| 2023 | 2024 | ||||||
| Price: | 25.98 | EPS | 0 | 0 | |||
| Shares Out. (in M): | 455 | P/E | 0 | 0 | |||
| Market Cap (in $M): | 11,823 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | 164 | EBIT | 0 | 0 | |||
| TEV (in $M): | 11,987 | TEV/EBIT | 0 | 0 | |||
| Borrow Cost: | General Collateral | ||||||
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Summary / Thesis Overview
The legalization of sports betting and online casino in the US brought many to the party, resulting in a “familiar” blitz-scaling musical chairs scenario – multiple operators vying for a few scaled share positions, results in everyone racing to acquire customers while investors are willing to provide the funding before the music stops, valuations fall, investors start expecting a return on their investment, and self-funding (i.e., showing a profit) is required for survival. Sometimes, burning billions of investor capital is how winners are created. At this point, while still in very early days of legalized gambling in North America, it appears that the initial phase has been completed and a surviving cohort of operators has emerged - leaving behind heaps of competitive roadkill - and with the environment far more rational for chasing ~$40B+ in domestic TAM going forward.
Now that the music has stopped, four primary operators - DKNG, FD, BetMGM, and CZR – have emerged, controlling >80% of online sports betting (OSB) handle between them in effectively every state they operate in. In addition, an “honorable mention” goes out to a handful of others with region-specific strength (RSI) and/or well-capitalized staying power (PENN, Fanatics) bringing up the rear on a national level. While the iGaming market is harder to quantify accurately given minimal legal states (6) and the lack of operator-specific disclosures across all of them, there is a similar dynamic here, with the top 3-4 operators controlling the vast majority of the market. As such, at this point the dialogue has largely turned away from scaling share and more toward conversations about breakeven / achieving profitability, self-funding, and long-term margin targets.
And yet, with that first leg largely completed and the landscape far more rational, one operator does not look like the others. While most of these “final cut” operators (FD, BetMGM, CZR, PENN, RSI) are expecting breakeven-ish results or better over the coming year, DKNG is still running quite bloated, pushing their breakeven targets out to 2024, despite #2 share position nationally. Similarly, while everyone is seeing meaningful improvements in hold rates (% of customer wagers kept by the operator) – including DKNG - from the increasingly rational promotional environment, DKNG’s rates on an absolute level remain well behind competitors, despite significant product investments.
Both of these issues were more easily “handwaved” during the blitz-scaling phase but are starting to stand out more meaningfully as expectations of reaping those early investments come to the fore, sewing seeds of doubt regarding DKNG’s ability to manage their platform and/or hold on to customers without meaningful “pricing” incentives (or both). As the dust begins to clear, it appears that DKNG has a monetization problem, wherein the company’s fundamental gross/net splits ($ wagered vs. house take) are poor, which is meaningfully problematic when the cost structure and customer acquisition effort are built around gross volume vs. net take. Further, as growth begins to slow near-term (minimal new state legalizations expected over next 1-2 years) and some players (PENN, Fanatics) make a “second wind” push for market share that likely disproportionately aims at DKNG, deficiencies in cost structure and scaling hold rates leave DKNG with minimal room to defend its turf.
As a result, DKNG is setting up to hit a wall (positive revisions to negative EBITDA doesn’t equal positive absolute EBITDA) absent several new state legalizations in 2024 and/or a perfectly-executed overhaul of their cost structure by a management team that has yet to show that they possess such skills in their tool box. With Fanatics and Barstool/PENN expected to make an OSB push starting with the upcoming NFL season, a lot of DKNG’s under-the-hood issues may come to the forefront faster than the company can potentially grow out of, if that’s even possible.
Company Overview / Background
DKNG is a pure-play, vertically-integrated online gaming (as in gambling, not video games) operator, providing daily fantasy sports (DFS), online sports betting (OSB), and interactive casino (iGaming or iCasino) under the Draftkings and Golden Nugget Online brands. DKNG was founded by Jason Robins (now Chairman and CEO), Matt Kalish (now President of North America), and Paul Liberman (now head of product and technology) in 2011, focusing on DFS, before moving into OSB and iGaming upon legalization in the US. DKNG operates its own technology stack (originally via the acq of SBTech) and is primarily focused (for now) on the North American market.
