DraftKings Sinks As IRS Tax Threat Hits; Street Stays Bullish

DraftKings (DKNG) is in the spotlight following an internal IRS memo suggesting that daily fantasy sports (DFS) operators will have to pay tax on their entry fees.

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An IRS Chief Counsel Memorandum determined that DFS entry fees are taxable wagers, writing: “A DFS entry fee is a wager of money by the participant with respect to a sports event or contest placed with a person engaged in the business of accepting such wagers.”

It also stated that if a DFS operator is liable to pay excise taxes on wagers, then each DFS operator is liable to pay the occupational excise tax and is required to register as a person liable for the tax imposed.

The memo argued that the entry fee is not for a skill-based contest (and would therefore be non-taxable) as: “DFS participants merely select a lineup for their simulated teams and have no ability to exercise control or influence over the actions of the players participating in the game and who earn the participants their fantasy points.”

However Morgan Stanley analyst Thomas Allen reassured investors that the memo does not mean game-over. He has a buy rating on the stock and $25 price target. “This is just a memo and we expect DKNG and FLTR to fight the finding given numerous states have defined DFS as a game of skill not luck, and thus would not fall under the excise tax rule” the analyst wrote.

He continued: “If the rule does take effect, we estimate DFS is ~25% of DKNG’s revenue in 2020 but falling to <10% by 2025. Given half of ~40 states that the two operate in are explicitly legal for DFS, this only implies a ~$20-30m ongoing annual headwind for each operator in a worst case scenario, but there could be a larger 1x payment if enacted retroactively.”

Overall, DKNG boasts a Strong Buy analyst consensus with a more bullish average analyst price target of $47 (39% upside potential). “We are looking for commentary on an IRS memo indicating operators will have to pay excise taxes on DFS entries” Rosenblatt analyst Bernie McTernan wrote.

He reiterated his buy rating with a $60 price target following DKNG’s better than expected guide for ’20E PF, with the midpoint for 2H20 ~4% above consensus. The analyst also noted that DraftKings is now looking to enter Virginia, Tennessee and Michigan. (See DKNG stock analysis on TipRanks)

Shares in the sports betting company fell by 6% on Friday, but the stock is still up over 215% year-to-date.