DraftKings' Investor Day Points to Strong Improvement in Profitability Amid Intense Competition

Senior Equity Analyst

Dan Wasiolek

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DraftKings has extended its leading daily fantasy sports position, first established in 2012, into one of the top positions in the North American sports betting and iGaming market, with the company, along with FanDuel and no-moat MGM, holding a combined 70%-80% revenue share. While sports betting and iGaming are currently legal in nearly 40 and seven states, respectively, we expect another handful to be added to each market the next few years, as governments look to capitalize on tax revenue generated from the growing activity, which is benefiting from an improved product (parlay and in-play wagering) and technology (customized content) offering across the industry. As a result, we estimate the North American sports betting and iGaming market to reach $40 billion-$50 billion in revenue in the early part of the next decade from over $13 billion in 2022.

Despite our prognosis for strong market revenue growth over the next 10 years, we don’t believe DraftKings has a moat, as the industry is highly regulated and faces intense competition. To this point, states can change tax rates, delay legalization, and limit market access. Further, Fanatics and ESPN/Penn sports betting launches present new and meaningful competition for wagering dollars.

In the face of competition, we believe DraftKings will need to continue to invest behind its offering to remain relevant over the long term. We are positive that DraftKings' in-house technology platform (acquired in 2020) allows more control into leveraging customer data and launching new products. Further, the company’s strong financial profile should afford it latitude to invest more resources behind its brand. Here, DraftKings operates in a net cash position, and we expect positive adjusted EBITDA and free cash flow to the firm in 2024. But we view DraftKings' lack of physical casinos and media assets as a disadvantage to those peers with such an omnichannel presence, as it limits its ability to accumulate and leverage consumer data as well as cross-sell across various distribution channels.

Business Strategy & Outlook

Although DraftKings holds a leading revenue share in the North American sports betting and iGaming market, which we see expanding to $40 billion-$50 billion in sales by 2030 versus $12.5 billion in 2022, we do not believe it has a lasting economic moat, due to regulatory uncertainty and nascent switching costs in a highly competitive landscape.

DraftKings leveraged its early mover advantage in daily fantasy sports (platform launched in January 2012), where it operates in over 40 states, to gain a leading share position in online sports and iGaming betting as states legalized such wagering activity following a Supreme Court ruling in 2018. To this point, DraftKings roughly holds around a 30% gross gaming revenue share of the online sports betting markets (about 50% of its total revenue) in the 20-plus states where it operates the activity, as of the second quarter of 2023, trailing only FanDuel. Meanwhile, the company also has a leading sales share (along with BetMGM and FanDuel) in the handful of iGaming states where its product is offered. Overall, the stout ramp of sports and iGaming legalization drove DraftKings’ 2022 sales up 10-fold to over $2.2 billion from 2018’s $226 million level.

But despite DraftKings’ current revenue share position, the industry’s regulatory structure gives us pause on awarding the company an economic moat. Specifically, sports and iGaming are regulated at a state, not federal, level, which leads to varying tax structures, license fees, number of operators, location access (whether allowed offline and/or online), and overall legalization. And although we think licenses already granted to DraftKings and peers are likely to be renewed and granted for more than a 10-year period, the tax and license renewal costs could change, materially impacting economic returns in the industry. To this point, Ohio announced in 2023 that it would increase the tax on sports betting revenue to 20% from 10% starting in 2024. Another meaningful regulatory concern is that barriers to entry for fantasy sports are lower than sports betting, yet present rather direct competition to the latter. To illustrate, according to regulations in the U.S., fantasy sports are defined as being "games of skill" because users are placing wagers on individual athlete outcomes, which require research and knowledge. Meanwhile, sports betting is characterized as a "game of chance" because gamblers are betting on team results, as well as individual athletic outcomes, and therefore need state approval. As a result, fantasy sports are generally permitted to operate without state legalization, and in fact, are offered in California and Texas, which currently don’t permit sports betting. This allows companies like PrizePicks to garner wager activity in over 30 states, despite not having any legal state sports betting licenses. Finally, one other regulatory dynamic is that certain states give multiple sports betting and iGaming licenses only to physical retail gaming operators, who then sell them to online-only operators like DraftKings in exchange for a percent of winners, which places the company in a position of dependence for any future state legalization and awarding of licenses.

