DraftKings (DKNG) Is Drastically Overvalued. Robinhood/Retail Crowd Should Get Out ASAP to Avoid Huge Losses.
[Internal report. Privileged. Do not share.]
Summaries
· DraftKings (DKNG) stock price is going to the moon? It’s already on the Mars.
· At a sky-high 18 billion market cap, DraftKings (DKNG) is insanely overvalued. Robinhood/retail investors should get out ASAP to avoid huge losses.
· DraftKings stock’s recent 4x parabolic run is one of the biggest hype in the stock market for years. This huge bubble is poised to burst.
· Existing investors should get out ASAP to realize unbelievable profit now and avoid huge losses ahead when the stock price returns to the earth.
· Interested potential investors should avoid following the current hype until a real pullback well below $15 or in the range of $10, given its enormous downside risks.
· Aside from being in the “highly controversial” online gambling space, we see too many red flags in this company.
· There are multiple dangerous signs of a “pump and dump” scheme.
· Since George Soros’ fund disclosed a position in early May, its stock price has been skyrocketing non-stop. Mr. Soros had an infamous track of record of manipulating price, creating frenzy, and causing massive losses to average investors (Thailand, UK, etc), including his widely criticized attempt to artificially pump Bitcoin price (not to mention his recent alleged involvement in the nationwide riots).
· Major stock brokers including popular consumer trading app Robinhood are showing significantly lower-than-actual or hugely conflicting market cap numbers, a strange phenomenon that we have never seen before on any other stocks in the modern history.
· Based on DraftKings’ SEC filings, there are actually at least 437 million shares of Class A common stock outstanding on a fully diluted basis. This means an over $18 billion market cap.
· To our knowledge, none of any existing analyses/reports that covered DraftKings has calculated a correct market cap to date. None of these analysts has realized the huge dilutions from warrants/options/company incentive plan/RSUs, which was actually disclosed in DraftKings’ SEC filings.
· Robinhood and TD Ameritrade are showing a significantly lower-than-actual market cap based on 312.5 million shares, a whopping 40% discrepancy from the 437 million shares.
· Insanely, DraftKings’ over $18 billion market cap is now higher than the $18 billion market cap of Flutter Entertainment, the world’s largest online gambling company based on revenue.
· Flutter Entertainment, the parent company of FanDuel (DraftKings’ main direct competitor), had $5.17 billion revenue and $200 million net profit in 2019. On the other hand, DraftKings had just $323 million revenue and $142 million net loss in 2019.
· DraftKings’ revenue is just a tiny fraction (6.2%) of Flutter Entertainment’s revenue, not to mention Flutter Entertainment is a profitable company.
· DraftKings shares have been quietly diluted by a whopping 22% in May, unnoticed by most people. There are more massive dilutions ahead. The total number of Class A common shares outstanding on a fully diluted basis will be close to 500 million shares by the end of 2020.
· There are also approximately 394 million shares of non-transferable Class B common stock, all held by CEO Jason Robins.
· The huge number of non-transferable Class B shares with 10 times voting power were “artificially created” out of nowhere on April 23, 2020, and was given to CEO Jason Robins for free to secure his 90% voting power, forever.
· Dual share class is indeed common. But in other companies, a CEO’s Class B shares are “real” shares with economic value, and the CEO will lose voting power over time when the CEO’s shares are sold over time.
· Unbelievably, DraftKings CEO Jason Robins can do a “full cash out” by selling all his Class A shares without losing his 90% voting power thanks to his “artificial” Class B shares, and his net worth will then no longer tie to DraftKings stock performance ever. Such an unusual structure shows CEO Mr. Robins’ lack of confidence in the company and his intent to cash out.
· FanDuel, one of the subsidies owned by Flutter Entertainment, is the main direct competitor of DraftKings.
· Flutter Entertainment runs over a dozen international brands and platforms that cover the global market, including Paddy Power, Betfair, Pokerstars, Sky Bet, Sportsbet, FOX Bet, FanDuel, TVG and Adjarabet.
