The narrative has shifted for mobile sports-betting stocks as of late. Sentiment was at an all-time high during the heat of the pandemic as consumers relied on online platforms to place their bets. From April 2020 through September 2021, DraftKings (DKNG -4.91%) stock rallied more than 400%, reaching levels as high as $72 per share.
Since then, it has been a different story for DraftKings. The stock has plunged nearly 70% in the past six months to just above $14. As a result, investors are now pondering whether or not they should scoop up shares of the online gambling leader. Let’s consider.
On the surface, DraftKings seems poised for success. The company’s top line grew a walloping 111% year over year in 2021, up to $1.3 billion. As mobile betting becomes more widely accepted and states continue to pass favorable legislation, DraftKings is well-positioned to enjoy superb growth. The company has a commanding 29% share of the online sports betting market, second only to FanDuel, which is owned by Flutter Entertainment.
But when you examine DraftKings’ situation in greater detail, you’ll find that it has several alarming drawbacks. On that note, let’s discuss three flaws in DraftKings’ business that investors should consider before blindly buying the stock today.
1. Crowded industry
The online gaming market is set to expand at a compound annual rate of 12% to $127 billion by 2027. Needless to say, an industry with such upside will attract an immense amount of competition, which is exactly what’s transpiring. According to the American Gaming Association, approximately 2,800 websites now offer some mix of mobile gaming and betting.
Fortunately for DraftKings, the company has succeeded in establishing itself as an industry leader, but that doesn’t mean it is fully off the hook. More competition could eat away at margins and prevent it from achieving profitability in the long run.
2. Sky-high operating expenses
As you already know, DraftKings has reported robust growth in past years. There is one caveat that I failed to mention in the introduction, however. Management has made the decision to try to rapidly expand the business via marketing and advertising. This sounds wonderful on the surface, but bear in mind that everything costs money.
DraftKings spent $982 million on sales and marketing in its fiscal 2021, representing 76% of total revenue and a year-over-year increase of 97%. Total operating expenses, which expanded 99% from a year ago, ended at $2.8 billion and corresponded to more than twofold that of DraftKings’ total revenues. There’s no doubt that growth has been accomplished, but it has certainly come at a price. And consequently, DraftKings has been left with monstrous losses.
3. Monstrous net losses
DraftKings’ noteworthy growth serves as only one chapter of a very long story. As a result of its aggressive advertising spend, DraftKings has had to endure massive losses. Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) ended with a loss of $676 million this past year, or 70% higher than 2020’s $392 million loss. And since the company plans to continue investing in expanding its business, investors can expect similar results for the foreseeable future.
Management is guiding an adjusted EBITDA loss between $825 and $925 million this upcoming year, even greater than what was suffered in 2021. Analysts aren’t expecting a positive bottom line until 2025 at the very earliest, and even then, the stars will have to align perfectly for that to occur. As competition heats up and DraftKings continues to excessively burn through cash, there’s a chance that investors never see this company report positive earnings.
Investing in DraftKings is risky behavior
It’s hard to argue against the potential of the online gaming market in the long run. As the world in general becomes increasingly digital, we’ll continue to witness a paradigm shift toward mobile betting and casinos. DraftKings currently sits as a leader in the space, but the company’s business model poses several queries.
The payout in the future could be enormous, but I view DraftKings as an extraordinarily risky investment today. It wouldn’t be unwise to stay away from this company for now, but if you do choose to invest, I suggest only starting a small position.