Description

When discussing DKNG as a short, I believe that valuation cannot be a primary driver of the thesis.  Valuation metrics of current financials and near term forecasted financials are largely irrelevant.  No one owning the stock cares that the company is unprofitable and burns cash.  IMO, what matters is the momentum of the business.  In 2023, literally everything bounced DKNG’s way:

1. Competitors shutdown or pulled back marketing
2. Parlay product took off increasing both their hold and market share

With the increase in business momentum, investors start believing in:

1. TAM will be growing faster and be a lot larger than expectations
2. DKNG will continue to take a bigger slice of that TAM
3. Margins will easily grow to expectations and probably even surpass them
4. DKNG should be valued like any other software company that has monopolistic / oligopoly characteristics

My belief is that business momentum has peaked and will be decelerating this year. As this occurs, the “beat and raises” will discontinue and then there will be more of a focus on financials and valuation.  When that happens, that is when DKNG is in big trouble   

1. OSB, Great Market (TAM) but a Bad Business (intense competition with low margins):
   1. OSB is a business that has a very small marginal cost and almost no barriers to entry.  This is a problem when there isn’t a large moat.
   2. In the US, there is no moat in OSB.  In most states there are multiple licenses available, very little barriers to entry and multiple participants with very little product differentiation.  As technology gets better (all the major operators own their own tech and are investing heavily to improve), the current product differentiation will get smaller to nonexistent.
   3. Most of the current advantages have to do with the “first mover” advantage.  But the ultimate experience of using the product is very similar across platforms and will only become more similar as time goes on
   4. OSB and iGaming are not a new business.  EBITDA Margins have been established overseas for years and have been in the high teens to low 20’s (versus the 30% EBITDA margins that everyone assumes will occur in the US)
2. 2023 was an incredible year for DKNG, but many of the positives wont be repeated and the “Positive News Flow” will come to an end shortly
   1. In 2023, many competitors pulled back on their business with some closing down.  Leading to easy share gains, which wont be repeated in 2024.
      1. WYNN Bet Pointsbet & Barstool all closed operations
      2. RSI – pulled out of Connecticut.  RSI in general has been more focused on their iGaming product
      3. MGM, RSI and CZR all pulled back much harder on promotional activity to get to EBITDA positive.
   2. New strong competitors entering in 2024–
      1. ESPNBet
      2. Fanatics – took over Pointsbet US business and has relaunched.  They hired former FanDuel CEO to run this business.
      3. Bet365, a late entrant with a great product has slowly been making share gains
      4. BetMGM, which pulled back on some marketing in 2023 while waiting to close the Angstrom acquisition, is looking to regain market share in 2024
   3. Parlay a game changer for the business but, IMO, a short lived advantage
      1. Both DKNG and FLUT had a first mover advantage with parlays which led to the constant “beat and raises” by DKNG as it increased revenues both by taking market share and by increasing the hold
      2. This change is unlikely to continue to increase, which will cause a deceleration of their growth
      3. Current Competitors have been improving their product, which will cause DKNG and FLUT to lose their “competitive advantage” and both will likely cede share. 
         1. Entain (BetMGM) closed their acquisition of Angstrom in October 2023 which will improve their parlay product
         2. Ceasars moved their product to their Liberty platform in mid 2023 and now has a comparable product
         3. ESPN Bet launched in late 2023, and their product is still behind but improving
      4. The increase in structural hold has its limits
         1. There is just so much that players can lose before they just stop better.  This is equivalent to Casino’s increasing the hold on slot machines from 9% to 11%.  Eventually, players will notice that they are losing more and wont play. 
         2. The increase in hold is responsible for a big part of the 2023 growth.  Not being able to increase hold again will again lead to a deceleration of growth
   4. Closing of Golden Nugget led to Share gains in iGaming in 2023, now that the acquisition has been lapped, I would expect a deceleration of share gains
   5. State legalization has really slowed down In a recent initiation report, Mizuho listed Georgia, Missouri, Minnesota, Nebraska and Mississippi as states with near term legalization possibilities
      1. Mississippi – has the most promise of any state and can be legalized this year. But probably wont move the needle as it has a small population and an extremely high poverty rate
      2. Minnesota is a mess.  There are competing bills in the state that have a tremendous amount of onerous restrictions and limitations (like high tax rates, no betting on college sports, no in-play betting.  They also need to contend with tribal gaming