Without getting too deep into the history, DKNG and FanDuel (“FD”; owned by LSE:FLTR) emerged from a crowded DFS field to create a duopoly (~60/35 split favoring DKNG, with the other 5% “others”), that both operators leveraged into a first-to-market advantage in aggressively scaling up in the nascent US legalized gambling market. DKNG's expansion strategy for OSB has mirrored its DFS playbook - aggressive capital outlays for customer acquisition and territorial expansion. DKNG has been the first operator (or among the first group of operators) to launch in every state they operate in (which is every state of consequence). In addition, DKNG has led (sometimes with consortiums) legal battles for legalization in CA and FL (and other states), sacrificed economics for pole position in several scenarios, including NY, CT, and OR, and has pursued aggressive M&A to add capability on the fly (including the acq of SBTech as part of a 3-way SPAC deal to go public, the acq of GNOG, and the ultimately abandoned pursuit of LSE:ENT).
Today, DKNG is one of the primary operators in a rapidly consolidating field (more on this below). DKNG currently operates in 22 states plus Ontario, with more coming (PR in 2023) and has the number-1 or number-2 share of OSB handle (total bets placed) and/or win (raw pre-tax take of total bets placed, aka gross gaming revenue or "GGR") in every state they operate in. Additionally, DKNG has a strong position in iGaming as well (despite its heavily male, heavily sports-associated brand), though there are other challengers here (most notably BetMGM). Overall, DKNG is the number-2 overall share holder in the US legal online gaming market, behind FD/FLTR, but nicely ahead of everyone else.
Key Thesis Points
1) Bloated cost structure
Primary points:
Gaming operators are currently working in an in-between state of proving out the ability to achieve and scale profits/margins, while not being expected to hit target maturity margins tomorrow. In the near-term, this has allowed DKNG to “earn points” for positive revisions to EBITDA guidance over the last 2 quarters and hitting positive incremental EBITDA margins over the last 3. However, taking a slightly longer view, DKNG’s cost structure is clearly problematic and the “positive revisions” will hit a wall absent material changes.
To be somewhat fair, there aren’t great like-for-like comparisons given the dearth of full US financials from scaled operators, so it’s difficult to single out a specific issue relative to others. However, at a basic/simple level, the magnitude of DKNG’s EBITDA losses / cash burn stands in stark contrast to its peers, especially when considering DKNG’s level of scale and the maturity of their operation and participation. Other leading operators - FanDuel (FLTR), BetMGM, CZR, PENN, and RSI - all expect to be breakeven or better in 2023, whereas DKNG is still expecting ~$300M+ of EBITDA losses in 2023 and won’t hit breakeven on an annual basis until 2024. The figure from DKNG is after a formal cost-cut / restructuring effort announced in February 2023 to cut 3.5% of the workforce.
Given that DKNG’s peers encompass different focuses, it’s hard to give DKNG the benefit of the doubt of having some other/different operating profile - DKNG compares quite poorly vs. smaller operators, larger operators, those focused more on iGaming, and those more tilted toward sports, those with smaller geographic footprints, and those with national footprints. Effectively any way you cut it, something is off throughout the cost structure. While any one issue enumerated below may not be comparable across the bulk of surviving peers (again, given lack of full financials from everyone), the totality of the issues are concerning with regard to DKNG’s ability to scale profits efficiently.
Starting from the top, DKNG’s GM% for 2022 was 34%, down from 39% in 2021 and 44% in 2020. The largest factor in GM% is state taxes, so having a high volume of GGR coming from a high-tax jurisdiction (e.g., NY) will color GM%. But FanDuel is operating in the same high-tax jurisdictions as DKNG and at comparable volume and timeline, yet running GM% >1,500 bps higher (50% GM for FLTR US in 2022). PointsBet – who also in-houses the entirety of their tech stack – is running at ~40% (though presumably higher in Australia vs. US), while RSI’s GM% is comparable to DKNG (consistently low-30s), despite outsourcing their OSB stack to Kambi and operating at a fraction of the scale (RSI had $540M in 2022 US rev vs. $2.2B in DKNG US rev).
