DKNG – Fundamental DD Inside – DKNG

by IAMB4TMAN

This is an example of fundamental DD that takes place at ‘smart’ money institutions based on my professional experience in IBD, Private Equity & most recently at a HF (mods can message me for proof). Not thoroughly fleshed out b/c you autists have limited attention spans, but a summary. Figured I’d take the time to give back to this community that has provided many lolz, & should be a good measuring stick when evaluating other forms of fundamental DD posted here.

NFA.

DKNG – DraftKings, Inc.: vertically integrated US mobile betting operator that also provides retail sports betting & back-end betting solutions through SBTech. Think of SBTech as the tech ‘market-maker’ for traditional sports betting, they do all the funny math to set the betting odds & seem to be working on back-end solutions for DKNG Casino

The Big Picture

  • Total annual US Gambling Revenue: ~$90Bn [1]
    • Casinos: ~$75Bn
    • Illegal Sports Betting: ~$13Bn
    • Horse Racing: ~$0.8Bn
    • Daily Fantasy Sports: ~$0.4Bn

Only ~2% of the ~$90Bn gambling revenues were placed online which is the lowest in the world where betting online is legal. For example, in other countries online gaming activity represents ~6% – ~52% of total gambling revenues, with ~12% being the average.

Wall Street expects online gaming revenue to be $20Bn-$40Bn within the next 10 years. For this to be achieved, the online gambling market will have to achieve a ~30% penetration rate on total country gaming revenues. There is an expectation that this is could be easily achievable given penetration trends overseas – see page 11 of this: s1.rationalcdn.com/vendors/stars-group/documents/presentations/TSG-Investor-Day_March-27-2019.pdf

Other catalysts include increasing adaptation of sports betting in more states. States that have both legal sports betting + online sports betting permitted: NV, NJ, WV, PA, IA. Sports betting permitted but no online: DE, MS, RI, MO, AR. Prior to COVID there was ongoing discussions across many States, especially ones with growing deficits to explore how permitting sports betting could create a fresh avenue of tax dollars. Post COVID there is an expectation that these discussions will be given extra focus as many States will be hungry for incremental tax dollars. Important to note that currently 43/50 States allow DFS, but given the small share DFS has on total Gaming Revenues, it increasingly looks like DKNG is banking on traditional sports betting for a variety of reasons, more later. There are entire articles on Google arguing this catalyst so I’ll end this here.

Digging Deeper

DKNG’s main offerings are Daily Fantasy Sports (“DFS”) products & traditional sports book products to its clients. Long story short, a metric to look for in my opinion (that is curiously not reported by management or remarked on) is the hold % in traditional gaming sector parlance or the ‘rake’ & compare it to the ‘traditional’ gaming products like sports betting & Blackjack.

For DFS: DKNG takes ~15% of the prize pool (note: used to be ~6-11% [2]). Curiously, their main competitor FanDuel also has moved up to a ~15% rake recently. Google searches show the smaller competitors have a rake in the ~13% range.

This ‘rake’ has grown ~2x in 6 years, but it has been a delicate move on behalf of management. Why? B/c the more ‘sophisticated’ DFS players (equal to autistic day traders on Robinhood) have noted this increase & based on some Googling, some have moved down market to the smaller players. As a side note, many live casino games have their rules altered to grow the Hold %. For example, Blackjack games with 6:5 payouts on 21 have materially higher Hold % than the traditional BJ rules that pay out 3:2. Given the findings so far, DKNG may not have much room to materially increase its hold % in DFS games in the near-term from current of 15%. More on this later.

Now why is this important? This is important b/c the typical sports book (ex-Parlays) have a ~5% hold %/rake. Parlays have up to a ~30% hold (which is why it’s commonly known as the sucker’s bet), & just for reference, the average Blackjack table clocks in 14.5%. What this means: Every dollar put into these games, the “House” or DKNG, will take 15% of your money for DFS games, for sports bets they will be pocketing ~5%, up to ~30% if you’re into parlays, & we’ll just use the standard 14.5% BJ hold for the DraftKings Casino platform.

