What is going on, guys nick here back with another video.
DraftKings reported earnings on February 18th, and the investor reaction wasn't great. While
DraftKings beat estimates, the stock fell 21% after DraftKings announced they expected
a more enormous EBITDA loss for 2022.
The sports betting market is massive, with some estimates as high as $180 billion by
2028. And right now, DraftKings, Penn, Fandual, and most major casinos are fighting for market
share as states legalize online betting.
DraftKings's business strategy has been to aggressively market themselves everywhere
they can. They want customers to think of DraftKings, especially the younger online
audience, as the first place they look when thinking about betting. Their strategy has
included TV commercials and sponsorships during sporting events to hiring influencers like
Pat McAfee, Jomboy, the NBA.
But this marketing strategy is expensive, and I think there have been some pretty valid
questions about how sustainable this business model is.
So in February, when DraftKings announced their earnings, they reported a loss of $0.35
per share versus a loss of $0.81 per share expected. And revenue came in at $473 million
versus $445 million expected. So DraftKings was able to beat estimates on both top and
bottom lines.
The issue came when DraftKings said that they expected and adjusted about a loss for 2022
between $825M to $925M. This is a much bigger loss than the anticipated $572 million that
analysts anticipated.
When we look at the trailing 12 months of earnings reported by each quarter, with the
most recent earnings report shown in red, this most recent quarter seems like a positive
improvement for now. Over the last year and a half, DraftKings has lost somewhere between
$0.75 per share all the way up to $1.80 per share each quarter, so a $0.35 loss is a big
improvement.
When we look at the past five years worth of revenue and net income we can see that
while revenue is growing pretty quickly, their losses are actually growing even faster. They've
actually lost more money than they made in revenue over the past two years, which to
me isnt really something I want to see.
When we look at their revenue versus expenses to try to understand why they're losing so
much money, we can see that while the cost of revenue is not that bad in comparison to
the revenue; their sales and marketing budget is absolutely massive. And this is on top
of an already enormous general administrative cost. The sales and marketing budget increase
is pretty self-explanatory. But the general and administrative costs increase is due to
them paying $267. 5 million in stock-based compensation. They also had to hire more staff
to deal with advocate advocacy efforts and other legal costs in areas that they currently
do not operate in, as they try to lobby to legalize sports betting in those areas.
Now, this is a new chart that I have not used before. This chart basically shows the breakdown
of their expenses so that you can see the change in where they are spending their money.
These percentages are the percentage of their spending in relation to their revenue. We
can see that while sales and marketing in 2020 was 80% of the revenue in 2021, that
slightly dropped.
We can also see that the cost of revenue did slightly increase and has been increasing
since 2019. It's grown from just 31% of the revenue, all the way to 61%. DraftKings explains
that part of this issue is due to certain states requiring DraftKings to have a relationship
with a retail operator for their online sportsbooks. DraftKings also explains that about $270 million
of their cost of revenue increase is due to product taxes and payment processing fees,
as well as revenue sharing arrangements with other companies.
Now DraftKings breaks their business down into two segments business to consumer, and
business to business. We can see that business to consumer is pretty much their entire business,
but neither of these generates a profit.
When we look at DraftKings forecasted earnings we can see that while revenue growth is projected
to continue to rise, 2022 is expected to result in an even larger loss than we've previously
seen. The current analyst estimates see a loss of about $2.9B while they only anticipate
DraftKings to bring in about 1.9 billion. Even going all the way out to 2024 and we
only see DraftKings bring in about $3.2 billion versus a loss of $1.2 billion. So DraftKings
appears to be a pretty long way away from becoming a profitable company.
Looking at the revenue growth, we can see that DraftKings revenue, while they still
are projected a huge loss by 2024 is also projected to slow down to just 26% by that
year. Which I think creates a bigger problem. If DraftKings is still going to be that far away
from profitability, and revenue is projected to slow down, is it possible that DraftKings
never really becomes profitable?
Now I think for this valuation I'll look at it in two ways. First, since they are not
profitable yet, we will have to use a price to sales valuation. I'm going to use a growth
rate of 20 to 25% for them. The tricky part is figuring out the appropriate profit margins.
I think a 10% profit margin is about what I would reasonably expect this type of business
to be able to achieve. Although, plenty in this industry do produce higher profit margins.
However, if rising competition, and high taxes, which are common in this industry, eat into
the profit margins, I think a profit margin of 5% is possible as the worst case scenario.
But the industry average seems to be much higher so I have some doubts it would be this
low. Since DraftKings reaching profitability is a long way away, I think it's better to
look at different potential outcomes so we can understand all of the possibilities as
things shake out.
So using a 20 to 25% growth rate and a 10% profit margin gives us a price sales ratio
of 5.2 to 7.9
So when we look at this valuation chart, it seems like DraftKings is currently very cheap.
I think this is because the market is pricing in a lot of the potential risk the DraftKings
never really becomes profitable. So if we cut the valuation and half and use a profit
margin of just 5% this adjusts our price of sales ratio down to 2.6 to 3.9. Looking at
this more risk-adjusted valuation, we can see that DraftKings is currently trading slightly
higher than this current valuation and wouldn't hit the bottom end of fair value until after
2023. I would say this valuation is a good estimate of their value because it seems like
their profits are going completely in the opposite direction, even if the most recent
quarterly earnings were better than expected.
This is a Big valuation drop from what I had previously thought they were worth. Using
my forecasted earnings from my last video, we can see how much the 2022 projected losses
have changed. It looks like during that video they were forecasted to lose around $300M,
and that number today sits at nearly $3B. Even when we look at 2021 analysts had only
anticipated a $500 million loss, and those numbers finalized at a $1.5 billion loss.
So about $1 billion over what was anticipated.
This is why we've seen DraftKings stock fall so much in addition to the big negative trend
in small cap and growth stocks. The company is so aggressively trying to grow the revenue
they're driving incredibly steep losses. And this has investors spooked. Now these current
forecast and projections could change, DraftKings could slow down some of their advertising.
But this could also mean that revenue growth is impacted. I'm not sure that DraftKings
is an established enough name where people would automatically use their product so at
this point, I think they probably still need to market aggressively to continue to grow.
Especially because I'm just not entirely sure if most people realize they are a sportsbook,
and not just a daily fantasy app.