· FanDuel runs the exact same businesses (Daily Fantasy Sports, Sportsbook and iGaming) as DraftKings in the same market (United States), with a larger market share. To most people, FanDuel and DraftKings are essentially two interchangeable platforms. It is fair to conclude that FanDuel alone is at least as valuable as DraftKings.
· Trying to evaluate an online gambling company as a tech company is wrong, or an attempt to mislead retail investors. Unlike tech companies, there are no high profit margin, no monopoly, and no network effect.
· A mature online gambling company has a lower than 4 times P/S (market cap to revenue) ratio due to the business model’s inevitably low profit margin and competitions.
· With a fair addressable market outlook, a fair forward-looking valuation of DraftKings stock is well below $15 ($6.5 billion market cap), or even below $10 ($4.4 billion market cap).
Background
DraftKings recently completed a reverse acquisition, effectively an IPO. The reverse acquisition deal was announced on December 23, 2019. [1] . The reverse acquisition closed on April 24, 2020.
The stock price has been 4x YTD from January 2, 2020’s close price $10.58, and has been ~3.5x from March’s range of $11-$12. DraftKings now has a market cap of over $18 billion.
On a high-level analysis, DraftKings’ current over $18 billion market cap is already higher than the $18 billion market cap of the combined Flutter Entertainment, the world’s largest online gambling company.
The combined Flutter Entertainment owns Paddy Power (Europe), FanDuel (US), BetFair (Europe), The Stars Group (Canada-based, also owns UK-based Sky Betting & Gaming), and other subsidies. It runs over a dozen international brands and platforms that cover the global market, including Paddy Power, Betfair, Pokerstars, Sky Bet, Sportsbet, FOX Bet, FanDuel, TVG and Adjarabet.
This online gambling giant had in total $5.17 billion revenue and $200 million net profit in full year 2019 [2]
It’s worth mentioning that FanDuel, one of the subsidies owned by the combined Flutter Entertainment, is the main direct competitor of DraftKings.
DraftKings, on the other hand, had just $323 million revenue and $142 million loss in full year 2019.
Also, DraftKings’ most recent Q1 2020 earnings were actually rather disappointing: The company missed both revenue and EPS consensus in Q1 by a lot: a widened loss of $68.7 million on an $88.5 million revenue: $88.5m revenue missed the consensus $104m revenue, and $68.7m loss or -$0.18 EPS largely missed the consensus -$0.08 EPS [3]
That is to say, DraftKings is losing $0.78 on every $1 revenue. (!) This looks like a fundamentally unprofitable and hyped business.
Anyway, if we just compare the top lines of DraftKings and the combined Flutter Entertainment, DraftKings has just a tiny fraction of the revenue (6.2% to be precise in terms of revenue in 2019, $323 million vs. Flutter’s $5.17 billion) of the combined Flutter Entertainment’s gigantic revenue.
How can on earth that DraftKings’ stock reaches the current unbelievably high market cap that is higher than the combined giant Flutter Entertainment’s market cap, while DraftKings’ revenue is just a tiny fraction (6.2%) of the combined Flutter Entertainment’s revenue ?!
Plus, DraftKings’ main direct competitor FanDuel is actually owned by Flutter Entertainment as a subsidy, and these two companies are doing the exact same business with the exact same business model!
Also, not to mention that, first, FanDuel has a larger market share than DraftKings, and second, the combined Flutter Entertainment is a profitable company ($200 million net profit in 2019), while DraftKings is nowadays losing about $70 million each quarter.
DraftKings will likely do a secondary stock offering to raise money at a certain point in the foreseeable future. DraftKings’ cash reserve is about $490 million according to the its latest earning.
Side-by-side comparison between DraftKings and Flutter Entertainment
Flutter Entertainment (US ADR ticker: PDYPY, ticker: FLTR in London Stock Exchange [4]) is the world’s largest online gambling company based on revenue.
