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Investing in sports-books. Is it a lock?

While I’ve yet to attend a brick and mortar casino, I have tried my hand at online sports betting, rather unsuccessfully I might add. Quite quickly into my gambling foray, I experienced firsthand the popular saying, “the house always wins.” After realizing just how unprofitable this new hobby was becoming, I decided to cut my losses and retire (for now…). However, I can’t help but marvel at the product; most people are fully aware that they will very likely lose money by gambling, and yet the industry is growing rapidly as participation continues to rise. So if I return to gambling, it won’t be as a bettor but instead with the other team, buying shares of the “house”.

It certainly seems like there are gambling advertisements (online casinos/sports-books etc.) everywhere you look nowadays. For example, I watched a few minutes of the NHL playoffs the other night, and in that very short time span I noticed the DraftKings logo painted at center ice, and I also saw an ad for BetMGM featuring their brand ambassadour Wayne Gretzky. My father remarked that this partnership was rather interesting considering Gretzky’s wife's alleged ties to an illegal gambling ring financed by former NHL coach Rich Tocchet back in ‘06. Anyway, the point is is that it’s very difficult to go without seeing any sort of promotional material for these sportsbooks throughout the course of a day. Recently I’ve been doing some research on the financial performances of some of the major online sportsbooks, but for this article I’d like to focus primarily on DraftKings.

Like many tech stocks right now, the past few months have not been kind to DraftKings (ticker: DKNG). As of June 13 the stock was selling for about $11/share, down about 60% year to date and a far cry from the $74 the stock commanded in March of 2021. Even though the technology sector has been getting battered as of late, you’re probably still looking for the reason behind the extreme drop. Simply put, it’s is because the only thing worse than a tech company in today’s market is an unprofitable tech company. Although essentially doubling their revenue every year from 2019-2021 (most recently going from $614M to $1.3B from ’21 to ‘22), the operating losses continue to pile up for DraftKings (843M in 2020 and 1.5B in 2021).

This could come as a surprise to some given that the Supreme Court lifted the federal ban on sports betting in 2018, and every year since has seen new states opening their doors to sports betting (i.e. more customers for companies like DraftKings). However, upon examination of DraftKings’ most recent financial statements, you can see they have a very large marketing expense (coming as a surprise to absolutely no one); in 2021 they allocated just over $980M to promotional activities. While cutting back on advertising could potentially lend a hand in the business becoming profitable, clearly DraftKings’ strategy is to capture as much market share as possible through widespread advertising (creating a strong brand) in new markets as they open up.

It seems to be working too, as just within the last two weeks TheScore Media and Gaming announced its plans to shut down its sports-book in the United States. TheScore Bet (which operated in only four U.S. states) was unable to gain a foothold in the U.S. market competing against well-capitalized sports betting giants like DraftKings, BetMGM, etc. Chad Beynon, analyst at Macquarie Capital reaffirmed DraftKings approach when he told Yahoo Finance Canada that “acquiring customers is all about marketing and losing money right now”, and only some companies are “willing to lose hundreds of millions of dollars.” As of today, sports gambling legally operates in 30 states, and if DraftKings can expand to Maryland and Ohio in 2023 (as expected), the sportsbook would be available to 42% of the entire U.S. population. The company also expects to enter California, Florida, and Texas (largest states in the U.S.) upon legalization of mobile sports gambling in those particular states.

The sports gambling sector is attractive as it’s still quite young with lots of room to grow as states continue to pass legalization legislation; Zion Market Research predicts that the world-wide sports betting industry will generate about $179B in revenue by 2028. For a company like DraftKings, their revenues have indicated that they have, and in my estimation, will continue to capitalize on the rapid growth in sports betting to maintain their position at the forefront of the industry. However, I would be remiss not to acknowledge the obstacles that DraftKings faces - they have an abundance of competition (although it does appear to be thinning as the spending war on marketing drags on), and they have rather large costs (e.g. regulatory) when entering into new states.

When it comes to actually investing in the company, the big question is whether DraftKings will actually be able to start making money because investors can only be satisfied by metrics like revenue growth and market share for so long. At this time, I would hesitate to invest as I don’t believe the potential upside justifies the risk. Although DKNG believe they will have positive EBITDA (certainly a step) in the final quarter of 2023, in their Feb. 2022 10-k filing they stated that they “may continue to experience losses in the future,” and they cannot guarantee that they “will achieve profitability.” As such, I might suggest keeping an eye on DraftKings, and to consider investing once the market volatility that we are currently seeing decreases (making the tech sector a more favourable investment), and most importantly if DraftKings is able to start turning a profit. A positive bottom line will go a long way for the stock, and as an investor you would reap the benefits so that BOTH you and “the house” can “always win.”

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