I usually avoid the word “bet” when providing financial analysis. That’s because rigorous financial analysis is the opposite of a bet. Rather, it’s a decision supported by solid arguments and facts, all of which form either a bullish or a bearish thesis. But when it comes to sports-betting company DraftKings (NASDAQ:DKNG), I guess I’ll allow an exception to the rule. After all, I have some good reasons to bet against DKNG stock.
There are four main things I considered before making my “bet” against the company: news, earnings, fundamentals and valuation. All of these elements play toward my bearish thesis.
With that in mind, here’s a closer look at the dirty details behind my bet.
DKNG Stock: High-Profile Acquisition Is Still Far From Certain
First, let’s start with the latest business news surrounding the company. DraftKings recently revealed plans to buy U.K. sports betting company Entain for $22 billion.
The offer is a combination of stock and cash, which could add a lot of value to DraftKings. Specifically, “[t]he deal would rapidly expand DraftKings’ expansion into 27 countries where Entain has licenses.” As a strategic move, it seems like a promising way to strengthen DraftKings’ global presence.
However, I am concerned that this offer for Entain is too high. As MarketWatch’s Callum Keown points out, it’s twice as much as a pervious $11 billion offer made by MGM Resorts International (NYSE:MGM). (Note: The offer was was rejected in January 2021). Such a high premium of 100% signals a very bold move. Bold as it may appear, to me this is an indication that the offer is too high.
Why should DraftKings risk paying such a high premium? News of the offer sent DKNG shares tumbling, as investors believe the company may be overpaying for this offer.
Another key point to consider with this deal is that “MGM’s presence makes a potential deal between DraftKings and Entain far from straightforward. Entain owns half of BetMGM, a joint venture with MGM. BetMGM has positioned itself as a key player in the industry in recent years.”
I have the feeling that MGM Resorts will either block the deal or make it too difficult to get approved. None of that is great news for DKNG stock moving forward.
MGM Resorts is a competitor of DraftKings. And it is very difficult for competitors to agree on crucial business decisions and cooperate smoothly.
Q2 2021 Report: Strong on Revenue, But Increasing Losses From Operations
Another key aspect to consider when betting for or against DKNG stock is its recent earnings report. Specifically, for its Q2 2021 earnings, it “reported revenue of $298 million, an increase of 320% compared to $71 million during the same period in 2020.” The company also mentioned in one of its subheadings that “Strong Customer Retention and Acquisition Drove Q2 Results.”
Furthermore, “DraftKings is raising its fiscal year 2021 revenue guidance from a range of $1.05 billion to $1.15 billion to a range of $1.21 billion to $1.29 billion, which equates to year-over-year growth of 88% to 100% and a 14% increase compared to the midpoint of our previous guidance.”
This revenue growth is a big positive factor for DraftKings. However, the 10-Q report showed that loss from operations widened to $646 million for the 6 months ended June 30 2021. Compare that to its loss from operations of $226 million for same period in the year prior and you’ll see why the case for DKNG stock is murky.
My readers know that when I see losses from operations this is not a good thing. Why? Because the company cannot make a profit from its core operations. It demonstrates a business model that does not deliver results and value for the shareholders.
Fundamentals: Examining DraftKing’s Short and Worrisome History
DraftKings went public in 2020 as it combined with Diamond Eagle, a special-purpose acquisition company (SPAC). As such, we have very little public financial data on the company’s history. MarketWatch data shows robust sales growth of 90.02% for 2020 to $614.53 million from $323.41 million in 2019. However, the net loss of $142.73 million in 2019 widened to a net loss of $1.23 billion in 2020.
As expected, DraftKings is also burning cash. It had negative free cash flow in 2019 and 2020, with losses of $63.28 million and $205.91 million. respectively. Its operating margin of -132.19%, net margin of -200.45% and return on equity of -81.56% (according to MarketWatch data) are all terrifying as well.
Valuation: Too Pricey
The final dig against DKNG stock is its valuation. Data taken from Money MSN shows that. on a relative basis, the stock is overvalued.
Specifically, its price-to-sales ratio is 34.63x compared to the P/S ratio of only 3.76x for the Hotels & Entertainment Services industry. Meanwhile, the price-to-book ratio of DraftKings is 15.83x, compared to the P/B of 3.10x for its industry.
DraftKings: A Fifth Factor to Consider
But wait, there’s more! My bet against DKNG stock isn’t complete until you consider a few other challenges the company might face in the long term.
Hindenburg Research posted a report on DraftKings where it mentions that “DraftKings has systematically skirted the law and taken elaborate steps to obfuscate its black market operations. These violations appear to be continuing to this day, all while insiders aggressively cash out amidst the market froth.”
If the allegations of black market operations are correct, then this will be a huge negative DraftKings. Ultimately, when you add all the pieces together, it should be clear why I consider DKNG stock too pricey now. With widening net losses and cash burn, I simply cannot get enthusiastic about the stock.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.