While some degree of tech stack costs roll through cost of revenue, DKNG actually splits those costs out on the opex line with a “product and technology” line item that many others don’t have (e.g., both FLTR and RSI break out opex as “sales & marketing” and “G&A/other”), and DKNG’s expense line items compare worse than GM% (i.e., no matter where the bulk of tech stack costs are going, all line items compare poorly). Put another way, it’s bizarre that DKNG’s GM% is meaningfully below FanDuel and comparable to low-scale peers, given the scale of DKNG’s operation, ownership of their tech stack (fixed cost vs. scaled rev), and some portion of that tech stack costs rolling through the opex line instead of cost of rev.
The recently-announced cost reductions/RiF aimed at international personnel is a hint in this direction – DKNG’s tech stack is by way of their SBTech acquisition, which was based abroad. While there have been noted issues with some of the legacy B2B business from SBTech, DKNG has largely wound that down. Certainly, the reductions abroad could easily be associated with exiting the B2B business, but there’s a good chance it includes some aspect of trying to improve the operating efficiency of their internal tech stack operations. If DKNG’s internal product and tech operations are structurally higher cost than competitors, DKNG would be materially disadvantaged over the long-run. Moreover, for a company looking to differentiate on product (as DKNG professes to do), cuts to the product side seem counterintuitive.
Of course, several other factors could be in-play here as well – DKNG pays for market access everywhere it operates, DKNG’s jurisdictional mix may be poor next to comparable peers (i.e., NY and PA as a % of total handle), and DKNG’s heavy promotional tactics could be making certain jurisdictions effectively GM%-negative more so than peers with comparable mix of handle. None of these come out as positives for DKNG. Conversely, explaining away the GM% delta to FanDuel on product mix (OSB vs. iGaming), scale of operation, maturity of operation, doubled-up expenses from GNOG (not-yet fully-integrated), and / or fully-expensing in-house tech costs (whereas others can share that cost with a global operation) don’t stand up well when considering both the size of the gap with FanDuel, how early DKNG was (first-to-market everywhere), as well as the GM% and/or EBITDA% levels of other, smaller scale peers.
If there is a reasonable explanation for DKNG’s GM% deficiency, it’s hard to unify that view with the bloat in DKNG’s expense lines. Certainly, DKNG’s sales and marketing expenses have been quite high. However, to be fair, that is likely the most easily “handwaved” expense line – its higher than peers but fits DKNG’s narrative of making big top–of-funnel push upfront and optimize over time (CZR did the same thing, on a much smaller scale, to great success already, taking a near-term hit to get a large volume of customers into the funnel before separating out profitable customers based on user behavior data). The bigger complaint on customer acquisition is that both S&M is very high AND hold rates are low on an absolute basis, indicating DKNG is buying both its acquisition and retention – the hold rate issues will be discussed further below as it warrants its own section of discussion.
Arguably more concerning in terms of being “out of narrative” is DKNG’s astronomical G&A expense line. DKNG’s GAAP (i.e., including SBC) G&A intensity (as a % of rev) was 34% in 2022 - $763M overall – down from 64% in 2021. FLTR hasn’t been over 28% since 2019 and was 22% last year. RSI is at ~11%. Why is a company with >$2B in revenue running G&A% that high? If backing out SBC (though not all of it is attributable to the G&A line) the numbers look more manageable, but still quite high. For 2023, DKNG guided SBC to “less than $400M”; that’s still 10-13% of revenue on what will be a $3.2B rev base and implies a G&A line >20% (inclusive of SBC). It’s difficult to understand what is going on there (other than having too many heads and/or paying themselves too much), especially considering that many peers don’t even have a separate product/tech breakout and just roll it in to corporate G&A or cost of rev. The associated dilution has been wild – fully diluted shares were +13% y/y in 1Q23 and is the fourth consecutive quarter of share growth accelerating y/y.