So why the acquisition of SBTech & a foray into the traditional sports gambling market? As you can see previously, the illegal sports betting market is >30x the size of the current daily fantasy sports market. So it’s clear that the DFS providers including DKNG are foraying into the space to capture this user base & hopefully convert them into games that have a higher hold %, such as DFS/DKNG Casino.

As of May 2020, DKNG has achieved a 30% penetration rate on its ~4mm ‘monetized’ DFS clientele to its Online Sports Book (OSB), from the OSB+DFS clientele, DKNG has converted 50% into its DraftKings Casino platform.

Including non-monetized users, user base totals at 12mm. Based on these unit economics: every 1mm of additional users -> 333k monetized users for DFS -> 100k users for OSB -> 50k users for DraftKings Casino.

Some Numbers – Italicized/Bolded the important

  • In total, DKNG has DFS paying clientele of ~4mm, the metric management focuses on is “Monthly Unique Payers (MUP)” which spans across DFS & online sports betting***. As of Q1’20 they reported 720,000*** MUPs, representing +16% YoY growth [3]
    • Average revenue per monthly user (ARPU) of ~$41, +11% YoY
      • Based on previous observation of Hold %, looks like ARPU growth will be limited
    • Since ’17, MUP has grown at a ~11% CAGR & ARPU has grown at a ~19% CAGR
    • As a side note: the ~4mm monetized user base was acquired at ~$122/user over 3 years. Total users cost them $41/user over the last 3 years [3].
  • They are currently EBITDA negative & Wall St expects them to be positive by 2023
    • I took a dive into the math driving this, here is a summary:
      • Based on their current cost structure they will need to have ~1.7mm MUPs at an ARPU of ~$46 to break-even. This implies total monetized users of ~10mm from ~4mm currently

Numbers that represent Risks to Long Thesis

  • DKNG’s user base of ~12mm is on the low end of the sector vs. its ‘brick & mortar’ competitor’s user bases (online betting platforms with physical casino presence)
    • CZR with 55mm, MGM with 33mm, ERI with 10mm (in pending merger with CZR, could have a lot of overlap), FanDuel with 8.5mm
    • Is there a concern for increased marketing costs to increase user base? Let’s look at a case study of NJ, the first state to open both mobile & retail sports betting:
      • FanDuel + DraftKings have held 80%+ of the OSB market share since 12/2018 which is estimated to be driven by the conversion opportunity from DFS that is unique to both companies [4]
      • On the flipside, a case study to examine going forward is how DKNG can get OSB customers in a State that does not allow DFS. Nevada. Home to Las Vegas. Prior to NV pushing FanDuel/DKNG out (highly likely due to casino lobbying), NV was a top-15 State in terms of revenue for them. NV is home to the fattest sports book in the US, & recently the gaming commission started to parse the data on sportsbook wagers done online vs. in-person, & it came out to roughly 50/50. It will be interesting to see how they try to capture market share in a state with no DFS
  • Long-term EBITDA margin target of 35% requires huge growth in MUPs
    • Based on their estimated ’22 cost structure: Holding ARPU of ~$46, MUPs will have to be ~5.2mm, a 7x increase from current to achieve a EBITDA margin of 35%
      • A focus on future earnings will be management’s ability to shift to a more fixed-cost structure which would effectively lower the MUP requirement for profitability

Things to look for when going Long

– Progress of additional States legalizing sports betting – specifically, States with DFS already legalized

– Cost structure evolving to a more fixed mix vs. the mostly variable mix currently as this will be the forward figure that determines profitability

– Increasing User Base (Curr.: 12mm) -> Monetized Base (Curr.: 4mm) -> MUP (1Q’20: 0.7mm)

  • Management seems to be focused more on the first step, but one thing to note is that the 33% monetization rate is very high when compared to something like League of Legends which isn’t entirely comparable but in 2013 had a ~4% monetization rate [5]. This, combined with the below implies that this conversion rate may be the ceiling for now
  • As a side note, ~6 years ago FanDuel had ~300k monetized on an ~800k user base for a monetization rate of ~37% [6]

Share Price Target

Given the cost structure of the company, I’m going to base the price targets around Enterprise Value / Revenues (driven by MUPs & ARPUs).