In addition to regulatory uncertainty, the online sports betting and iGaming industry remains competitive. DraftKings faces dozens of pure-play online competitors as well as operators that have both a physical and digital component. Unlike some of its peers, DraftKings does not have any retail presence. This lack of physical casinos gives DraftKings no cross-sell opportunity and less customer data to utilize compared with its omnichannel peers. Further, DraftKings doesn’t have a strong media presence, like Penn’s social partnership with ESPN and its app theScore, whose exposure can help drive lower customer acquisition costs and traffic to its platform. As a result, the traffic on DraftKings could come under pressure if competitors choose to reengage in heavy promotions to capture revenue share, while leveraging their omnichannel and media asset exposures.

To be fair, DraftKings is not sitting idle but rather is making prudent technology, asset, and product investments to remain competitive. One such outlay was the acquisition of SB Technology in 2020, which provided the gaming operator with an in-house platform. We believe that having a vertically integrated technology platform is important to remaining relevant in the industry, as it offers companies more control into leveraging customer data and launching new product offerings. In this vein, DraftKings noted that its technology platform lifted hold rate (the amount of wager the operator keeps) by 20 basis points in 2022, while new parlay products drove another 70-basis-point lift in hold that year (total 2022 hold was 7.7%, and the company estimates hold to reach 9.5% in 2023). After the SB Technology acquisition, DraftKings acquired Golden Nugget’s casino customer database and online iGaming offering in 2022, which is driving further improvement in customer acquisition costs. We calculate that marketing spending on unique users has trended down from 107% growth in 2020, to a 17% increase in 2021, and a decline of 6% in 2022, while revenue per marketing dollar has improved to $1.89 in 2022 from $1.24 in 2020. We think DraftKings’ healthy liquidity profile affords it latitude to invest further behind its brand, which we think is necessary in an intensely competitive landscape. In this vein, the company operates in a net cash position (which equated to roughly $500 million at the end of 2022), with an untapped $125 million credit facility, and we expect positive EBITDA and free cash flow to the firm beginning in 2024.

It will remain crucial for DraftKings to continue to strengthen its offering, as new peers like Fanatics and ESPN (through its partnership with Penn) emerge and existing heavyweights like no-moat peers MGM and Caesars continue to enhance their offerings. To this point, Fanatics is entering the online sports betting market and presents a formidable competitor, given its 100 million user base of sports merchandise consumers and billions of recently raised financing. Meanwhile, ESPN entered the sports betting market in the fall of 2023 through a partnership with Penn. We expect the relationship to elevate Penn's revenue share, given ESPN has nearly 400 million social media followers. Further, larger revenue share leaders are moving to swallow up smaller peers. For instance, Penn acquired technology and media company theScore, and MGM has been engaged at times to acquire its remaining 50% stake in BetMGM. Conversely, under the pressure of a competitive landscape, some smaller peers have deemphasized their presence. To illustrate, narrow-moat Wynn scrapped its plans to take its online sports and iGaming business public in late 2021 and has since reverted investment away from the segment, focusing only on markets where it has a physical presence (Las Vegas and Boston), leading to just low-single-digit revenue share. Also, Churchill Downs announced in early 2022 that it would not pursue online sports betting outside of its core horse-racing offering. Additionally, in late 2022, 888 Holdings communicated it will leave online sports betting-only markets and focus on states that offer both iGaming and sports wagering, as it focuses on reducing debt after its acquisition of William Hill International (a sports betting technology company). Further, smaller peers Fubo Gaming and MaximBet also announced they were exiting online sports betting in late 2022.

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Economic Moat

DraftKings

DraftKings, Inc. provides online fantasy sports and sports betting services. It provides users with daily fantasy sports, sports betting and iGaming opportunities, and is also involved in the design and development of sports betting and casino gaming platform software for online and retail sportsbook and casino gaming products. The company was founded on August 6, 2021 and is headquartered in Boston, MA.

Earnings data Q1 2024

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DraftKings, Inc. is a digital sports entertainment and gaming company, which engages in the provision of online sports betting, online casino, daily fantasy sports product offerings, DraftKings Marketplace, retail sportsbook, media, and other consumer product offerings. The company was founded by Jason D. Robins, Matthew Kalish, and Paul Liberman on December 31, 2011 and is headquartered in Boston, MA.

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