Stocks to buy

DraftKings (NASDAQ:DKNG) stock has underperformed, remaining sideways so far in 2021. Elsewhere in the market, cryptocurrencies have been providing multi-fold returns at the blink of an eye. In such a scenario, investors seem to have less patience with trades like DKNG stock and favor cryptos instead.

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However, it would be a financial blunder to be solely exposed to cryptocurrencies. There needs to be a balance between high-risk and low-risk investments. In the equity segment, I would look for stocks that have been under-performers, but have positive industry tailwinds.

From that perspective, DKNG stock looks far more interesting. After an extended period of consolidation, it seems positioned for a break-out rally.

Applying a top-down analysis, DraftKings is in an industry that’s positioned for multi-year growth. According to Eilers and Krejcik Gaming, sports betting revenue in the U.S. totaled $2.12 billion through July 2021.

The firm further believes that number can reach $19 billion if the practice is legalized in all states. Further, online casino and poker revenue is likely to hit $20.8 billion once it’s legalized across the U.S.

These estimates imply a total addressable market of $40 billion for DraftKings. Therefore, the growth we see for the company right now is just the tip of the iceberg.

DraftKings Is Pursuing Inorganic Growth

In August 2021, DraftKings announced the acquisition of Golden Nugget Online (NASDAQ:GNOG). With the purchase, the company’s market share in iGaming is likely to increase. At the same time, DraftKings believes the acquisition will bring synergies of more than $300 million in EBITDA at maturity.

It was also reported in September 2021 that DraftKings made a $20 billion offer for Entain, a U.K. sports betting company. More recently, it was reported that DraftKings must decide on a formal buyout offer before Nov. 16. The company is still in a due diligence stage.

However, the key point is that DraftKings is looking to gain market share and enter new markets through acquisitions. It’s worth noting that as of June 2021, the company reported $2.6 billion in cash and equivalents. Further, the balance sheet is not leveraged and this provides ample flexibility to pursue acquisition-driven growth.

On the flip-side, the company continues to report EBITDA level losses. I would not consider it a big risk as long as DraftKings’ top line remains robust. Additionally, monthly unique payer (MUP) growth has been healthy. For Q2 2021, MUP increased by 281% on a year-over-year basis.

Furthermore, the average revenue per monthly unique payer was $80 compared to $63 in the prior year period. If average revenue per MUP continues to trend higher, its EBITDA margin is likely to improve.

The Bottom Line on DKNG Stock

DraftKings has ambitious plans in terms of growth through multiple revenue streams. These include advertising, distribution, subscriptions, licensing and sponsorship. The company’s marketplace is also slated for launch in the coming quarters.

The marketplace will allow customers to buy and sell digital collectibles. This is a high margin business and likely to support its EBITDA margin improvement. DraftKings also believes the marketplace will help in improving customer retention.

In terms of revenue upside potential, the following point is important to note: The company is live with online sports betting in 12 states, and this represents 25% of the U.S. population. Further, the company is live with iGaming in four states. This represents 10% of the U.S. population.

Clearly, there remains a big untapped market. Even if we leave aside the inorganic growth story, there is ample headroom for revenue upside.

Overall, the underperformance in DKNG stock seems like a golden opportunity for accumulation. There can be a case for leveraging and dilution for growth. However, any dilution impact is likely to be more than offset by the revenue upside potential.

On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.