Analysts with Morgan Stanley Research on Wednesday issued an upgrade on DraftKings stock, based on the company’s status as one of the leaders in a hot industry.
In a research note titled “too big an opportunity to ignore,” Morgan Stanley said the early results from legalized gaming in New York state indicate the US sports betting/iGaming market is “likely to be very large,” but with only a handful of market share winners.
The firm said it expects DraftKings to be one of those market share leaders, adding with sentiment at an all-time low on near-term loss concerns, “we see now as a good time to invest for the long term.”
Morgan Stanley upgraded DKNG to “Overweight,” noting the stock is approximately 75% off its 52-week high.
“While we and the market have been focused on near- to medium-term profit concerns, we believe at the current price, one should not ignore that DKNG is a leading market share player in what will be a very large profitable market,” the firm wrote in its analysis. “At $19, the stock is trading at 9x our 2025e EBITDA; using 15x to comp to other High Growth Internet stocks and reflect what we think will still be a double-digit EBITDA grower post-2025, we get to $31, implying ~60% upside.”
The results released by New York state on January 21 were a reminder of “how big and how concentrated an opportunity US sports betting/iGaming is,” the report continued. Given how well the first eight days of online sports betting went, Morgan Stanley said the implied market revenue runrate is $1.9bn, well above its prior $600m 2022 forecast and $1bn 2025 forecast.
The report went on to note Arizona was the last large state to launch and, similarly, annualized revenue is tracking at approximately $400m vs. Morgan Stanley’s pre-market launch 2022 forecast of $219m.
With only four operators live during the first eight days of the New York market, Morgan Stanley said the success of sports betting showed how the leading players “dominate.” DraftKings, FanDuel and Caesars Sportsbook took in 98%/99% of handle and GGR.
In Arizona, the top five operators have had approximately 95% market share to date, in a marketplace with nine operators.
High barriers to entry
In every state that releases market share data, the top five operators have at least 82% combined share, Morgan Stanley noted. Even in Michigan, where there are 14 online sports betting operators, the top five have 90% share.
“Though there is a lot negative written about the levels of marketing and promotional spending, this has driven a very concentrated market that only players of scale can really compete in,” the firm wrote. “The importance of technology and the need to enter into many states, sometimes at relatively similar times, furthers the benefits of scale.”
While barriers to entry are lower online than in-person, “gambling in general is a profitable business,” the report stated. For online, there are numerous public companies globally that have margins ranging from 15%-40%, despite similarly operating in competitive markets.
While the US will not allow iGaming in many states, Morgan Stanley pointed to Australian companies that just have sports betting, yet have margins exceeding 30%.
“DKNG has been able to rationalize promotional spending in PA better than the market, while maintaining market share,” MS said. “Our deep dive of state-by-state marketing and profitability suggests DKNG’s losses should be lower in 2023 than 2022 (and 2021), which we believe could be a major positive catalyst for the stock (though admittedly approximately one year away).”
Potential California market driving bullish expectations
The analysis noted gaming industry watchers are “increasingly confident” California could legalize online sports betting this year.
“If it does, our current market model suggests that could add $2bn to our total addressable market forecasts, and New York could suggest further upside. Louisiana, Ohio, Maryland and Nebraska all are poised to launch this year, which based off recent new market outperformance, could drive additional upside.”
As for bear risks, Morgan Stanley said it expects EBITDA losses of $(883m) this year, which it noted is higher than expectations by others of $(550m).
“Our client conversations suggest the buy side is much closer to us. We also doubt there will be meaningful incremental positive data points around profits near-term, unlike (OW-rated) Flutter. Our model suggests DKNG needs to raise capital again before 2024, but is currently sitting on >$2B of cash, so it can be relatively patient. California legalizing would be positive for long-term value but also push out near-term profitability, and shorten the timeline for a capital raise. There will be new competition in the market, we expect, likely from sports companies Fanatics and ESPN. DKNG's technology is not as good as ENT or FLTR's, but we believe it is better than others. Assuming revenue growth remains impressive, we see a realistic bear case multiple of 3x 2023e revenue = $15.”
