It always makes sense to hold quality stocks in a portfolio from industries that have a multi-year tailwind. Some examples include electric vehicles and clean energy. Another industry that’s positioned for sustained growth is the iGaming and sports betting industry. DraftKings (DKNG) seems like one of the stocks that’s worth considering from this industry.
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Year-to-date, DKNG stock has been an underperformer. However, I am bullish on the stock and I believe that a strong reversal is likely from current levels of $41. (See Analysts’ Top Stocks on TipRanks)
Starting with the industry outlook, Eilers & Krejcik Gaming estimates that sports betting revenue in the United States is $2.1 billion. However, if all states legalize iGaming and sports betting, the industry size is expected to be $40 billion.
For the first nine months of 2021, DraftKings reported revenue of $823 million. This would imply annualized revenue potential of $1.1 billion.
DraftKings is among the leading players in the iGaming and sports betting industry. Even if the company can capture 20% of the potential market share, the revenue potential is approximately $8 billion.
This provides a ball-park insight on the growth potential for DraftKings in the next few years. The stock is trading sideways. Therefore, it seems like a good accumulation opportunity.
Strong Revenue Growth Likely to Sustain
For the first nine months of 2021, DraftKings reported revenue growth of 181%. Further, the company has guided for full-year revenue of $1.26 billion. Even for 2022, the initial guidance of $1.8 billion (mid-range) implies strong year-over-year growth potential. Clearly, DraftKings seems to be benefiting from the industry tailwinds.
It would make investors wonder why the stock has been an underperformer. It’s worth noting that for the first nine months of 2021, DraftKings reported an adjusted EBITDA loss of $548 million. Cash burn is a concern.
However, DraftKings has more than doubled its sales and marketing expenses during the given period. For a company that’s still at an early growth stage, cash burn is not a worry. If cash burn is not associated with robust top-line growth, it would be a red flag. That’s not the case with DraftKings.
This point is further underscored by the fact that the average revenue per monthly unique payer was $47 for Q3 2021. On a year-over-year basis, revenue per monthly unique user increased by 38%. Once investments peak out, EBITDA margin expansion is likely on average revenue per user growth.
Financial Flexibility to Pursue Aggressive Growth
Considering the big market potential, DraftKings has also been looking at acquisition-driven growth. In August 2021, DraftKings acquired Golden Nugget Online Gaming (GNOG) for a consideration of $1.56 billion. The acquisition is likely to result in synergies of $300 million in EBITDA at maturity.
It’s worth noting that as of Q3 2021, DraftKings reported ~$2.4 billion in cash and equivalents. Additionally, there is scope for leveraging with the company having a clean balance sheet. The key point is that the company is positioned for further acquisition-driven growth.
At the same time, the financial strength is likely to ensure that the company navigates an extended period of cash burn. The financial risk, therefore, seems low even as the company continues to report operating-level losses.
DraftKings has also been looking at diversified sources of revenue. For example, the company has launched DraftKings Marketplace, which is a digital collectibles ecosystem and exchange. For Q3 2021, the marketplace reported $20 million in merchandise volume.
Wall Street’s Take
Turning to Wall Street, DraftKings has a Moderate Buy consensus rating, based on 10 Buys, four Holds, and one Sell rating assigned in the past three months. The average DraftKings price target of $68.38 implies 66.4% upside potential.
Bottom Line
The sideways movement in DraftKings is a good accumulation opportunity, in my opinion. With more states in the United States legalizing iGaming and sports betting, the revenue growth potential seems immense.
DraftKings has a strong balance sheet, which will help in navigating its cash burn. Additionally, there may be more acquisitions on the cards.
Considering the factors discussed, a sharp rally might be just around the corner.
Disclosure: At the time of publication, Faisal Humayun did not have a position in any of the securities mentioned in this article.
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