Right now, the market is piling its bets on rebound pays – stocks that will do well once a vaccine is widely distributed and the economy largely goes back to normal. One stock that remains ~25% down from all-time highs and is heavily tethered to a broader economic recovery is DraftKings (DKNG), the leading online sportsbook operator and pioneer in daily fantasy sports. I was fortunate to add a position in DraftKings in the low $40s, and as we continue to see the benefits of major sports returning plus the expanded territories in which DraftKings can now legally operate, I think the stock is building up substantial momentum to outperform the market dramatically in 2021.
DraftKings has seen a wild roller-coaster ride of trading since mid-summer, but investors would do well to refresh themselves on the key bullish drivers for this stock heading into 2021:
- Pent-up demand for sports. With spring and summer almost entirely devoid of the sports that we love (in the time when we probably needed the distraction the most), the packed sports calendar for fall/winter is bound to drive upside in viewers and engagement.
- Expanded territories driven by additional legalizations. As I wrote in my prior article on DraftKings, the company operated in states representing only around ~14% of the U.S. population in 2020. By the end of 2021, driven by additional legalizations, analysts expect that coverage to expand to 35% of the U.S. population. Many major states, like California, are still holdouts – creating a huge greenfield opportunity for growth down the road.
- Best in breed. DraftKings remains the #1 brand in sports betting, driven especially by the long list of top-tier partnerships it has notched. A non-exhaustive list: DraftKings is the exclusive sports book partner for ESPN and Turner Sports. It is also the official partner of the PGA (golf) and the MLB (baseball).
In my view, DraftKings remains in the early stages of a burgeoning sports betting, fantasy sports, and online casino gaming market. Another major thing I like about DraftKings is the fact that it has something for everyone: DraftKings’ portfolio covers virtually every major sport, plus a variety of non sports-related revenue streams like operating national lotteries and iGaming. The cooldown in share prices since their September/October peaks gives investors a good chance to load up on shares at a discount, especially heading into a 2021 that has many bullish catalysts to propel DraftKings forward.
Q3 download: driven by resumption of many major sports, DraftKings bounces back into growth mode
Let’s now review DraftKings’ latest third-quarter results in greater detail, which show DraftKings firmly getting back on its feet after a first-half that was challenged due to the drought on the sports calendar.
DraftKings’ revenue grew 42% y/y to $132.8 million on a pro forma basis, which includes the revenue from the SBTech subsidiary it acquired in mid-2019 in the prior-year comp. This was ahead of the $131.4 million (+31% y/y growth) that Wall Street had expected, and a major improvement versus a -10% y/y revenue decline in Q2.
As evident from the sharp snap-back in DraftKings’ results, the company is heavily dependent on the availability of sports to drive user engagement and generate revenue. Thankfully for the company, basically all major sports have been revived heading into both Q3 and Q4, and the fact that A) many of us still remain cooped at home in the U.S. due to broad lockdowns across many states, and B) the lack of sports and other forms of entertainment in the first half of the year, have created strong pent-up demand for sports and services like DraftKings which create a far more immersive fan experience.
The resumption of the sports calendar has led to a dramatic increase in DraftKings’ user counts. Its primary metric, monthly unique payers (“MUPs”), defined as any user that had a “paid engagement” such as engaging in a real-money daily fantasy contest or making a direct sports bet, saw 64% y/y growth to 1.02 million users.
Jason Robins, DraftKings’ CEO, made optimistic comments about continued fundamental recovery on the Q3 earnings call:
First, our Q3 performance confirms what we foreshadowed on our previous earnings call. The return on major sports has generated tremendous customer engagement […]
We are optimistic that sports will continue to be played and believe any disruptions will be short-term in nature and not impact the long-term prospects of the sports gaming industry or our competitive positioning. Looking ahead to 2021, we are likely to see another unique sports calendar with the NBA and NHL expected to kick off their season either later this year or early next year as compared to their typical start dates in October.”
But it wasn’t just continued normalization from the depths of the coronavirus that drove DraftKings’ growth. The company also continues to enjoy tailwinds from the opening of new territories. In Q3 alone, DraftKings began iGaming (casino game) operations in West Virginia, and it also launched sports betting operations in Illinois (roughly 4% of the U.S. population).
Illinois merits further highlights. As reported by Seeking Alpha, sports betting in Illinois has ramped up extremely quickly – in the month of September, total bets tallied up to $305 million, making it only one of four states to reach the >$300 million threshold, and so quickly after legalization earlier this summer. Monthly handle more than doubled relative to $140 million in August, suggesting rapid month-over-month growth. This data cements DraftKings’ thesis that once a state legalizes, there’s enough pent-up demand in that market to scale the business incredibly quickly.
Q4 will bring another state launch – Tennessee (~2% of the U.S. population) went live on November 1, making it the tenth state in DraftKings’ sports betting portfolio. The company is also actively working with officials in Virginia and Michigan, which recently legalized sports betting, to launch operations as soon as possible.
In acknowledging the momentum in its underlying business, DraftKings also guided to FY21 revenue: guiding to $750-$850 million in revenue, representing 45% y/y growth at the midpoint versus FY20’s midpoint revenue guidance of $550 million. Note that this guidance midpoint is well above the $770.5 million (+40% y/y) that Wall Street had called for.
Valuation and key takeaways
DraftKings has a lot of momentum heading into 2021, driven by the opening up of additional markets (especially large ones like Illinois) plus the resumption of the sports calendar. We can already see the impacts of pent-up demand in DraftKings swift recovery from -10% y/y revenue declines in Q2 to 42% y/y revenue growth and 64% y/y user growth in Q3.
There’s no doubt that DraftKings, despite the recent selloff, remains at elevated valuations. At current share prices near $48, DraftKings has an $18.96 billion market cap, and after netting off the $1.14 billion of cash on its balance sheet, DraftKings’ enterprise value is $17.82 billion. This represents a fairly hefty 22.2x EV/FY21 revenue multiple, versus the $800 million midpoint of the company’s FY21 guidance range. Considering that DraftKings’ gross margin is currently still low (27% of revenue on a GAAP basis in Q3), this is undoubtedly an elevated multiple.
However, in my view, I’d recommend taking near-term valuation multiples with a grain of salt for DraftKings given A) the rapid growth the company is seeing; the ~45% y/y growth that the company is guiding to in FY21 is likely to be overachieved, and B) the fact that DraftKings is still sitting in the early stages of a massive market. Investors’ focus is far more on the development of DraftKings’ story and its growth trajectory rather than near-term valuations. From that regard, it’s a good move to buy DraftKings on the upswing while it’s still down from all-time highs.
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Disclosure: I am/we are long DKNG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.