To review – DKNG is the only premier operator still burning heavy cash in 2023 and is running average-at-best GM%, a bad combo of high marketing expenses and low hold rates, and astronomical G&A / SBC, despite being early, vertically-integrated, and scaled (at least relative to the field). It’s hard to find a unifying theory of DKNG that explains all of these issues in a neutral (let alone favorable) sense. While many of DKNG’s peers have “help” by being part of a larger organization better able to absorb fixed overhead (either via brick-and-mortar casinos and/or a global online footprint), the contrast is stark – everyone else of note is expecting to be breakeven or positive this year, most of whom are quite smaller than DKNG, but also their largest (and larger) competitor.
The more likely unifying theory of DKNG is that there is a cultural issue with the leadership team, whose skill set favors blitz-scaling and product, but lacks efficient operational management. Looking at the history of DKNG, back to its DFS days, management has done a great job in marketing and product, where the aggressive spending tendencies of the founder team have generally worked in DKNG’s favor. Even back when they were only a DFS-only company, DKNG never turned a profit, preferring to spend first and ask questions later – DKNG rose to the top of a crowded DFS landscape by essentially acquiring major competitors and marketing aggressively. The pre-2019 financials (DKNG launched OSB in NJ – its first launch – in August 2018) published in the original prospectus show that the DFS-only DKNG wasn’t profitable either, despite the market plateauing well before OSB came into the picture (2017 rev for both DKNG and FanDuel was essentially flat; DKNG burned $49M of EBITDA in 2017, with G&A still high at 29% and S&M comprising 82% of rev, on a much higher GM% in DFS of >80%).
Certainly, the public markets have been helpful in financing much of DKNG’s expansion on both the customer acquisition and product development side, which has been able to paper over whether management has ever possessed “efficient growth” as a skillset in their toolbox. Given Jason Robins’ voting control, it is unlikely that he will leave the CEO chair involuntarily, but driving DKNG toward its long-term target margin may require a different, more operations-focused manager with a better feel for managing spending against growth.
Ultimately, this will come to a head. OSB handle growth has already slowed considerably and is effectively mature in states legal for 2+ years. Vast majority of topline growth for the industry over the last few quarters and for the rest of 2023 is coming from increases to hold rate from a less promotional environment, the few new states that have come on recently, and more structural growth in the iGaming market. Ultimately, DKNG will have a hard time growing out of their problem without further cuts to their expense structure. Even in the event that a few new states come online over the course of 2024, running negative on the excuse of new state openings when everyone else is in the black is not going to be a good look. Maybe they can do it cleanly, but the range of outcomes favors either not making further expense cuts, making them too late (e.g., after getting punished by the markets for lack of it), or potentially cutting bone vs. a perfect harmony of pure fat cuts while not impacting the business, all executed by a management team that has never operated in a cost-efficient manner.
2) Poor hold rates are a red flag
Primary points:
A basic measure of a gaming operator’s monetization ability is hold rate – the % of a customer’s wager that the house keeps. In a basic 50/50 sports bet (spread or over/under bet), the line is typically quoted at -110, which means a bet of $110 will win $100. From the sportsbook’s perspective, an even amount of bets on either side at -110 yields a hold rate of 4.5%: both sides wager $110 = $220 in total wagers; one side is going to win $100 + their principle = $210 in payouts, with $10 being kept by the sportsbook. $10 / $220 = 4.5%. Similarly, a casino game that favors the house with a 51% rate of victory yields a 2% hold rate (100 bets of $1 each would have the house win $51 but pay out $49 = $2 on $100 of total wagers; in casino games, the term of art is usually “win” rate, as opposed to hold rate).
