool Sports, a digital sports media company, in January, which already has more than 56 million followers on social media — and likely a few bettors among them. Penn already owns gaming and racing properties, as well as 8,800 hotel rooms. Their more traditional casino approach may eventually prove to be a more tempting wager for consumers interested in both in-person and virtual betting.

Additionally, there’s MGM Resorts (NYSE:MGM)’s BetMGM sportsbook app. In a huge vote of confidence, IAC last month said it had taken a 12% interest in MGM valued at about $1 billion, and specifically pointed to online gaming revenue as a massive and still nascent opportunity.

While DraftKings is in vogue, both Penn, Barstool and MGM are household names already. And they’re all up against each other.

Finally, there’s the elephant in the room: Covid-19. Several major sports leagues were on hiatus last quarter because of the virus, and though most have restarted, chances of a health crisis halting play are always right around the corner.

“There are significant risks here and it’s really priced to perfection,” Jonas said.