To The Moon

"Pret--ay, pret- tay, pret-tay good." - Larry David Fool me once, shame on you. Fool me twice, shame on me, goes the old saw about the inherent gullibility of some investors who cannot withstand the onrush of frenzywhen a stock spikes. In the case of DraftKings Inc.(NASDAQ:DKNG$DraftKings Inc.(DKNG)$ ), we have a prime example of a revival of the heavy breathing that produced the first run-up of the stock from its debut in April 2020. Beginning at $20, DKNG shot to a crazed range of $63 to $72 in 2021 and subsequently collapsed to~$11 last spring as some rationality returned. Neither its highs nor lows reflect a realistic appraisal of smart value for DKNG shares. This stock is again rearing its head with the solid 4Q22 performance ofDKNG's Q4 earningsreleased last week. It should be, at best, a casefor a hold and perhaps an underweighted toe dip for a gaming portfolio. The year ahead does have promise for the sector but is also loaded with potholes that may not support exponential spikes in valuations yet. We checked various formulae for calculating the discounted cash flow ("DCF") value of DKNG. Alpha spread's call is at $19.75, indicating that their numbers showed the stock is fully valued now. That makes a reasonable case in our view. However, GuruFocus puts DKNG's fair value at $16.60 a share, or $3.40 a share overvalued. What raises my red flag on DKNG stock is the mounting number of analysts hopping once more on the bandwagon, projecting exponential upsides ahead based on the solid4Q22 performance. Some PTs ran as high as $33, others north to $46 and up. Some analysts figured a 3X forward FY22 sales implies a valuation of $6.4b, or 28% above its current trade. Its market cap today is at $9.27b compared with $29.2b for PDYPY. (Flutter Entertainment plc (OTCPK:PDYPF) is getting closer to a decision on spinning off FanDuel as a NASDAQ-traded entity entirely based on its U.S. business. That is part of our rationale in preferring that stock to DKNG.) My own value based on an analysis of the entire sports betting spectrum for 2023, and the probable forward events my industry colleagues see, gets DKNG stock into a hold range ~$12-$14 in comparison with key competitors. My favorite in the space was, and is, Fluttter Entertainment, the U.S.-traded global online betting giant based in Ireland. Flutter shares have nearly doubled this year from $45 to $83, as they own the #1 rated possessor of the top share of the U.S. market in FanDuel. (Note: For those inclined to a possible little arbitrage play, I noted in prior articles that PDYPY's London-traded parent, (FLT:RL), trades in Great British Pence equivalent around the same as the NADSAQ security. But there are blips in between due to head and tailwinds out of the EU and other markets where FLTR has operations.) DKNG had a fine 4Q22 in which it reported revenue up a dazzling 81% y/y to $855m, achieved mainly from existing states. That clearly was the good news. Also positive was the trimming of operating losses from an estimated ($525m) to ($400m). One can feel a bit weirded-out when a shrinking of losses is cause for celebration, for certain. But in the case of DKNG, its marketing costs shrinking even that amount is at least a signal from management that they are focused on margin. The company has raised revenue guidance from $2.8b to $3b, which we believe will be achievable, despite the absence of new states with legislation close enough to indicate legalization and operations for 2023. Big kahuna, California, is farther than ever due to a failed referendum. Florida is still tangled in court challenges involving the Seminole casino/gaming exclusivity in that state. Tribal stirrings in Oklahoma and Minnesota are being heard through my own intelligence network, plus faint pulses even coming from Hawaii and Texas. Overall at this point, don't hold your breath on any of these states getting into action at any time we can now see forward to the end of this year. DKNG gross margins have steadily eroded from an early high of 83.45% when the sector was new, and their share of market - far less challenge - to 38.72% in 2021. Since then they have narrowed further, tipping below 30% when the sector grew to 14 viable competitors all throwing mad money at new player marketing. The cost, after state and federal taxes, takes 50 c of every dollar, then marketing, leaving 30% more or less. The same math to a degree engulfs the numbers of competitors. The normalized 7.5% historical mathematical probable hold percentage was reached in 2022. But the good-news front had more to share in that the average betting value per DKNG monthly users ticked up a bit to 2.6m from 2.5m. My last look at the stock before the sunny 4Q22 results spiked the shares over 15% last week was simply this. DKNG had one compelling reason to hold: Either the prospect at some point this year that it would do a transaction as part of an industry-wide consolidation; Or, it would be acquired at a nice premium (given its trading range at the time) by someone like ESPN, or even Amazon (AMZN). Otherwise, I saw a continuing battle between DKNG's ability to hold market share as the #2 platform in the space and the continuing assault of marketing costs in an overcrowded sector that... would become even more crowded ahead. The bad news is that DKNG continues to burn cash as a losing operation even though it still sits on $1.31b after a 40% bonfire of its dough for 2022. But the company will find open windows to borrow if needed, but thanks to the FED that will cost a lot more and not do much for a possible turn to positive EBITDA by early 2024. Sports betting: Real-world headwinds and tailwinds to keep in mind in 2023 that can sneak up on the dream-landers An overview of where the sports betting sector sits now at the gateways of 2023 is meant to be instructive to would-be investors in the space starting to get giddy all over again seeing the dollars raining down based on DKNG 4Q22 results. Discounting that entirely, my only rationale for continuing to hold DKNG is that I do believe that if FLTR moves to unleash FanDuel as a separate entity, then DKNG will be more actively seeking some kind of deal. They still maintain a first-tier share in the sector, and I expect that will continue. Though MGM Resorts International (MGM) has been spurned in its bid for the 50% of BetMGM it doesn't own, I likewise see this happening as well. Consolidation will