The crown slips: is DraftKings a takeover target as its shares tank and with cash running out?

There is a ‘be careful what you wish for’ vibe about DraftKings that derives from its status as the bellwether of the US sports betting opportunity. As the highest profile of a very small group of pure-play online gambling operators, it has seen its share price wax and wane depending on how the sector’s fortunes are viewed by the market.

Since floating via a high-profile merger and de-SPAC in early 2020, DraftKings rode the wave of investor enthusiasm to a high of over $70 before sinking back to earth as questions were asked about the sector’s prospects for profitability.

DraftKings’ diminishing cash

The worries about profitability across the sector are particularly acute with DraftKings. The last time the company accessed the markets for cash, it raised $1.27bn in an over-subscribed convertible loan offering. Now, however, after sustaining some considerable losses in the intervening year or so, analysts are speculating about whether the company actually has enough funds to get it through to profitability.

A note from senior analyst John DeCree at CBRE in early May stated that the slow progress of igaming legislation in the US has left investors less confident in the “long-term profitability of a sports-only business in much of the US”.

“This underpins the consensus view that DraftKings will ultimately need to raise money by the end of 2023. We are forecasting the company to end 2023 with about $494m of cash, though we suspect this number could be less if several more states launch between now and then,” DeCree said.

Fears that DraftKings would need to return to the markets to raise more cash – whether as debt or equity – understandably haven’t assisted the shares and helps explain its most recent slump. In the year to date, the shares are off by over 54% at around $11. They have somewhat stabilised in the past month, though, helped by more soothing words from other analysts.

David Katz at Jefferies suggested the markets were being overly pessimistic. “There have been increased concerns around whether the company has enough cash to support the EBITDA burn before turning to profit, which we believe is overblown,” he told clients in a note in mid-May.

Highlighting the convertible loan as well as the $1.77bn of cash at the turn of the year, Katz said the predicted cash burn of about $950m between the second quarter of this year and the fourth quarter of 2023 meant the current cash balance was “sufficient”, even if there is the need to splash out a further $675m should the DraftKings-sponsored note on mobile gaming in California get the nod this coming November.

A foreseeable situation

“If you IPO without profitability, then you are reliant on the capital markets to keep you alive,” says Paul Richardson, a partner at the gambling M&A advisory firm Partis Capital. “This has happened in many other sectors; you are reliant on market sentiment not changing on the sector and the macro situation
remaining stable.”

Echoing this point, Paul Leyland, partner at strategic advisory firm Regulus Partners, says it can be “very dangerous to have a fragile business model at a time of a fragile macro environment”.

Hence (perhaps) the emphasis during DraftKings’ recent second-quarter earnings call on the measures it is taking to staunch some of the losses. There was a notable focus on cost efficiencies (though this was partly about shifting some costs into the second quarter) and CEO Jason Robins was keen to point out that DraftKings was seeing some moderation in the promotional environment.

“I think some of the very aggressive new user offers have tapered off significantly,” Robins told the analysts.

“We all hoped that when the US market opened up operators wouldn’t bonus themselves to death, but that is exactly what happened,” says Richardson, who points out that DraftKings followed a similar strategy in daily fantasy.

The issue for DraftKings is more than just about cost-cutting around the margins, suggests Leyland. “The management thinks the company can lose money because they are in growth mode,” he argues. “But the cost base is too heavy and shaving marketing doesn’t solve the problem.”

So, what happens next?

DraftKings would no doubt counter that it is already moving to ensure its own future. The recent completion of the acquisition of Golden Nugget Online Gaming (GNOG) puts it in a better place when it comes to igaming.

Katz at Jefferies highlighted that while DraftKings has been relatively successful cross-selling gaming to its sports betting customers, adding the Golden Nugget brand means it “should fare better acquiring igaming-only players, given its bricks-and-mortar brand and database”.

However, the prospects for further M&A seem limited. The deal for Golden Nugget was all-shares and came at a time when the shares were trading at a lofty $50-plus. By the time of the failed Entain bid, the shares were already on their way back down. “The reaction to the Entain rejection was brutal and accelerated the share price fall,” says Richardson.

It has left the operator looking vulnerable for the first time in its short history. “The problem they have comes down to the lack of cash,” Richardson adds.

Leyland agrees, remarking that if DraftKings “carries on with what it was doing, and with the same results” then funding would be an issue.

In response to the evident fears on the part of investors around profitability, the company should “invest more in the gaming side and in the product,” Leyland adds. “But the problem will be if they panic about the top line. I don’t think the markets are there for that.”

Richardson agrees that the company will need to prove profitability in 2023 and hopes that the macro situation has improved by then, should the company need to access further finance.

Will profitability be enough?

As it stands, it seems unlikely DraftKings will be regaining the share price heights it achieved as recently as last September. DeCree at CBRE suggested a lack of potential catalysts to change the narrative. “Positive EBITDA may be the only thing this market will be willing to bet on at this point and that could be at least two years away,” he explained.

One potential catalyst, of course, would be if one bidder was to emerge that might have a higher capacity for stomaching the losses until profitability and beyond.

Richardson dismisses the potential for private equity to get involved, however. “Private equity likes to leverage their returns in any deal by borrowing against target companies’ profits,” he says. “But with DraftKings, not only is it currently loss-making, as it stands even when the profits start coming, they won’t be in a big enough wave to support any material borrowings for a while.”

Instead, he thinks that the likeliest endgame would be a bid from an operator, either currently in the market or with ambitions to enter the space. “If it starts to lose market share – because of its focus on making profits rather than grabbing more GGR – that then is problematic and the company really becomes a prime target.”

Richardson suggests a surprising name as one potential candidate for a deal. “If the shareholders ever wanted to go public, I think a reverse takeover by bet365 might be an ideal fit,” he speculates. “They both have powerful brands and bet365 would be able to bring the best product and tech people to the table to complement DraftKings’ market position and customer base.”

Leyland, meanwhile, offers another potential outcome. “DraftKings could buy Entain,” he suggests, pointing out that it would be a scenario where “Entain would need to be super-wounded”, perhaps from the fallout from a split with MGM. At that point, Leyland muses, DraftKings might be able to revive its interest but under much better terms.

The road less followed

Whichever path DraftKings follows from this point, it seems fair to say that the way forward for the operator is now more complicated than was the case when it first floated; its future more unclear than at any time since its IPO.

Growing up in public is a phrase normally associated with the lives of the offspring of celebrity parents, but something similar applies to DraftKings with its high-profile status, as every earnings statement is dissected, every move second-guessed. Such is the fate of a bellwether, the leader with a bell around its neck. And a target on its back.