While we primarily focus on biotech, we are opportunistic investors and love to invest in high-growth startups that are revolutionizing their industries. DraftKings (DKNG) is a high-growth startup that recently IPO'd through a reverse merger last Friday and saw a 10% increase in value on their first day of trading, ending the day with a market cap of >$3.3B. DKNG's IPO amid the pause of sports during the COVID-19 crisis has some people scratching their heads, but after conducting an opportunity assessment and financial diligence on DKNG, we believe it is a BUY and is well positioned to continue leading online sports betting and also breaking into the online casino space.
Here's why we think DKNG is well positioned as a growth stock:
1. DKNG is in close competition with FanDuel for market leadership in U.S. sports betting. When consumers were asked to list companies offering daily fantasy sports and sportsbetting, DKNG was top of mind for a quarter of interviewees while it was the preferred brand for almost a third of consumers. We personally conducted several consumer interviews on their preferred daily fantasy sports and sports betting companies and DKNG ranked top, with consumers citing the platform as more "user-friendly." Furthermore, consumers cited more attractive promotions with better odds offered by DKNG than FanDuel in order to drive user adoption and retention. In a competitive space like this, it's promising that DKNG is focused on customer acquisition and retention.
2. DKNG is quick to penetrate markets upon online sports betting legalization. DKNG has a track record of moving quick to acquire customers when states legalize online sports betting. For example, DKNG moved quick to win the exclusive bid in New Hampshire and quickly turned online in Pennsylvania when legalization occurred. While DKNG is surely no longer a startup, their talented and driven team is versatile and quick to address make-or-break situations that allow them to take market share quickly. With so many states on the cusp of legalizing online sports betting, it's easy to see upside and growth potential in online sports betting. DKNG is well positioned to take a significant share of that growing market.
3. DKNG's diverse set of offerings allow them to weather the sports shutdown caused by COVID-19. While DKNG is known for daily fantasy sports and sports betting, it's diversified greatly into e-sports (e.g., League of Legends, Counter-Strike) and online casino (e.g., Blackjack). In the month of March, internet gaming revenue (excluding sports wagers) in New Jersey rose 66% in March, to $65 million. Clearly, while sports are out of commission, DKNG will benefit from the rise in online gambling and the continued interest in e-sports betting.
4. DKNG is positioned to expand the online casino industry by making online gambling mainstream. Daily fantasy sports and online sports betting is arguably much more mainstream than online casino gambling. Consumers perceive fantasy sports and sports betting to be a skill and information-based game while online casino gambling as sheer luck. DKNG is positioned to link the two together by bringing consumers onto the platform through daily fantasy sports and sports betting and having them dip their toes in the online casino through promos. The adjacency of its sports betting and online casino offerings creates a powerful pipeline that has the opportunity to make online casino gambling more mainstream and DKNG may be at the forefront of it.
5. The reverse merger provided $500M in cash to DKNG, which will help DKNG through the COVID-19 crisis. In the reverse merger, DKNG has access to $500M in cash, which is enough to cover its average operating costs for approximately 2.5 years. There may be headcount cuts to look out for as they've hired significantly in the past two years and their general & administrative costs has increased almost 100% since last year. However, DKNG's increased cash position with the reverse merger will definitely help it weather through the suspension in sports.
6. However, at $20 per share, DKNG is overpriced compared to its competitors based on its price-to-sales ratio (P/S). DKNG has a P/S of >8.2 compared to Stars Group, FanDuel, and Churchill Downs, which have P/S ratios of 4.1, 3.7, and 2.6 respectively. DKNG is more similar to Stars group and FanDuel given they have more of an online presence and higher growth potential. Churchill Downs on the other hand owns several horse racing tracks and is less poised for growth and therefore has a lower P/S ratio. At a P/S of >8.2, DKNG is overpriced compared to its competitors.
Overall, we perceive DKNG as a buy. It's currently a leader in the space and is well positioned to maintain leadership in the U.S. market with its fast-moving team and diverse offering of games. While COVID-19-driven suspension of sports is concerning, the company has money on hand from the reverse merger IPO and has several revenue streams that are not impacted by the suspension of sports. As long as states continue to lift online sports betting and gambling restrictions, DKNG will be waiting to charge into the new markets.