be the most important engine of upside possibilities in the sector for this year. It is not a matter of if, but only when. Whether it is this year, or 2024, when many sites presumably will begin turning cash flow positive, or the out years, count on this: There will not be 14 major sports betting sites crowding the sector long term, plus dozens of wannabees behind them. 2022 was a solid year overall for the entire casino and wagering market. The AGA has reported that when tribal results are counted in a month, total U.S. gaming revenue will reach $100.6b, from its near 1,000 casinos. Part of that number was the $7.5b in win shared by the sports betting subsector. The top tier platforms, FanDuel, DKNG, BetMGM, and Caesars Sports Book (CZR) still own more than 50% share of the entire market, and we expect that to continue. No moat:I have had numerous discussions with my clients and associates in the gaming business regarding the possible edges one or several of the sites may have on competition. My conclusion is this: Nobody has a distinct, tech stack, marketing, site design, or customer service moat. All sites follow the same recipe with the same ingredients. Having dealt with gamblers from everyday recreational grinders all the way up to whales, I do recognize the comfort levels between various properties they visit, or sites they bet on, which can produce a pecking order of favorites. But in sports betting it is all about the deal. Churn comes because of many reasons too numerous to list here. But given a choice between a tempting promotional deal and a meh one by comparison to the site they decide to join, they will always opt for the best deal. My archived data about the behavior patterns of sports bettors through my own years in gaming has research that clearly shows newbies move first and fastest for the most tempting deal. Say hello to my little friend: He's called Fanatics and he comes armed for the war with more than a pea shooter I have repeatedly noted in my coverage of this sector that I believe that super sports apparel entrepreneur Mitchell Rubin's proclaiming that his company, Fanatics, would become the #1 revenue generator in the sports betting is a bloviation worthy of Baron Munchausen. This is not in any way to diminish the possibilities hiding in Rubin's presumed 82m customer base. The issues are clear: How many of these passionate sports fans who buy team jerseys, hats and other memorabilia can be converted into everyday bettors on the Fanatics site? The site, BetFanatics, or some version of it, is expected to debut imminently both as an operator and subsequently, an IPO. The company has raised $700m and is valued at $31 billion. On a dollar-for-dollar basis, it is theoretically worth more than PDYPY at this moment. (That includes the apparel business.) But Rubin is coming armed to the teeth no matter how exaggerated his claims are at this point. Fanatics will need to enter the market state-by-state with a powerful promotional surge. It is certain its data sets of existing apparel customers have been sliced, diced, and re-diced to tease out the potential bettors from the hat buyers. Bear in mind we don't really know what percentage of Fanatics buyers are under the age of 21-it's no small number. But despite the tough road ahead, Fanatics will arrive at some share of market only by stealing share from existing platforms. Remember that current betting platform databases contain a percentage of players who also buy jerseys and hats. Duplication, as it has dogged the industry from day one, will be a factor here. So one has to conclude that the entry of a well-financed new operator will be disruptive in every state in which they go live no matter their results. And the companies with the fattest market shares are clearly the easiest targets for poaching simply because they have so many customers to begin with. Curb Your Enthusiasm for DraftKings Inc.'s 4Q22 results by more than a shrug when you understand that the meat and potatoes of the NFL season fall in 4Q. That alone is a pop in betting action that all competitors enjoyed. The next biggie is, of course, the NCAA Final Four, which should contain a March bulge. Beyond that, with the number of states now legal probably being stable with no big new legalizations, the battle for market share will heat up. Fanatics won't be the only disrupter. The other will be a recession hitting the economy. Ordinarily, recessions do not hit gaming sectors disproportionately to the rest of the discretionary spending economy. They happen, revenues do tick down. Just consider the very good numbers of DKNG this last quarter. Average monthly users hit $109 in win per month. The TV streamers are already experiencing life with a perpetual churn of ups and downs of subscriber rolls. More critically, consumers are becoming tougher, taking free trials to get a hit show, then canceling when they realize their monthly subscriber bills have run up to three figures. That kind of echoes what happens in sports betting when a player might sign up on a hot deal, use the site a while, then shift his or her action back to another site for an even better deal. It's a psychology that will be exacerbated by an economy moving into the dumpster. Whether it's a hard or soft landing, or even a depression-like collapse of the economy a la 2007/9, there will be a pullback on consumer discretionary spend. It will be even worse, given the skyrocketing cost of food, fuel and housing at the same time, if customers have to decide between the grocery cart and the weekly laydown on a favorite team. These are but a few of the red flags ahead that investors should keep in mind now and not get caught up again in the fervor of one fine quarter for the likes of DraftKings Inc. Hammering away at costs is great. More of the same would be greater. But the top tides of excessive marketing spend will not go away. Though the industry has gotten some religion, it continues to spend in what is a crowded, low-margin business. Somewhere, someone will create a brilliant breakthrough in a software app the operators can use that provides an exponential improvement in measuring the myriad of conditions physical and psychological that form patterns that give more predictability to projections. That is when guidance in the sector will have the kind of heft investors can feel more certain about in determining where to be long, and when. Source: seeking alpha