Flutter Entertainment recently completed its merger with Canada-based The Stars Group (TSG) on May 5, 2020.
The combined Flutter Entertainment runs over a dozen international brands and platforms that cover the global market, including Paddy Power, Betfair, Pokerstars, Sky Bet, Sportsbet, FOX Bet, FanDuel, TVG and Adjarabet.
FanDuel, as the main direct competitor of DraftKings in US, is a subsidy of the combined Flutter Entertainment.
FanDuel alone has a larger market share than DraftKings in US. We can safely conclude that FanDuel alone should be at least as valuable as DraftKings, based on various metrics such as market share, number of users, revenue, etc.
Before the Flutter Entertainment/The Stars Group merger, Flutter Entertainment had $2.64 billion revenue and $138.12 million net profit in full year 2019; The Stars Group had $2.53 billion revenue and $61.9 million net profit in full year 2019.
In total, the combined Flutter Entertainment had $5.17 billion revenue and $200 million net profit in full year 2019. [2]
Given the nature of the low profit margin (typically a low single digit percent) of an online gambling company and fierce competitions (no one can monopoly in this online gambling space), an online gambling company’s P/S ratio (market cap to revenue ratio) is typically less than 3 times, definitely less than 4 times P/S ratio.
This typical relatively low P/S ratio also applies to other established brick-and-mortar casinos such as MGM Resorts (ticker: MGM).
Let’s just do some quick math and calculate Flutter Entertainment’s P/S ratio based on its 2019 revenue as an example:
Before merged with The Stars Group, Flutter Entertainment (which includes FanDuel in US, Paddy Power and Betfair in Europe) had a market cap of ~$7 billion, on a $2.64 billion revenue in 2019. This means a 2.65 times P/S ratio. ($7b / $2.64b) Yes, less than 3.
Flutter Entertainment paid a premium to acquire The Stars Group. Now the combined Flutter Entertainment has a market cap of ~$18 billion, on a combined $5.17 billion revenue in 2019. This means a 3.5 times P/S ratio. ($18b / $5.17b) Still less than 4.
Now let’s go back to DraftKings and do a reality check.
DraftKings has an over $18 billion market cap now (over 437 million outstanding class A shares including warrants/options to be exercised, over $40 stock price now) on a $323 million revenue in 2019.
This means… a jaw-dropping 55.7 P/S ratio! ($18 billion / $323 million)
You read it right: 55.7 times P/S ratio for an online gambling company.
DrafKings now has more than 10 times of P/S ratio of the parent company of its main direct competitor FanDuel, while FanDuel alone has a larger market share than DraftKings!
This obviously makes no sense.
Such ridiculous P/S ratio cannot and will not sustain long.
And again… Don’t forget that the combined Flutter Entertainment is a profitable company with a $200 million net profit in 2019, while DraftKings is losing ~$70 million each quarter now and won’t turn profitable in the foreseeable future.
We think once the initial hype is worn off, DraftKings will never be able to justify its current “artificially boosted” market cap during the lifetime of the company. Period.
We think DraftKings’ current sky-high market cap is pure hype, caused by a mix of the following reasons:
- Lack of gambling outlets now (casinos/sports are all in shutdown). The gambling enthusiasts thus now turn to gamble on DraftKings stock itself.
- Inexperienced Robinhood crowd with little financial knowledge in favor of meme stocks. There are lots of new and young investors on Robinhood who had never invested in stocks before. Those new investors need to learn a lesson. (which BTW might not be a bad thing in the long run.)
- FOMO (fear of missing out) from retail investors.
- A thin number of floating shares before the lock-up period.
However, like every hype, this hype will be over soon.
