Overview
DraftKings is a digital sports entertainment and gaming company that recently became public this year. Draftkings started as a way for fantasy football players to differentiate their playing experience but has recently turned into a massive growth opportunity within the legal sports gambling business. Draftkings is creating a platform where you can have access to all the best sports betting opportunities all from the convenience of your smartphone. No more traveling to Las Vegas in order to place a bet on your favorite sports team. Not only do they offer some of the best ways to engage with sports through daily fantasy and sports betting but they also offer an online casino gaming platform for those that prefer more traditional gambling.
Thesis
Legalization
Online sports betting is relatively new, but there has been lots of progress in terms of the legalization of sports betting throughout the United States. So far, DraftKings is live in nine states for mobile sports betting and in three states for iGaming. Over time, as sports betting becomes more normalized and other states start to see the tax benefits, Draftings will be able to successfully scale up their sports betting business, which is already growing at a healthy rate despite the current limitations.
There’s no doubt that multiple sports seasons have been disrupted due to COVID-19. Many schedules have either been canceled or pushed back. This includes the NFL, which is Draftkings’ official partner. There's a chance that some of the sports schedules may get disrupted, as we’ve seen with college football, but we still believe sports will continue to be resilient and will find a way to continue. The lack of fan engagement—through people not attending sports stadiums, tailgating, and other aspects of the traditional ways we consume sports—has left a big opportunity for DraftKings, as fans are left with no way to really connect with their favorite sports team.
In our opinion, fans will turn to put money on the line to substitute for the lack of engagement with their favorite sports. Advertisers and major sports leagues are struggling to navigate the difficult landscape without in-game fans and need a way to connect with the consumer. We think they will begin to push gambling onto the consumer as this creates a network effect of sports engagement. The betting naturally incentivizes people to watch the games and has the potential to further enhance TV ratings and viewership.
DraftKings is an industry leader within the sports betting and fantasy space. They have continued to establish a unique brand that has been embraced by other media industry leaders. I’ve mentioned that they are the official partner of the NFL, but also, Disney holds a 6% stake within the company. Disney owns ESPN, which is by far the leader in sports media. With those types of connections, it wouldn’t be surprising to see ESPN start to push sports betting via DraftKings onto their viewers as sports return. Michael Jordan has also recently backed the company and has joined as a special advisor to the board. DraftKings is backed by other successful brands and are continuing to establish their own. We believe DraftKings will continue to be at the forefront of people’s minds when it comes to sports betting and fantasy sports.
There's still lots of uncertainty around the launch of sports and success of legalization in other states, but the total addressable market that is available if both of these factors can play out the way we expect is large. We believe DraftKings is best positioned to take advantage. With their deep roots within the sports and gambling industry, they have tremendous future growth ahead of them with a total gross revenue opportunity estimate of $2.9-4.7 billion.
DraftKings (DKNG): Q2 GAAP EPS of -$0.55 misses by $0.38.
Revenue of $70.93 million (+23.6% Y/Y) beats by $3.08 million.
Revenue guidance for the next quarter of $500-540 million, which equates to Y/Y revenue growth of 22-37% in 2H20.
The B2C segment, which represents U.S. product offerings of daily fantasy sports, sportsbooks, and iGaming, generated $56 million of revenue in Q2, down just 2% versus that same period in 2019.
B2C monthly unique players (MUPs) in the quarter declined 35% year on year to 295,000. More than 100% of the decline came from daily fantasy sports MUPs, which is the largest source of monthly unique players and the product offering that has been most impacted by the disruption in this sports calendar.
MUPs improved in late May and June as some sports resumed their schedules. However, ARPMUP (average revenue per MUP) increased 51% in Q2 to $63 from $42 in the same period in 2019, which was predominantly driven by a shift into the iGaming product offering.
B2B business generated $19 million of Pro-forma revenue in the quarter, down 26% compared to the same period in 2019.
“There is clearly pent-up demand that is compounded by a truly unique sports calendar. A byproduct of this demand is that we’re seeing very strong marketing response rates and return on advertising spend. And in response to these great returns, we intend to invest to expand our leadership position in the market.”
“With these launches, DraftKings is now live in nine states for mobile sports betting and in three states for iGaming.”
“Virginia and Tennessee have already legalized online sports betting and Michigan has legalized both online sports betting and iGaming. These three states account for 8% of the U.S. population. Separately, we're working together with state officials on regulations and licensing and look forward to launching as soon as possible.”
"So we expect to see with all these states that we're not live—the beginning of the next NFL shows really robust returns on our marketing spend, and you couple that with what we've been seeing over the last couple of months. First, in the pandemic, even as, you know, very small numbers of sports started to trickle back with the PGA Tour, NASCAR, UFC, all the way through the start of MLB and resumption of NHL and NBA. We're seeing record response rates and have continued to be able to acquire above our targets at lower tax. So if that is any indication of what this fall could look like, we think that coupled with the new states that are now live, the beginning of the NFL season could prove to be a really strong period for us to be able to invest in acquiring new customers."
"It's really all about customer acquisition and retention. So the fact that we're seeing such a huge response in record customer acquisition numbers this time of year, to me indicates that it's potentially creating a faster sort of race to that larger TAM simply because there are just more people that are joining the platform right now."
