DraftKings Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

DraftKings is a digital sports entertainment and gaming company that provides online sports betting and daily fantasy sports (DFS) products, and is focused on the design and development of gaming software, and more, with its operations being primarily located in the United States.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

DraftKings operates in the highly dynamic and competitive online sports gaming industry. Its revenue streams are primarily categorized into two areas: Business-to-Consumer (B2C) and Business-to-Business (B2B). Within the B2C segment, the core offerings are real-money sports betting, which includes the provision of online sportsbooks for users to place wagers on a diverse range of sporting events, and daily fantasy sports, where users create fantasy teams for various sports and compete for cash prizes based on the performance of their teams. In the B2B segment, DraftKings partners with other companies to provide its technology and gaming solutions.

Revenue Distribution:

  • B2C: The vast majority of DraftKings’ revenues come from its B2C segment, including both sportsbook operations and DFS. This segment is driven by customer acquisition, retention, and the handle (or money wagered) placed on the platform.

    • Sportsbook: A significant portion of B2C revenue is derived from its sportsbooks, where the company takes a commission on user losses and also generates revenue via features like in-game wagering. The growth in this segment is driven by customer acquisition, the expansion of the offering to new states as legislation allows, and an increase in betting volume from existing users.
    • Daily Fantasy Sports: The other major component of B2C revenues are DFS contests. Users pay an entry fee to participate, and the prize pool is distributed to the winners. DraftKings profits from the fees it collects minus the prize pool distributed.

  • B2B: This segment includes revenues from various sources, such as its partnership with other sports betting and online gaming companies, as well as fees charged for providing services, such as technology solutions and licensing.

Industry Trends:

  • Online Gaming Growth: The online sports betting market is growing rapidly, spurred by the legalization and increasing acceptance of online betting across various jurisdictions. The expansion of online sports gaming has been one of the fastest-growing in the industry in the past few years.
  • Increased Regulation: The regulatory environment is evolving rapidly, with varying rules and regulations from jurisdiction to jurisdiction. This includes rules on licensing, taxation, and consumer protection.
  • Competition: The online gaming space is competitive, with numerous companies all vying for the same customer base. The increased competition among these companies is leading to innovation in their offerings as well as increasing marketing spend.
  • Technological Innovations: Continuous innovation in technology, both on the customer-facing side and in data management is driving the growth of the industry, and enhancing the overall user experience, while improving engagement and efficiency.

Competitive Landscape:

DraftKings operates in a market that is characterized by intense competition. Key competitors include, but are not limited to, FanDuel, BetMGM, Caesars Sportsbook, and other more regional or international players. The competitive landscape revolves around a variety of factors, including user experience, the variety of available betting markets, promotions and marketing, brand recognition, and technology. Companies compete for users via multiple channels, and have to spend significant amounts on promotions, customer acquisition and advertisement.

What Makes DraftKings Different?

  • Established Brand: DraftKings boasts a strong brand name with a high level of awareness, especially in the daily fantasy sports domain, where it was an early pioneer. A significant amount of revenue is derived from repeat customers. The brand is a significant moat for them.
  • Platform Versatility: Their ability to offer multiple services on a singular platform sets them apart. While several platforms are specialized, DraftKings offers sportsbooks, daily fantasy sports, and even an NFT marketplace, all under one umbrella.
  • Data and Technology: DraftKings makes significant investments in data infrastructure and analytics to provide insights for marketing, engagement, and pricing, giving the company a technology-driven edge.
  • Proprietary Technology: DraftKings uses its own proprietary system which they have to maintain and update, leading to a high barrier of entry for new players.
  • Partnerships and Brand Awareness: DraftKings has numerous partnerships in the sports leagues and with various well known figures. They have a lot of partnerships with sports teams, leagues, and even individual athletes. These partnerships and marketing techniques are essential for long-term growth and to gain a competitive edge over others.

Financial Analysis:

  • Revenue Growth: DraftKings has been experiencing solid revenue growth driven by expansion to more states, an increase in its user base, and more use of its platform.
  • Margins: Due to increased competition in the industry, DraftKings’ cost of revenue has been increasing. This is likely to continue to a degree, as DraftKings has to offer more and more competitive offers to its user base. Operating margins are expected to improve in coming periods with better cost management and also from the economies of scale of the business.
  • Profitability: Due to a variety of factors, including competition and heavy reinvestment into the business, especially marketing and technology expenses, DraftKings is not profitable. While this is likely to continue for the next few years, management does have plans to improve margins and make the business profitable.
  • Cash Flow: Free cash flow remains negative as the company spends a significant amount on acquiring new customers and scaling its operations. It can be expected to improve as the company stabilizes its expenses, leading to better cost-efficiency.