While hold/win rates on the casino side are fairly fixed per game, sportsbook hold can vary more meaningfully based on the type of bet, similar to how bid/ask spreads in securities vary based on liquidity - the more vanilla and liquid the bet, the lower the hold (remember – sportsbooks are market makers, not risk-takers; their goal is to balance their book and clip the “vig” or hold, so greater liquidity on both sides of a bet allows for lower hold given lower book risk). This is a big reason why sportsbooks push to increase the breadth of their betting menu, both in terms of prop betting, as well as live/in-game and parlay bets – props, parlays, and live/in-game price at a far greater hold than more typical spread, money-line, and over/under bets. If a book does a good job pricing their bets, the higher hold bets come at only moderately higher book risk and results in better monetization for the same customer acquisition cost.
As a result, the aggregate hold rate of any given operator is largely driven by 3 factors: 1) proficiency of managing a sportsbook (pricing bets correctly, managing liability/exposure to one side of an event, accurately identifying “sharps” vs. “whales”, and adjusting prices accordingly, etc.); 2) mix of bets (vanilla bets vs. more “exotic”, higher hold bets); and 3) pricing strategy (i.e., if a given operator is willing to accept a lower hold in order to have a better “price”, with the downside of lower monetization per acquired customer, which impacts LTV/CAC ratios). Put another way, hold rates are the result of an operator’s skill at managing a book, quality of product, and ability to/methods of attract(ing) and retain(ing) customers.
In the earliest of innings in US online gaming legalization, hold rates on OSB were quite low. This is typical for any new market – operators typically start with more simplified bet menus at attractive promotional prices, while having minimal to no data on the new customers that are being aggressively acquired, thus skewing risk and liability profiles for the overall book relative to long-term norms. As expected, hold rates have grown meaningfully since those earliest of days. In fact, while same-state handle/wager growth has slowed down meaningfully, most operators are still showing strong growth rates y/y, almost entirely due to increases in hold rate from a combination of the factors cited above (less promo pricing, improvements to product/betting menu, better management of meat-and-potatoes sportsbook ops).
Indeed, looking at the state-by-state data, hold rate on an LTM basis ending March 2023 was 8.9% for the overall market, an increase of ~220 basis points from that same measure in December 2020, with the improvement linear on a month to month basis. Similarly, looking at a 10 state sample (NY, MI, PA, CT, AZ, IL, IN, MA, MD, OH) that accounts for ~60% of the market and breaks out data on an operator-specific basis, the average hold rate increased from 7.1% to 9.4%, with every operator – including DKNG – participating in that improvement.
However, while DKNG has improved with everyone else, their hold rates remain well-below peers and the market average. In that 10 state sample, DKNG’s LTM hold rate in December 2020 was 5.8% (vs. the average of 7.1% cited above); in March 2023, that figure is 7.7%, vs. FLTR at 12%, BetMGM at 9.2%, the sample average at 9.4%, and the average of “longer-tail” operators (i.e., anyone beyond FLTR, DKNG, CZR, and BetMGM) at 8.4%. The only “major” operator with a worse absolute hold level is CZR (6.6%). Not only is DKNG well-below, but the gap with peers has widened over time, despite a consolidating market and DKNG’s heavy focus on product (broad betting menu, first to market with live in-game parlay for NBA, etc.).
Thus, as referenced above, 1-3 factors are compressing DKNG’s hold rates relative to the market – either DKNG has an adverse mix of vanilla/non-vanilla bets, DKNG is not very good at managing the operations of a sportsbook (bet pricing, risk management, book liability, etc.), or DKNG is purposely suppressing hold rates as a promotional tool for customer acquisition/retention purposes. Based on DKNG’s commentary on earnings calls and presentations, management would have you believe that the primary factor in DKNG’s lower hold rates is bet mix, but the data points to the opposite and this is generally counter to other commentary provided by management.
From a commentary perspective, DKNG has been touting its product leadership for a while, certainly with regard to betting menus, same-game parlays, and live/in-game betting (including live same-game parlay). While talk is cheap, certainly anecdotal experience backs up DKNG’s commentary – the betting menu and both in-game and parlay-focused promos and advertising are significant at DKNG, rivaled only by FanDuel (and Bet365 in certain areas). Certainly, DKNG’s leadership in certain betting types (first to market on live same-game parlay for NBA) would imply a better-than-average aggregate hold rate, all other factors being equal.
