Why DraftKings Is Out of Favor Despite Its Strong Prospects

Stock Market

In late summer 2021, DraftKings (NASDAQ:DKNG) rebounded to more than $60 and looked ready to find a new high. At its bullish peak, speculators bet that the National Football League (NFL) season start would lift DKNG stock. Traders also thought sports betting gaming license wins would be positive catalysts.

Image of the DraftKings app on a smartphone screen.

Source: Tada Images / Shutterstock.com

However, gaming license delays and a dramatic shift in market sentiment toward bearishness have added risks for the sector. Fortunately, DraftKings has a strong brand name that consumers recognize. Its aggressive promotional activities will solidify its market share growth in sports betting.

DKNG Stock Is Stalling

Investors are losing patience waiting for DraftKings to win approval for operating sportsbook operations. It began the process for getting Nevada gaming licenses back on March 11, 2020.

The applications are still pending. Shareholders will need to wait for the Board to review and approve DraftKings’ gaming license. Without it, the firm cannot have the title of a national sports betting, online casino and daily fantasy sports firm.

In Florida, the launch of legalized sports betting stalled. In November 2021, the federal court made a ruling that puts an end to sports betting legalization. DraftKings and Penn National Gaming’s (NASDAQ:PENN) Barstool Sports are seeking petition signers to support adding sports betting to the Florida ballot.

The Bearish Bet on DraftKings Grows

The short float on DKNG stock is around 10%. Famed short-seller Jim Chanos disclosed his bet against the company’s stock, and Chief Executive Officer Jason Robins questioned his concerns on valuations.

Investors need not fear Chanos’ assertions. The investor bet against Tesla (NASDAQ:TSLA), saying in December 2017 that the stock was worth zero. Recently, TSLA stock traded in the $1 trillion market capitalization.

For now, Chanos is right that the excessive valuation will lead to a drop. The bad news for shareholders is that insiders sold more shares in the last 12 months than they bought. Though some of the sales are automated, this will give investors a negative perception of the DKNG stock value.

In the most bullish scenario, readers may assume revenue will grow 60% to 80% over the next five years. Plugging in those figures in a five-year discounted cash flow EBITDA Exit model, DKNG shares are worth around $11:

Metrics Range Conclusion
Discount Rate 7.0% – 6.0% 6.50%
Terminal EBITDA Multiple 23.2x – 25.2x 24.2x
Fair Value $10.82 – $11.40 $11.10

Model from Finbox

The stock’s fair value will rise considerably if readers assume a positive EBITDA sooner than the fiscal year 2022. Conversely, DraftKings may post ongoing losses and a break-even quarter starting next year. That would validate Chanos’ short position because the stock trades well above its fair value.

On Wall Street, analysts have an average price target of $46 per TipRanks. The firm may achieve that target if sports betting volumes grow in the year ahead.

The Opportunity Outweighs Risks

The NFL post-season will have strong betting volumes compared to the regular season. Even though sports betting is legal for DraftKings in limited places, it should lift its results.

Bears may justify the ongoing losses as a reason to bet against the company. Still, DraftKings’ heavy advertising spending is temporary. As its business attracts customer growth, revenue will rise. The company still risks losing customers to competitors. When it reports results next quarter, investors should look at the company’s operating margins closely.

Growing competition is a long-term risk for DraftKings. It cannot rely on rising advertising spending to grow. If customers shop for a better sports betting platform, DraftKings’ stock will face selling pressure.

A company with a weak moat has a broken business model. In the quarters ahead, DraftKings needs to demonstrate sustained revenue growth as operating expenses declined.

On Jan. 12, 2022, DraftKings said it will become the official sportsbook provider of the Oregon Lottery. This achievement will complement the company’s goal of building a top-rated online sportsbook.

Barry Pack, Oregon Lottery’s Director, said, “We see benefits for Lottery too, as the shift to DraftKings means fewer third-party service providers and a simpler financial structure for player accounts.”

This win will lift the company’s brand awareness and give it an edge over the competition. On the app store, Oregon Lottery will replace the Scoreboard app with DraftKings Sportsbook. Customers will get a better online sportsbook experience.

The Takeaway on DKNG Stock

The sports betting sector is deeply out of favor. Eventually, the negative sentiment will reverse. DraftKings needs to shrink its expenses in the quarters ahead.

Once investors grow more confident that the business is profitable, they will accumulate shares. The stock is above fair value at current levels. Investors are compensated by holding a firm belief that it is a leader in the betting field.

On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.

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