DraftKings Combination of High Marketing Costs, Lofty Valuation Concerning, Say Analysts

Posted on: September 8, 2020, 12:28h. 

Last updated on: September 8, 2020, 01:39h.

DraftKings (NASDAQ:DKNG) is a prime example of a stock in the limelight, as the US sports betting market rapidly expands this year. But some on Wall Street are concerned about the familiar issues of costs and valuations.

Jason Robins DraftKings
DraftKings CEO Jason Robins seen here in 2016. Some on Wall Street are concerned about the company’s marketing costs and frothy valuation. (Image: Vox)

DraftKings went public in April via a reverse merger with a special purpose acquisition company (SPAC). Immediately after, shares climbed higher, thanks to investors willing to wager on sports wagering growth.

Year-to-date, the name is higher by almost 246 percent. But the market in which DraftKings operates is hyper-competitive, and capturing share won’t come cheap, renewing concerns about the company’s time line to profitability.

Based on the recent events and efforts by the company, we conclude that the Street’s near-term profitability estimates are likely too high, particularly for the remainder of 2020,” said Jefferies analyst David Katz in a note to clients today.

The analyst cites costs incurred by DraftKings to enter new markets this year, namely Colorado, Illinois, and Michigan.

Industry observers believe all three will be lucrative areas for sportsbook operators, and data out of Colorado confirms as much, But costs to enter new arenas reminds investors that there aren’t any free lunches with DraftKings and other sports betting equities.

It Costs To Be King

In the second quarter, the daily fantasy sports (DFS) company reported a loss that was far wider than the year-earlier period, with customer acquisition costs playing a major role in that scenario. However, DraftKings forecast 2020 revenue of $500 million to $540 million, implying second-half growth of up to 37 percent.

While analysts and investors cheered the revenue estimate, costs to lure new clients is an issue that’s not going away anytime soon for DraftKings and its rivals. Not when more states are mulling the legalization of iGaming and sports betting. In a bid to grab share, DraftKings and competitors are essentially saying they’ll attempt to procure licenses in each new market that opens. That’s an expensive endeavor, but it’s essential for early-stage companies to generate growth.

“While marketing spend is increased, we expect this is necessary in the initial stages of an increasingly competitive landscape,” said Katz. “We remain confident in the forthcoming size of the digital wagering market, and in brands, technology, and management execution to outperform, with debate around valuation far less relevant.”

The Jefferies analyst forecasts 2023 as the year in which DraftKings will turn positive on the basis of earnings before interest, taxes, depreciation and amortization (EBITDA).

Shift into Neutral

While Katz says DraftKings’ multiples are becoming less relevant, not all of his colleagues agree. In fact, valuation is an oft-cited concern with this stock.

“Even when compared to ultra-high growth consumer ‘disruptors’ (Tesla, Peloton, Beyond Meat, Virgin Galactic), DKNG trades at a +75%/+40% premium on 2022E/2025E sales despite having similar long-term growth,” writes Bank of America analyst Shaun Kelley.

He initiated coverage of DraftKings today with a “neutral” rating and a $40 price target, which implies 6x the 2025 enterprise value estimate.