More importantly, from a hard data perspective, the issue does not appear to be bet mix at all. The state disclosures in IL are quite intriguing in this regard, where, as opposed to other states, IL’s disclosures include bets by sport and parlay at the operator level. In IL, FLTR leads the pack in parlay bet mix, with >70% of their bets and >30% of wager dollars being parlays. Fittingly, this corresponds to FLTR’s leadership in hold rate, which is running in the ~12% range, broken down to ~25% hold rate on parlay bets and ~5% on non-parlay. After FLTR, DKNG has the next-highest parlay mix, with ~55% of bets and ~25% of wager dollars being parlays. However, hold rates for DKNG are ~7% overall, split between a 4% hold rate on “vanilla” bets (vs. state average of 5%) and 15-16% on parlays (vs. state average of 20% and most other peers at 16-17%). If IL is anything of a proxy for the rest of the country, bet mix isn’t the problem at all, but rather some combination of pricing and book management.
As a result, it appears that either DKNG is just not very good at the meat-and-potatoes of running a sportsbook or still feels the need to utilize pricing as an acquisition/retention tool (while others have been able to wean off pricing and retain customers through other, more leverageable means), or both. Regardless of which, they both feed into the cost issues cited above – if being generous, DKNG’s cost structure is workable in the context of their aggregate wager volume, but they are under-monetizing due to structural issues. If not being generous, DKNG has spent their way to the top on the backs of shareholders, papering over subpar talent/competency/capability with regard to in-the-trenches aspects of managing an online gaming business, including sportsbook operations and general corporate operational excellence. Put another way, either the need to fix hold rate/monetization and grow their way out of their cost issues, or they can’t even grow their way out and they need to both cut costs and improve monetization. Either way, it’s not a good look and will eventually come to a head as DKNG will have a difficult time driving sufficient operating leverage off their existing cost structure and monetization rates, in addition to leaving them susceptible to competitors over the long-run.
3) Most Vulnerable To Upcoming 2nd-Leg Pushes from Other Premier Operators
Primary points:
While the above noted issues are long-run problems, they will likely come to the fore in the next 6-12 months as a result of second-wave pushes from two well-funded OSB-focused operators who will likely threaten DKNG more than others. As noted above, DKNG appears to have major deficiencies in cost structure – both under-the-hood structure as well as customer acquisition – as well as monetization/hold rate. This is a long-term problem for sure, but will become a near-term issue when DKNG tries to fend off a fresh round of OSB-specific competition around the start of the upcoming NFL season, while also trying to show the ability to scale profits and achieve breakeven.
The most immediate threat comes from PENN’s Barstool Sportsbook, who has been waiting for the market to rationalize, as well as fully prove out and test their in-house-built tech stack. PENN’s online strategy (specifically the OSB angle) has been built around 2 acquisitions over the past 3 years – Barstool (fully acquired in 2023, but initial 36% investment was in Jan 2020) and TheScore (August 2021). Barstool is well-known as a media/content site and organization, largely aimed at sports and the young male demographic, which overlaps heavily with OSB demographics. TheScore is a Canadian-based sports content app, mostly focused on live sports scores, stats, etc. (like ESPN or Yahoo Sports without the editorials; personally, when I want to know the score in the Knick game, my go-to is TheScore app).
When PENN acquired Barstool, they made an initial push on OSB but then largely pulled back. What PENN had realized early on was that lack of ownership over their tech stack was significantly limiting in utilizing the Barstool brand and content machine to drive the product and experience. As a result, they acquired TheScore, who was building a fresh OSB and PAM platform from scratch. The plan was to wean off of Kambi’s platform when TheScore finished building their internal system, roll it out in Canada over 2022-23, and then port it over to the US for the 2023 NFL season, hopefully fully-tested and validated in Canada. In the meantime, PENN management pulled back on customer acquisition, given the waste of throwing money after a product that wasn’t ready for prime-time. This allowed PENN to scale up their digital business at a more slow-and-steady, respectable-but-profitable pace.
