DraftKings (DKNG) – Earnings Review – May 4, 2024
Demand
DraftKings met analyst revenue estimates. Its 54.3% 3-year revenue CAGR compares to 56.3% last quarter and 81.2% 2 quarters ago. A lot of DraftKings growth comes from an expanding footprint of legal gambling states. Vitally, its 2018-2022 state cohort is still growing at a 40% Y/Y clip. This indicates a long growth runway, especially considering there’s a large black market market share in the oldest legal states.
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Profitability & Margins
- Beat GAAP EBIT estimates slightly.
- Beat $4M EBITDA estimates by $18M. It posted a 60% incremental EBITDA margin for the quarter.
- Beat -$0.11 EPS estimates by $0.14. Surprise positive EPS quarter.
- Missed GAAP GPM estimates.
Note that margins for this business are highly seasonal. Focus on Y/Y comps.
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Balance Sheet
- $1.2 billion in cash & equivalents.
- $1.25 billion in convertible senior notes.
- No traditional debt.
- Share count rose by 4.2% Y/Y. Not ideal, not terrible, but still my least favorite part of the great report. The team did cite ramping free cash flow (FCF) confidence as a signal to likely initiate a buyback in the coming quarters.
Annual Guidance & Valuation
Guidance does not yet include its Jackpocket online lottery acquisition.
- Raised revenue guidance by 2.6%, which beat estimates by 2%.
- Raised EBITDA guidance by 4.2%, which beat estimates by 2.8%.
- Reiterated 46% adjusted GPM guidance.
- Sees $400 million in 2024 FCF generation.
- Sees 25% Y/Y revenue growth for Q2 and 30% growth in Q3 and Q4.
- Sees $150 million in Q2 EBITDA, $0 in Q3 EBITDA and more than $325 million in Q4 EBITDA. (again, highly seasonal)
DraftKings is currently inflecting to profitability across all relevant metrics. It trades for 94x 2024 earnings, 30x 2025 earnings and 18x 2026 earnings. It trades at a 2024 PEG ratio (using 2-year compounded earnings growth) of 0.75x.
Call & Release
A Blue Chip Brand Emerging:
Sports gambling has extremely low switching costs. The products are relatively similar and the opportunity for competitive differentiation is not abundant. That leaves the potential for spending a fortune on customer acquisition just to lose an established customer to another app. Despite this, DraftKings continues to show clear signs that differentiation is present. Sales and marketing spend again declined by 11% Y/Y, while its overall market share of sports and iCasino rose from 27% to 31%. Its customer acquisition cost (CAC) plummeted by another 40% Y/Y. If this product were purely a commodity, pulling all of that off would be close to impossible. DraftKings has achieved this for several quarters in a row. How is this happening?
I think there are several small factors adding up to something more material. First, the brand has better awareness than anyone else in the space besides ESPN and maybe Flutter’s FanDual. Its online gambling footprint is among the most broadly spread in the USA, which enables more efficient marketing and CAC. Its app interface is also (in my view) on par with FanDual’s for the two best in the market.
Its parley options are as broad or broader than anyone’s in the market, which means happier customers and a more profitable DraftKings. Its pricing and modeling algorithms are also well seasoned with more data than most competitors. This allows DraftKings to offer better uptime vs. substitutes, which is highly important for lucrative categories like live betting. Better data also allows DraftKings to personalize the customer experience more granularly while perfecting back-end processes. Competition can easily emulate and copy a front-end interface. It’s much harder to copy back-end optimizations on user experience, hold rate and engagement as those aren’t visible. Finally, its tech stack vertical integration provides a compelling cost edge.
None of these items seem monumental in isolation, but the data is telling me that the combination is forming the beginnings of a moat.
Cost Discipline from Here:
As already mentioned, DKNG just raised profit targets again. It sees more upside to payments leverage than previously assumed and sees ample opportunity for AI-powered efficiency gains. Margins will keep expanding even through expected increases in overall OpEx. This cost growth is a response to improving marketing payback periods, which unlocks more opportunities to spend.
Sources of Outperformance:
Stronger than expected customer acquisition, retention, and engagement all powered the firm’s Q1 outperformance. Its hold rate of 9.8% also beat expectations and led to the firm raising 2024 hold rate assumptions from 10.25% to 10.5%. That’s the byproduct of its more compelling parlay menu, and more average bets per parlay. It sees more upside here in the coming years. For profits, better-than-expected marketing efficiency drove the success. The outperformance during the quarter was despite abnormally favorable gambler outcomes. This cost DKNG $60 million in revenue and $42 million in EBITDA for the full year guide. It raised guidance despite this headwind.
Cross-Selling:
One of the best ways to drive retention and lifetime value is via cross-selling. The main opportunity here will be more states legalizing iCasino, but its proposed Jackpocket acquisition provides another outlet in the lottery market. It will also be able to market its current offering to that firm’s 700,000+ users (with a bit of customer overlap, I’m sure). Cross-selling means more revenue without commensurate customer acquisition costs. It means lower marketing intensity and higher quality revenue. It helps everywhere.
New States, Footprint & Regulation:
The Vermont and North Carolina debuts went very well. CAC was strong and both states will turn EBITDA positive by the second half of this year. That inflection will come much more quickly than for previous states as DraftKings perfects go-to-market.
DraftKings is live in 25 states (49% of population) for sports gambling and 5 states (11% of the population) for iCasino. It’s in Ontario (40% of Canada) for both. There are 9 states (11% of the population) considering sports gambling legalization and 5 states (12% of the population) for iCasino. The rate of sports gambling legalization is set to slow, with just 3 additional states representing the vast majority of the remaining opportunity. Texas, one of the three big stragglers, should vote on legalization in 2025. The need for more tax revenue is only increasing… legalization throughout the nation is all but inevitable.
DKNG’s daily fantasy products are a great way for it to build early market share in states that haven’t legalized. For example, its new Pick 6 product is performing well in Texas and familiarizing bettors with the brand.
Robins was asked about potential tax rate increases in some states. He sees that as possible only in a couple of them and thinks most realize raising rates will simply push more people to the black market. He also thinks the company can offset higher taxes with lower marketing spend, but that negative trade-off could impact demand levels.
Take
I thought this quarter was fantastic. Anyone disagreeing is likely just looking at how the stock reacted. There’s nothing in here to fundamentally pick at.