      3. Georgia recently failed to pass a OSB bill – they couldn’t even garner enough support to send it to a vote.  Nothing can happen there until 2026 at the earliest
      4. California and Florida (the big population states) must contend with the Tribal gaming, which may not present an opportunity for outside companies
      5. Recent sports betting scandals put a damper on the willingness of politicians to pursue legalization
   6. Growth expectations from iGaming (which is a more profitable product) will be a lot slower than anticipated.  A recent report from Mizuho listed New York, Maryland & Illinois as possible near term legalizations
      1. Maryland, the state with the highest probability of near term legalization failed to approve it and now legalization in 2024 is dead
      2. New York, which has been high on the list of States with possible iGaming legalization, looks like it will be pushed out for a while
         1. Certainly a dead issue in 2024, could be revisited in 2025
         2. NY Downstate Casinos’s probably wont be licensed until 2026 and it is doubtful that the state would legalize iGaming before resolving the downstate licenses
      3. Pushback against legalization is strong – recent article from Craig Billings, WYNN CEO on Linkedin (https://www.linkedin.com/pulse/online-casino-cannibalization-debate-reductive-thus-far-billings-jyapc/) expresses tremendous for legalizing iCasino
      4. Chris Grove, Industry expert and Partner Emeritus at E&K, summed up the current legislative environment with this tweet https://x.com/OPReport/status/1773572130929569827?s=20
3. Margin degradation
   1. Taxes increasing – NY and Pennsylvania have much higher tax rates.  Expecting other States to play copycat and increase their online gaming taxes
      1. Ohio doubled its tax rate from 10% to 20%
      2. Illinois looking to raise taxes from 15% to 35%
      3. NJ looking to raise taxes from 15% to 30%
   2. Data providers (GENI and SRAD) will be increasing their take rate in 2024
4. IMO, despite its excellent market share, DKNG, thus far, has a vastly inferior margin profile
   1. Almost all competitors successfully were able to get to EBITDA breakeven, where DKNG is far away from it (without the addback Stock based comp)
   2. DKNG has guided to a much larger improvement in margins in 2024, which I think will be extremely difficult for them to attain
5. New Acquisition Strategy- Jackpocket and changing of the roles of CFO
   1. Generally, IMO, when companies start making acquisitions it signals a problem with their business, especially when the there isn’t obvious logic to the acquisition (like the DKNG purchase of Golden Nugget)
   2. Jackpocket is a gimmicky company (Lottery courier) with no natural connection to sports betting.  IMO, more states will decide to sell tickets online which will marginalize Jackpockets business
   3. DKNG thinks there could be “revenue synergies” as they can source players from people who use the courier service and turn them into sports betters.  Even if this is correct, $750 million is a big price to pay for lead generation
   4. Role change for Jason Park from CFO to newly created “Chief Transformation Officer”, signaling that more M&A is coming
      1. Recently, RSI reached to DKNG to see if they would be interested in buying them
      2. DKNG trying to get into the Latin American market so RSI would make a sensible target
6. Consensus Long – so few if any upgrades coming
   1. 27 Buys with a median price target of $53 or a 18% increase from current levels (range 49-60)
   2. 6 Holds (Deutsche Bank on bulge bracket with a hold)
   3. 2 Sells
7. Non Stop insider selling – IMO, insider selling generally isn’t a signal as people can sell for many different reasons.  But here, the numbers are so large and all in one direction, that its difficult to totally ignore it
   1. Since the beginning of 0f 2023 insiders of sold over $640 million of stock of which, CEO Jason Robins has sold $238 million and CFO Jason Park has sold $154 million

Since this is the “Value Investors Club” I will talk a little bit about valuation. 

Where DKNG is currently trading assumes the following (obviously some knobs can be adjusted differently, but trying to provide a broad framework for thought)

1. 1. 1. 1. Market matures in 2030 at a $45 billion TAM
         2. DKNG achieves 30% market share
         3. DKNG achieves 30% real EBITDA margins
         4. Stocks trade at 10x EBITDA at industry maturity
         5. 5 yr Discount at 12%= $48 a share

My base case for DKNG valuation is as follows:

1. Market matures in 2030 at a $40 billion TAM
2. DKNG achieves 25% market share
3. DKNG achieves 25% real EBITDA margins
   1. Higher than the 20% EBITDA margins in Europe
4. Stocks trade at 10x EBITDA at industry maturity
   1. Higher than the mid to high single digit multiples in Europe
5. 5 yr Discount at 12%= $30 a share

My “downside” case for DKNG valuation is as follows:

1. Market matures in 2030 at a $35 billion TAM
2. DKNG achieves 20% market share
3. DKNG achieves 20% real EBITDA margins
4. Stocks trade at 8x EBITDA at industry maturity
5. 5 yr Discount at 12%= $13 a share

Catalyst

Competative offerings and loss of market share
More acquisitions