The early returns out of Canada have been quite good. PENN management has updated investors on progress every quarter and TheScore Bet is doing quite well on its organic platform, with everything on track for the US roll out (under the Barstool brand) just prior to the start of the 2023 NFL season. PENN has been clear that they expect to “turn on the juice” in terms of marketing/customer acquisition with the launch of the new platform (e.g., they conceded their achievement of profitability may revert the other way based on the marketing push in late 2023 and 2024). The Barstool angle on OSB should be in direct conflict with DKNG, both brand-wise, but also where share is available to take – DKNG is the 2nd-largest share holder in OSB with customer base demographics that heavily overlap with that of the Barstool content consumer. This is exactly who PENN is going after.
Beyond PENN, Fanatics is also expected to make a sports-focused push starting with the upcoming NFL season. Fanatics is an extremely well-funded private company that already dominates sports apparel and collectibles and has excellent relationships with the major North American sports leagues – Fanatics runs all the online merchandising for all major US sports (if you buy a Boston Celtics replica jersey or Kansas City Chiefs hat online, its coming from Fanatics). In 2021, Fanatics did a $320M funding round (valuing them at $18B, followed by another $1.5B in 2022, valuing them at $27B) to make a push into creating a broader “digital sports platform”, including NFTs, OSB, ticketing, and several other sub-verticals. As part of this, Fanatics has been developing a sports betting platform for ~2 years and has secured licenses in several states (including NY) ahead of their general availability launch (Fanatics betting is in beta in a few states right now). Most recently, Fanatics announced it would be acquiring PointsBet’s North American business, with source code access to its tech stack, which would both further the development of Fanatics’ tech stack, as well as gives them an immediate 2-5% market share in most legalized OSB states.
While every “primary” operator has their own angle, DKNG is specifically sports-led. FanDuel is a sports brand, but one of several brands held by FLTR, some of which are iGaming-focused (e.g., Poker Stars), thus protecting their customer base by way of demographic diversification. BetMGM and CZR are casino brands (obviously). Even PENN has an obvious casino angle beyond Barstool given their core brick-and-mortar casino roots. DKNG is the only primary without some organic non-sports angle, which is what led to the GNOG acquisition in the first place (Robins said explicitly that DKNG was looking for a casino brand that could diversify DKNG’s demographics). This leaves DKNG most vulnerable in the near-term – while the environment has largely rationalized, 2 sports-focused, well-capitalized operators are going to be hunting for share starting the end of Q2 through the end of the year, with heavy demographic overlap with DKNG. More importantly, as opposed to other operators, DKNG doesn’t have another angle to fall back on, nor the margins nor hold rates to fight back effectively if also trying to prove out profitability and margin scalability.
Key Risks / Negatives / Bear Case
1) Expenses and hold rates are figured out – certainly, there have been positive revisions borne from positive momentum under-the-hood at DKNG for the last 2 quarters. As noted above, there is still tremendous wood to chop on many angles, but that doesn’t mean it can’t get pulled off. The drop in SBC should bring down the G&A line and DKNG’s commentary about retention should bring down S&M and external marketing specifically, as management expects to leverage those lines this year. If DKNG sees retention kick up meaningfully, they may be able to improve their bet pricing (assuming a degree of their low hold rate is purposeful). There’s also the GNOG acquisition, where DKNG expects to fully integrate the back-end of both companies (i.e., putting GNOG on the DKNG PAM), which could yield savings and greater efficiency. Ultimately, the bull case and bear case are 2 sides of the same coin – they either can get costs down and hold rate up or they can’t. If they can, then DKNG is working with a very large volume of wagers, which would translate into substantial profits; if not (as argued above to be unlikely), profit scaling will hit a wall, share will be lost, and another restructuring will be announced.
2) New state legalizations – DKNG’s 2024 soft guidance includes assumptions on a “reasonable range of outcomes” on new state legalizations, based on states with legislation working its way through the system. Any new state comes with an upfront expense of launching in the state, (hopefully) offset by a whole bunch of new revenue. DKNG has been reporting that more recent states are hitting positive contribution profit (basically GP less marketing) faster than in the earlier days of OSB legalization, which makes sense from the perspective of DKNG getting more experience over time and thus improving their efficiency of new state launches, in addition to the assist they get from national marketing. Thus, a bunch of new state legalizations over 2024 could meaningfully increase DKNG’s revenue further, allow DKNG to paper over cost issues under the guise of new state launches, and otherwise buy time to fix underlying issues and/or grow their way out of their issues without having to do a formal restructuring/cut.