Balance Sheet Health: 3 / 5

  • Assets: DraftKings has a large cash balance, which has helped mitigate risks. They also have large investments in noncurrent tangible and intangible assets that can add value to the company.
  • Liabilities: DraftKings has a substantial amount of liabilities, and has been historically using its equity to offset these debts. However, the risk profile is still manageable.
  • Debt-to-Equity Ratio: Although the Debt to Equity ratio is not high (given the amount of liabilities), they still are mostly financed by Equity. Their debt to capital ratio is within a manageable range, meaning that the company is not overly leveraged.
  • Quick Ratio & Cash Conversion Cycle: With $1.8 Billion in cash, the quick ratio is 2.14. They can easily meet their short term obligations. Cash conversion is still an ongoing process due to reinvestment into the business.

Overall, I have given DraftKings a balance sheet health rating of 3/5 because they are not currently profitable and have negative cash flows, yet have enough capital to continue operations.

Moat Rating: 2/5 DraftKings has a narrow moat, mainly based on a solid brand name, network effects, and proprietary technology, even though those might be more weak than they first appear. The brand is recognizable, but switching costs are quite low, given that users can create accounts and use multiple platforms. They have a proprietary technology that will help them in the long term, but this may not prevent others from building their own similar technologies as they are continually developing. In addition, they operate within the gaming and entertainment industries, where the risk of disruptive innovation is very high. Because of this, the moat can easily become less effective or be completely destroyed if something better comes along, giving them a rating of 2/5.

Legitimate Risks Affecting the Moat and Business Resilience:

  • Regulatory Changes: Changes in regulations and jurisdictions are a major threat to DraftKings’ market and can directly hamper the user base and reduce its revenue. Any changes to rules on gaming licensing, taxation, or advertising will have immediate effects on the business.
  • Competition: The extremely intense competition can eat into profitability and market share. This includes a combination of established and newer companies, who are all looking to make a mark in the industry.
  • Technology Disruption: The threat of new, disruptive technologies is a real risk as well. If the company cannot stay up to date with the current technology, their offerings may become uncompetitive, and therefore they will be unable to sustain returns.
  • User Acquisition Costs: The cost of acquiring and retaining users is high and is only likely to increase in the future. This is because more companies will look to take advantage of the expansion of online gaming.
  • Negative User Behavior: The risk of addiction and other negative user behaviors associated with online gaming may bring regulations, lower customer confidence, and may ultimately reduce the earning ability of the platform.
  • Economic Downturn: If a recession were to take hold, the spending on discretionary activities, including gaming and entertainment, could drop, resulting in fewer active users for the platform and a fall in their earnings.

However, they have multiple factors which make them resilient:

  • Strong Brand Recognition: A high-brand recognition that makes it easier for them to retain and acquire customers, and make it tougher for newcomers to attract consumers.
  • Technology Stack: Heavy investments in technology and infrastructure make it harder for potential competitors to compete.
  • Multiple revenue streams: In case, one area underperforms, they can fall back on other revenue streams that can help them withstand the turmoil. This includes the B2B segment as well as the daily fantasy sports segment.
  • A loyal customer base: Because they provide an enjoyable platform to the consumers, and because of the high switching costs associated with these types of services, existing users are more likely to stay with their platforms for long periods of time.

Understandability: 2/5 Although the products and services offered by DraftKings are not complex for the general public, the underlying business model and financials are quite complicated. They utilize a very complex revenue structure with various business segments, including B2C and B2B, and each section has its own complexities to analyze. The different legal considerations and risk factors due to the nature of the business are also quite complicated to follow. Also, the financials are quite difficult to analyze because of a lot of re-investment and high costs and also the various non-recurring items. This leads to a rating of 2/5.

Recent Concerns and Management’s Response:

  • Competition: The increased cost of acquisitions in this competitive industry is becoming a major concern to investors. Management plans to manage the cost of acquisitions by trying to gain operational synergies in their future targets and improve customer engagement to reduce attrition.
  • Profitability: While revenues have grown in the recent years, profit levels are still low. Management believes that their focus on profitability as the main driver of their business, coupled with a reduction in new offerings, and increased cost management will make them more profitable in the future.
  • Regulatory Changes: Changing laws and regulations with respect to online sports gaming is an ongoing concern. Management plans to constantly engage with regulators, making efforts to get favorable outcomes, and to make sure that they are not in violation of existing regulations.
  • Concerns on the economy: In their latest earnings calls and financial statements they mentioned concerns on the macroeconomy, but said that as the revenue drivers are tied to their specific industry, their overall impact may not be very high.