One may argue that maybe Flutter Entertainment’s stock is undervalued. This claim might be true to a certain limited extent, but Flutter Entertainment’s stock has been traded for years, a much longer time than DraftKings’ stock. Its stock price is also much more stable and less volatile than DraftKings’ stock price, and should much effectively reflect Flutter Entertainment’s true value. To be honest, we think even Flutter Entertainment’s stock price could be somewhat overpriced at a P/S ratio of 3.5, and at a P/E ratio of 90 ($18 billion market cap / $200 million net profit in 2019). But DraftKings’ current stock price is way too overpriced by any standards. Such hype tends to be short-lived.
One may also argue that DraftKings has a bright future, and its potential total market is huge. We will demonstrate later that even if we are optimistic and assumes DraftKings does capture a sizable market share of the US online gambling market, it still cannot justify its current sky-high market cap.
Comparison between DraftKings and Beyond Meat
One stock that had similar retail mania was Beyond Meat (ticker: BYND):
Beyond Meat’s all-time intraday high was $239.71 on July 26, 2019, or an all-time intraday high market cap of $14.91 billion.
Beyond Meat’s stock later fell sharply to a fraction of its high after the hype, to the range of $70-$80 in November 2019, or a market cap in the range of $4.3 billion-4.9 billion after the hype. It bounced back recently but still at a fraction of its high.
One may argue that Beyond Meat, with a huge potential market, does not have a mature similar company to compare with, thus Beyond Meat’s stock price could soar beyond any wildest imagination. Such claim might be true for Beyond Meat, but definitely not for DraftKings. DraftKings does have the mature combined Flutter Entertainment (contains Paddy Power/FanDuel/BetFair/The Stars Group) to compare with.
Flutter Entertainment is a also an online gambling company that does exactly the same business with the exact same business model; plus one of its subsidies FanDuel competes directly with DraftKings, while FanDuel alone has larger market share than DraftKings.
DraftKings’ total addressable market size is also limited, to be illustrated below.
A few key takeaways
After extensive research on DraftKings and the gambling industry in general, we have the following takeaways:
- The profit margin of running an online gambling business is actually fairly low, typically a low single digit percent, even when the market is fully matured and the competitions are less fierce. This profit margin is much lower than most people thought. The “profit” to be held from running a betting book is typically below 7% of the money wagered. (it’s like commissions), and there are high tax rates and other operating costs. Before the Flutter Entertainment/The Starts Group merger, Flutter Entertainment had a 5.2% profit margin in 2019, and The Starts Group had a 2.4% profit margin in 2019. [2] One should never evaluate an online gambling company as a tech company given its inevitably low profit margin. Trying to evaluate an online gambling company as a tech company is ridiculously wrong, or an attempt to mislead retail investors.
- The entire online gambling market in US is likely much smaller than a lot of people thought. “Nevada’s hold suggests, then, that a fully legalized nationwide market would only drive roughly $10 billion in revenue.” [5] Plus, this $10 billion market size could take tens of years to be fully legalized and materialize. This is a very limited total addressable market (TAM) size. Even if we are relatively optimistic that DraftKings can capture 20% out of the $10 billion fully legalized nationwide addressable market, which means a $2 billion revenue target in 2030, and even if we use a high end 3.5 P/S ratio, the company would then be worth around $7 billion market cap in 10 years. This would be, however, still less than half of DraftKings’ current sky-high $18 billion market cap.
- There are fierce competitions now and ahead (that’s partially why DraftKings is losing ~$70 million on a ~$90 million revenue in Q1 2020, and it will not turn profitable in the foreseeable future). First, FanDuel is in a better position in our opinion with a larger market share now. Secondly, brick-and-mortar casinos will all jump into this online gambling space and compete. Actually, brick-and-mortar casinos have advantages that they can get online gambling licenses easier, while DraftKings has to choose a brick-and-mortar casino partner in each state and do profit sharing per law. Once law permits, every casino will have its own online gambling app. Professional gamblers/gambling enthusiasts will just shop for the best line. There is little brand loyalty because it’s just commodity online gambling. There is no monopoly or network effect like tech companies.
