HEDGEYE EDGE
No business model is truly bullet proof but management was as confident yesterday as we’ve heard them. Yes, they’ve held bullish Analyst Days in the past but this one was focused and backed by highly relevant data and insight that actually supported a bullish view. What are the risks or what are you worried about are typical analyst questions at these types of events. Usually, our answers to these questions differ and are more numerous than what a management team would normally provide. This time, for DKNG we agree, it’s all about execution from here given the clear path to a significantly bigger and better business. So far, industry dynamics and management’s exemplary performance over the past 12-14 months have put the company’s business model in as much of a bullet proof scenario as we have in our universe of stocks.
DKNG’s recent Q3 release stole some of the Analyst Day thunder but the company did a nice job to frame up the long term outlook and the bridge to get there. The incremental analysis and commentary corroborated our long term view and we feel even better about the stock than we did before yesterday. We keep coming back to the stark improvement in current fundamentals from where they were when the stock was $72 both from and industry and company perspective. We were short then but now wouldn’t rule out a return to those levels in the not-too-distant future if the business plays like we and management expect. As such, DKNG remains a Best Idea Long at Hedgeye.
investor day | key points
Analyst Days can often be “sell the news” events for stocks without providing much additional insight other than a guidance nugget or two. DKNG, on the other hand, offered a presentation that packed the data punch and addressed the key areas with a lot of long term clarity. Prior analyst events from DKNG lacked direction and ultimately did more to confuse investors as many of the metrics provided didn’t really reconcile with the actual quarterly results format. Investor Relations got the message and offered a nice bridge from positively inflecting current results to its outlook for a long term prosperous business. Slides 17 – 24 outlined much of the bull case on where this company is today vs prior years, and where the company is headed.
DKNG is acquiring more customers at a faster rate, and as a result, ramping existing and new customers to profitability faster with each state vintage. How about handle growth? We remember those concerns in 1H. They were misplaced, and wrong. DKNG’s cohort math shows robust growth by year and ’23 is no exception – state level data shows this but there’s more confirmation after yesterday. Product improvement? DKNG continues to toggle and improve on the product side – major strides over the LTM. Progressive Parlays could be the next big thing. Escalating promotions? That’s one of the latest bear narratives that was disproved by Q3 results and yesterday’s deck further amplified that point. Promo rates are ratcheting down faster, and the level of promotions is lower than prior launches, too. Net revenue growth is exploding higher as a result and given where promos and hold % currently stand, a long tail of growth is likely. What about marketing and costs? No concerns there, either – a lot of improvement within the cohorts and the ’19 and ’21 cohorts are 300-400bps away from long term efficiency expectations.
In detailed fashion, management hit on all the core drivers that analysts and investors can monitor and model on a quarterly basis. The net output was higher than long term EBITDA expectations which should translate into higher estimates.
The EBITDA Ramp…
DKNG has thrown out long term EBITDA targets in the past for investors, but rarely have they done so with the granularity of timing. This investor deck addressed the drivers on how to expand margins and drive EBITDA, but also worked through the timing. DKNG implicitly raised long term EBITDA expectations by focusing its base case only on current and ’24 expected market launches. Even under that base case assumption, expectations for the next 3 years shake out well ahead of the Street, despite that most sell side models already reflecting additional states like MO, GA, SC, and TX to go live by ’26. Got longer term upside? DKNG has plenty of it under a few scenarios, but under the legislation expansion scenario (see slides 33-34), there’s a path toward >$2.5Bn annual EBITDA by ’28. Talk about a ramp…
The FCF Ramp…
We have been harping on the FCF story – see our note HERE and deck HERE – and yesterday’s commentary put that part of the story right out in front. DKNG has more than just strong revenue growth coming ahead, and it’s not just about EBITDA. In fact, EBITDA and FCF should soon be synonymous given the expected 90% FCF conversion. The crowd that has been looking for more could soon find it as DKNG builds into its first extended FCF harvesting cycle. EBITDA has already inflected and has been in the black for three quarters in a row, but free cash flow should as well, and as a result we can begin arguing that DKNG is cheap on FCF and EBITDA. Valuation is not our jam exclusively but with both outputs inflecting favorably and likely to accelerate over the coming years, the numbers work for us.
A tax shield of $1.2Bn from its years of cumulative losses and very low capital intensity should support management’s goal of an FCF conversion rate of ~90% for the foreseeable future. We don’t have many companies in our coverage that can do that – really, it’s just the Hotel C-Corps – and we don’t have any company that can drive those kinds of FCF conversion #’s with mid-teens or better top line growth. Even backing out the SBC tailwinds, the conversion rate would be 60-70%. On our current numbers, which have moved higher following yesterday, the stock is trading at an FCF yield of ~7% on ’25 or ~5% ex. SBC, which we’d argue is cheap given the long-term growth outlook. Between now and ’28, FCF could approach $2Bn annually, implying a 9-10% FCF yield - again, cheap given the long-term growth outlook. Expect to see much more commentary about FCF in the coming year as investors pivot further from EV / Sales and EV / EBITDA to value this machine.
CONCLUSION | Upside From Here…
A lot has gone right for this company, but DKNG still has a lot more respect to be earned given its roller coast start in the online gaming industry. Indeed, respect and a valuation are earned in the market, and DKNG had to claw it back through results and execution and proper investor messaging. From our vantage DKNG has delivered on multiple fronts this year – with four straight earnings beats, acceleration market share gains for all to see intra-quarter, and now, a clear path to real earnings and cash flow as laid out by management. Yes, the stock is up a lot and yes, the company is subject to all the macro risks our other gaming names would be. However, this organic growth story is differentiated, and the catalysts remain in place for numbers to march a lot higher from here.
Pull back the timeline on your stock charts and recall that three years ago this was a >$70 stock, it’s $37 today. The environment for the market was much different then, but we’d argue the visibility and proximity to real EBITDA and cash flow outweigh the changes in fed policy and implicit discount rates. Certainly, our scenario analysis of upside potential supports that view. It’s a moving target, but our analysis supports the stock price of $46 and likely higher as more of the longer term scenario work comes into play.