3) iGaming legislation – related to new state legalizations; iGaming is currently only legal in 6 states. iGaming carries far better margins and a far larger market size than OSB on an apples-to-apples basis. Any states that legalize iGaming (most likely coming from states that already have legal OSB) would significantly improve both revenue and profits quite quickly for DKNG. Moreover, given its easier to pass iGaming legislation in states where OSB is already legal (less hoops to jump through), one legalization could spur many others in tandem from neighboring states that would effectuate competitive share loss for tax dollars. For example, the thought is that a legalization from IN could push IL, OH, and IA to legalize in short order. Effectively, both new states and iGaming in existing states would be events that significantly unlock TAM for the larger market, which ostensibly pushes DKNG’s value higher, all things being equal.
4) Strategic alternatives – DKNG’s MO has been aggressive capital outlays. They acquired their way to DFS dominance and have not been afraid to acquire big targets in the gaming world, with the acquisition of GNOG, the attempted merger with LSE:ENT, and their reported talks with ESPN to potentially partner in an ESPN-branded product (DKNG and ESPN currently have a multi-year advertising deal). Whether it’s a scale, a mega-merger, or some other “strategic alternative”, Jason Robins likes to shoot his shot and there’s nothing that can be definitively taken off the table of possibilities that he could attempt to do from an “ex-operational” perspective.
Catalysts / Accelerators / Thesis Checkpoints
Valuation Thoughts / Numbers
DKNG trades at a ~$12B market cap and EV (~$160M in net debt). Consensus currently has ~20% top-line growth for each of the next 2 years and EBITDA going from -$307M this year to $140M in 2024 and $566M in 2025. The implication of those numbers is that DKNG generates an incremental $870M on the next ~$1.425B in revenue or 61% incremental margins.
The implication of this is somewhat ludicrous – DKNG’s GM% is in the low-30s, most of which is a factor of state tax rates. Sure, they could get some points on a more efficient and scaled tech stack, but even FanDuel is at 50%. Thus for EBITDA to scale to that level, GM% would have to materially improve, which would require a combination of huge convergence of gross and net gaming revenue (where the difference is promotional credits, e.g., “free bets”), material growth in lower tax jurisdictions, and/or meaningful legalization in iGaming. Given the turnaround time on legalization, there is no way we would see a meaningful impact to 2024 estimates from iGaming legalizations (nothing is meaningfully in-play right now and the turnaround time is probably close to a year from in-play legislation to go-live). Material growth in lower tax jurisdictions is hard to handicap (if not far from “likely”). This leaves promotions / NGR-GGR convergence. This is obviously the goal, but to the extent that GM% effectively doubles AND incremental margins beyond variable gross margin incur zero incremental costs (e.g., customer acquisition / some degree of marketing spend for acquisition/retention purposes seems far-fetched.
Further, the revenue growth expectations have a bunch of assumptions in there – handle growth is largely slowing meaningfully. For example, for 1Q23, the combined handle of NY, NJ, MI, PA, and IL (5 largest states that have been legal for >1 year) grew 2% year-over-year. OH and MA were huge additions to the TAM for this year, but the assumption should be that they will follow the same path as other large states and will see handle growth plateau after ~18 months. In a low-growth handle market, gains need to be made on hold rate and/or NGR-GGR split to continue top-line growth. This would require major leaps in DKNG’s hold rate and promotional intensity, or a spate of new state legalizations. And you can’t have both, because new state legalizations will kill incremental margins given upfront costs of acquiring customers.
Ultimately, a $4.2B 2025 revenue target seems a lot more reasonable, with ~30-40% incremental margins, which would yield $100-150M in 2025 EBITDA absent a material restructuring initiative.
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