- The DraftKings management/insiders/earlier investors were willing to go IPO (via a reverse acquisition) at a $3.3 billion market cap or $10 per share just a few months ago in December 2019. Their bigger competitor FanDuel, which has a larger market share, was sold for a fraction of that price at about $500 million in 2018 to Flutter Entertainment. We now witnessed the market cap of DraftKings sky-rocked from $3.3 billion to $18 billion market cap in just a few months, while DraftKings’ fundamentals had no material change. So, are the DraftKings’ management/insiders/earlier renowned investors so dumb that they left tons of money on the table to agree on a $10 per share/$3.3 billion market cap merger terms? (To be clearer, if the management were able to push for a higher market cap for DraftKings, the per-share stock price would remain the same at $10, but there will be much more new shares to be issued to the old DraftKings shareholders, making it a higher market cap) We think, to be honest, even $10 per share/$3.3 billion market cap is already over-priced given the current status of the company and the outlook of the industry. We believe that DraftKings’ negotiated $3.3 billion market cap was actually at the upper bound that the management/earlier investors were able to push during the merger negotiation with the old DEAC founders Harry Sloan and Jeff Sagansky. Remember, DraftKings’ renowned earlier investors (to name a few, the Raine Group, Redpoint Ventures, GGV Capital, Atlas Venture) have veto rights to reject a merger deal that they are not satisfied, and these renowned investors are extremely smart people and always do extensive market due diligence — they will never accept a deal that is not good enough. Now think about it: Who is smarter? Who will likely lose money when the hype is over? The average gamblers who are now gambling on a gambling company’s stock; or the smart and greedy (no offense because being greedy also means being responsible for LPs, which is good) insiders/earlier investors, who have far more power, money and influence than the average gamblers, run the gambling company itself, and know a lot more insider information? Unfortunately, the losers always tend to be the average gamblers.
Lock-up period
In particular, aside from other aforementioned reasons, one of the major reasons why DraftKings’ stock price has been soaring recently is because the number of floating shares is thin (just around 40 million floating shares out of over 437 million total class A shares). That’s less than 10% of the total outstanding class A stocks.
With such thin floating shares, a few people with relatively larger capital could possibly manipulate the stock price and play a “pump-and-dump” scheme.
Here are more details in terms of the lock-up period:
The founders/directors of the old DEAC company (the SPAC — special purpose acquisition company before the reverse merger), originally had a one year lock-up period from the date of completion of the reverse merger dated April 24, 2020, but their lock-up period has now shortened to 180 days given that “the stock is traded over $15 for at least for 20 out of 30 consecutive trading days” condition is met. (See DraftKings’ SEC filing that contains lock-up period information: https://www.sec.gov/Archives/edgar/data/1772757/000110465920001249/tv535007-s4.htm )
In short, the major shareholders of the old DEAC company management (mainly, Harry Sloan and Jeff Sagansky) now also have a 180-day lock-up period, and thus they can sell much earlier than they were originally allowed.
DraftKings’ major shareholders such as previous rounds of investors (to name a few, the Raine Group, Redpoint Ventures, GGV Capital, Atlas Venture, etc.), employees, management/directors all have a 180-day lock-up period from April 24, 2020.
There will be more than 300 million shares of DraftKings Class A stock (plus exercised warrants/options) to be unlocked into the market and become eligible for sale in October 2020, an ~10x times increase of the floating shares.
Those large shareholders/insiders will all rush to sell once the lock-up period is over. This happened to Beyond Meat before, according to Beyond Meat’s SEC filings, and will happen again on DraftKings. [6] BTW, Beyond Meat’s stock price began its sharp crash before the lock-up period expired, not after.
A meme stock
Interestingly, we found that almost half of the popular posts on Reddit stocks section recently are all about DKNG. The “stocks” section of Reddit should now be literally renamed to “DKNG” section.