DFS (daily fantasy sports)
The daily fantasy portion of the business is a peer-to-peer platform in which users compete against one another for prizes. Unlike traditional fantasy sports, DraftKings allows users to pick players for one contest rather than a whole season. Users pay an entry fee for a DFS contest and compete against each other for cash prizes. DFS revenue is generated from contest entry fees from users, net of prizes awarded to users.
Sportsbook
Sportsbook revenue is generated just like at a regular casino. The house (DraftKings) sets odds such that there is a built-in margin of safety where the law of large numbers gives the house a theoretical edge. Sportsbook revenue is generated from users’ wagers' net of payouts made on user winning wagers.
iGaming
Online casino offerings typically include wagering games available in traditional casinos, such as blackjack, roulette, and slot machines. Similar to traditional casinos, they generate revenue by gross winnings minus payouts to customers.
Gaming Software
The company contracts with business customers to provide sports and casino betting software solutions. Revenue is generally calculated as a percentage of the wagering revenue generated by the business customer using their software.
DraftKings provides distributors with the right to resell the company’s software-as-a-service offering to their clients, using their own infrastructure.
There is clear pent-up demand with sports being offline during the pandemic and as they have returned, DraftKings has seen a significant uptick in the number of fans registering for contests. They highlight this in their recent earnings report.
"Top NASCAR races, which have traditionally been a new sport for us, saw similar action to popular NBA regular-season games. In golf, prior to this year, our top event of all time was the 2019 U.S. Open. Since the restarted PGA Tour, six PGA Tour events and the Match II have topped that major. In both May and June, we more than tripled our previous best month for UFC handle."
“Not only did the Yankees’ national game on the opening night set records at DraftKings, but it was also ESPN's most-watched opening night baseball game ever, and the most-watched regular-season baseball game on any television network since 2011.”
“In the first week of the NHL’s return, our handle was more than twice the handle of the first week of the 2019 NHL playoff. With the NBA, Christmas Day 2019 was our highest handle day, but four of the next five highest handle days occurred in the first week of the NBA’s return.”
Traditional casinos have been negatively affected by COVID. Many have started to reopen, but we still don’t know whether they will return to the levels seen before the pandemic. Casinos still face liability risk upon opening', and there are still many who are concerned about the virus and will not put themselves back in a high-risk environment like a casino. This directly benefits DraftKings as many who still enjoy gambling will be seeking alternatives. With the launch of their Sportsbook and iGaming platforms, you can now get the same casino games from the convenience of your smartphone once it has been legalized everywhere.
Since many sports have been delayed, there is now a concentration of a lot of sports towards the back half of the year. This could set up DraftKings for a great Q3 and Q4 as the NFL, NBA, NHL, MLB, and PGA are now overlapping each other in a rare concentrated sports calendar year.
One of the biggest risks to DraftKings is the potential for the NFL season to be canceled or pushed back due to COVID-19. There remains some uncertainty, but so far the NFL has handled positive tests pretty well with the rescheduling of games where players have tested positive. Still, the NFL is DraftKings’ most popular sport, and they are anticipating significant user engagement as this is their first-ever NFL season with the launch of their Sportsbook app. Any pushback of the season or mid-season cancelation could result in depressed revenue due to a lack of user engagement.
Another risk associated with DraftKings is their dependency on state legislation in order to scale their business. They’ve had some success with many states, but the Sportsbook and iGaming are still only available in a limited number of states. This puts some limitations on how much they can grow these offerings and it creates a situation where the ability to expand is outside of their control.
Unlike a lot of the companies we cover, DraftKings is not yet profitable. This makes it a lot harder to justify the current valuation given their inability to create actual earnings. To gauge what the company is currently worth, we mainly have to use the top-line growth of revenue to come up with a multiple. Looking at the last 12 months, DraftKings has been trading at 82.5 x EV/revenue. This is an extremely high multiple given the industry standard and some of their competitors. The argument can be made that some of their revenue has been pushed back due to COVID-19, and while the sports schedule begins to return to normal, DraftKings will have to grow into this multiple as they expand their products and revenue growth.
DraftKings is a bit different from the traditional companies we look for. Usually, we look for companies that have already established themselves and proven the ability to generate earnings and produce consecutive quarters of revenue acceleration, gross margin expansion, and high levels of return on equity, but—unlike some of our other holdings—we think DraftKings offers an attractive competitive advantage over the traditional casino offerings.
With the impact of COVID and the increased adoption of sports betting in the United States, we believe DraftKings will continue to be a leader in the category for years to come. They continue to expand their offerings, and while the sports industry is desperate for fan engagement, we believe DraftKings is best positioned to take advantage of the pent-up demand for sports.
While they have faced some short-term headwinds in terms of engagement, they have a lot of favorable catalysts going for them if they can continue to execute on their daily fantasy, Sportsbook, and iGaming platforms. As long as the concentrated sports schedule continues to remain on track, DraftKings should be able to generate impressive top-line growth while continuing to scale their offerings as more and more states legalize online sports betting.
We do acknowledge that this is more of a bet on the future and understand the volatility and drawdowns that may occur on account of the uncertainty of sports. We are comfortable with our position as long as there is no deterioration in the investment thesis, which includes revenue acceleration, an increase in MUPs, an increase in ARPMUPs, and rapid adoption of the Sportsbook and iGaming offerings.
Engagement
Industry Position
(Graphic provided by DraftKings Earnings Presentation Slides)
Total Addressable Market
(Graphic provided by DraftKings Earnings Presentation Slides)
Earnings Highlights & Financials