  • MUP sensitivity of 5mm – 6mm
  • ARPU sensitivity from $41 – $47 for an average of $44, just a $3 increase from current of $41.
  • Share Price targets based on 2.0x – 4.5x EV / Sales.
    • Note: Flutter Entertainment (FanDuel ParentCo) trades at ~3.6x EV/Sales

Bear Case MUP: 5mm -> $20.32 – $45.73

Base Case MUP: 5.5mm -> $22.27 – $50.10

Bull Case MUP: 6mm -> $24.21 – $54.47

These MUPs imply a monetized customer base of 28mm – 33mm. At the high-end, this implies that DKNG monetized customer base will equal MGM’s current total user base.

At yesterday’s close of $43.70, DKNG is trading at 3.5x – 4.5x forward Revenues on an expected >5,000 MUPs.

Share Price drivers / considerations:

– Continued multiple expansion

  • Consideration: A 1x premium to FanDuel’s 3.6x, implies a ~15% upside to current. They’re bigger than FanDuel, do they deserve the premium?

– MUP Growth exceeding beyond targets

  • Consideration: Stock currently implies that they should on average be growing at 40% QoQ – during 2018 they had on average +30% growth QoQ in MUPs, marking their best year

Management Team

Jason Robins, 39 – Co-Founder & CEO. Duke BA, started DraftKings from day 1 in 2011. The 2 other buddies he started the Company with are still at DKNG. Dude navigated the Company through the scandal that rocked them in ’15 & ’16, and was the trailblazer in getting DFS labeled as a non-gambling product that enabled it to open in States without a gaming designation. This shit is the stuff that gets people in history books. His accomplishments make him seem like a very competent guy. Has 3 kids now, and only ~3% economic ownership in DKNG but has 90% of the voting power through his Class B share ownership. Also he actively participates in venture investments, sitting on 10 boards.

His comp plan performance bonus target is pretty murky, but main drivers are EPS growth, revenue growth, then a bunch of margin & return metrics, along with share price returns. Overall, very open-ended & it’s safe to say as long as shit doesn’t hit the fan, he will be eligible for his max payouts year over year. I’m assuming the lawyers tried to encompass everything possible for maximum flexibility to justify him earning his max comp as long as DKNG is still around.

Since he’s got voting control of 90%, I’ll end the specific-person overview here, but want to note that they have a very bloated C-suite. 12 folks at DKNG, 8 folks at SBTech, all with C-suite designations. Whereas their main competitor FanDuel, has 3 guys with a C-suite designations & 1 EVP, but is a sub under a larger ParentCo that has its own management team of ~5 guys.

Looking through glassdoor you can see the biggest complaint among employees giving bad reviews is based on management, all of the specific issues they point out IMO are a result of a top-heavy company. Seems like a good starting point to optimize their cost structure, but given Robins’ history of sticking this entire thing through with his co-founders since ’11 stuff like this doesn’t seem to be a part of his playbook. They’re a public company now though, so it’s going to be interesting to see going forward.

TL;DR:

If I were to initiate a position in DKNG, the stock would have to fall to the $35-$37 range for me to be a buyer of the stock, and based on this rough intro analysis I’ll be considering Put options if it breaches $50. I would not touch Calls at this level.

[1] Susquehanna Research – U.S. Online Gambling 6/27/19

[2] rotogrinders.com/articles/bang-for-your-buck-a-look-at-dfs-industry-rake-153302

[3] draftkings.gcs-web.com/static-files/8f3a5c5a-7228-45bf-aab2-63604111c48d

[4] Goldman Sachs Research – DKNG Initiation 5/19/20

[5]www.gamasutra.com/view/news/223071/Dont_monetize_like_League_of_Legends_consultant_says.php

[6] rotogrinders.com/threads/how-many-people-actually-play-dfs-regularly-252044

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.