Literally, everyone is talking about DKNG. Someone named it “everyone’s favorite DKNG”. There is even a popular nickname created for this stock: “Donkey Kong”. People are showing off how much profit they have earned (on the paper now). People are talking about how unbelievably profitable that this stock has been, and how it has gone up non-stop.
This does partially explain the current retail mania. But the fact that everybody is talking about/buying a particular stock, is actually a huge red flag and serves as an extreme bear signal. When everybody is talking about it, it’s too late for the party and it’s about to collapse.
Among many Reddit posts on DKNG, we noticed one unique different voice:
“Lots of positive discussions around DKNG.
But does anyone notice the majority of the reddit users encouraging to buy are new reddit users? When you click on their profile they’re under 100 day accounts. Some not even a week!
Not all accounts are new but the majority are. Is this common when a company wants you to buy? Like they create bot accounts to create hype?”
We did some check and it seems to be true that the majority of the users promoting the DKNG stock are new Reddit users. If they are indeed bots to create artificial hype, the impressive run from $11 to $40 of DKNG stock could be a part of a pump and dump scheme. If they are real humans, they are likely the new influx of inexperienced new retail investors. Either way, new users promoting DKNG stock is certainly a very dangerous sign.
One of the popular and widely accepted believes among the crowd is that “When NBA announces a return it’s gonna shoot up. When MLB announces a return it’s gonna shoot up.”.
This sounds reasonable at first glance, but such things have been well priced-in given the current extremely irrational demand/FOMO (fear of missing out) on this stock.
The crowd (in particular, the Robinhood new investor crowd) doesn’t even realize or doesn’t care the already sky-high market cap (BTW DKNG’s market cap shown on Robinhood app is wrong as of now) and pays little attention to the company’s fundamentals. Those new investors also don’t know the brutal fact that even DrafKings’ total addressable market can no longer justify its current valuation hype.
Conclusion
It’s just a retail mania on the DraftKings stock now. The retail crowd is intrigued by a fundamentally unprofitable and hyped business.
Reaching $1 billion annual revenue goal for DraftKings (from $323 million revenue in 2019, i.e. 3x from 2019) will be a long and hard road, even at a fully legalized nationwide market which itself would take years to materialize.
We doubt if DraftKings can reach the $1 billion revenue goal by 2025.
And even if one day that DraftKings finally achieves the $1 billion annual revenue goal after years, its then fair market cap should be just a few billion dollars (i.e. below $15 per share) as an online gambling company, due to the nature of the business model with an inevitably low P/S ratio when the stock price is stabilized and effectively reflects its fundamentals.
When the hype is over, people will realize that DraftKings is not a tech company, but another commodity online gambling company with low profit margin in an industry full of fierce competitions. Monopoly in the gambling industry does not exist.
We think once the initial hype is over, DaftKings’s stock price will go back to well below $20 (very likely below $15, or even below $10) given the limited total addressable market size and low profit margin, as aforementioned.
Existing DraftKings investors should sell ASAP to realize the already “too good to be real” profit to avoid big losses ahead, while interested potential investors should avoid buying it now until a real pullback below $15 or even below $10, given its huge downside risks.
Before merged with The Stars Group (TSG), Flutter Entertainment had 2.14 billion GBP revenue ($2.64 billion revenue, updated with the latest GBP/USD exchange rate), and 111.9 million GBP net profit ($138.12 million net profit) in full year 2019. [7]
The Stars Group had $2.53 billion revenue and $61.9 million net profit in full year 2019. [8]
The combined Flutter Entertainment had in total $5.17 billion revenue and $200 million net profit in full year 2019.
[5] https://www.nasdaq.com/articles/wait-for-the-pullback-in-draftkings-stock-2020-05-12
[7] https://en.wikipedia.org/wiki/Flutter_Entertainment
[8] https://www.onlinepokerreport.com/40384/stars-group-2019-online-gambling-revenue/
