HEDGEYE EDGE
DKNG fell short of making it 5 near-perfect quarters in a row, so the illustrious “5-peat” is now off the table. For a variety of reasons, we think the company and stock will be just fine, though. Even the best of “dynasties” in sports and business are rarely perfect. Last night, when working through the model and corresponding with clients, the idea of “dynasties” was on the mind. And perhaps for all the right reasons. Much has been made about the Kansas City Chiefs rise to “dynasty” status given their recent Super Bowl win, but then our mind drifted to examples of real dynasties (sorry Chiefs fans), and we thought of the New England Patriots in the 2000’s and 2010’s. Apple TV is attempting to document the greatness of those Patriots teams in their docuseries entitled “The Dynasty: New England Patriots” – released this week. The greatness of the show can be debated later, but the greatness of those championship winning dynasty teams shouldn’t really be debated.
Get to the point, Hedgeye GLL… Right, so what’s the connection between the New England Patriots “Dynasty” and DKNG? The connection is that while DKNG fell just short of “5-peating” with 5 perfect quarterly prints and guidance updates in a row, so did the New England Patriots in those dynasty years. In fact, the Patriots “only” “repeated” once in their dynasty run of 6 championships and 8 Super Bowl appearances. However, in the process of chasing perfection, the Patriots, or in this case DKNG, showed all the right signs of building for the future and readying for the next championship season. Indeed, while DKNG’s reported Q4 may have missed (hold adjusted materially beat), the upped guidance and forward commentary delivered in a big way. Ultimately, we don’t think a hold impacted quarterly miss is derailing this story – forward numbers need to move much higher, starting with the Q1, and expectations for long term growth and margin expansion also need to move higher. Additionally, we like DKNG’s move to bolt-on “free agent” target Jackpocket, a transaction that should bolster their lineup of brands and offerings.
Looking ahead, as the recent competition and promotional wave moderates and industry growth charges ahead, DKNG should benefit disproportionately. In the words of management, ’23 was a “prove it” year for the company. In the words of Hedgeye, ’24 should be the “breakout” year for the company. It’s time to reload and chase that next championship season (Q1 print and '24). DKNG remains a Best Idea Long.
QUARTERLY REVIEW | FOCUSING ON GUIDANCE… STREET NEEDS TO RAISE #'S
The Print – If not for some hold related headwinds in the quarter, DKNG probably would have destroyed our estimates by a greater magnitude than ever before, and that’s saying something. However, hold-related headwinds, which generally impact the profit line most, were apparent in the quarter. How could we not model them in advance? Our process in terms of modeling DKNG has evolved over the last three years but for the past 18 months has generally remained the same – mobile app data is a helping guide through the quarter, but our robust state by state build gets us to a GGR and then we infer NGR against a blended promo rate. Within that process, there are states where share breakdowns are unknown, or data is incomplete (states haven’t fully reported yet). In the case of Q4, we suspect the variance to our model hinges more on the latter. Additionally, DKNG may have blamed the miss solely on sports outcomes, but promotional trends also came in higher. The good and more important news is that guidance for Q1 and ’24 suggests these issues were a one-off event.
Revenue growth of 44% YoY didn’t accelerate from Q3, but adjusted for hold, growth would have been closer to 64% YoY (a big acceleration). The net effect is that guidance for Q1 is pointing to acceleration, so we’ll call it a wash. If DKNG had the added revenues, we have no doubt the EBITDA number would have been a blockbuster, likely >250MM, even under more conservative (below mgmt.) assumptions. Fixed costs came in 25MM better than modeled and the company showed significant leverage across virtually all cost lines. Despite some variable cost headwinds (higher taxes) due to stronger growth in high tax markets like NY and tax changes in OH, DKNG pulled through a very strong Gross Margin quarter. Marketing spend came in a little higher than modeled, but again, the funds seem well spent given the leverage, the YTD growth, and the outlook for S&M to decline in ’24. We’re looking ahead, and this release gave us plenty reason to do just that.
The Guide – We were looking for a guidance hike on both top and bottom line but DKNG exceeded even our estimates. The negative perception around the Super Bowl outcome (books lost to public) and the general posture towards the competitive landscape and industry growth were mostly proven wrong by DKNG’s guidance. Let’s see if they can deliver, but remember, this isn’t the DKNG of ’21-’22. Following the LTM, there’s some built up credibility with investors, or at least so we think.
DKNG raised the midpoint of their expected EBITDA range by another 60MM and their revenue range by 125MM. This guidance increase is significant because the midpoint of 460MM on EBITDA came 12-13% above pre-print expectations and 2-3% above revenue expectations. Additionally, these EBITDA ranges for ’24 are now 2x higher than where expectations were in the fall of ’21 when the stock was in the $50s. For the near term, management also guided to a Q1 revenue growth rate that was ~8% above pre-print Street revenue expectations. Also, by guiding to breakeven Q1 EBITDA, the Street will need to flip its 45MM (loss) and then smooth out the cadence for the year. The best part about this guide is that given our reset model, we actually see upside beyond these ranges so there could be another round of increases on the Q1 print.
The Acquisition – Part of the release that may have initially spooked some investors was DKNG’s announcement of its acquisition of Jackpocket – a US iLottery powerhouse and emerging iCasino brand. DKNG is funding the 750MM transaction with cash on hand and a small slug of stock. We’ll have a lot more coming as we dive further into the world of iLottery, but at first blush, we like the transaction on many levels. Deal terms are attractive as DKNG bolts on a growthy and high margin business for < 10x EBITDA, not a bad trade when the company’s stock is trading at a nice premium to those levels. Layering in another adjacent business and potentially having another iCasino brand is a good formula. Cross-sell opportunities and wallet share gains should be attractive. The market wasn’t totally enamored with the GNOG acquisition, but that brand is adding an incremental 400-500MM of highly profitable GGR to DKNG each year and growing significantly.
TRACKING INDUSTRY MOMENTUM
Prior to the print, our conversations with investors suggested there might be risk to the guide due to weakening mobile app download data in January and early February. A year or two ago we might have put considerably more weight in raw download data given the cadence of industry expansion, but the industry is further along in the process and January mobile download growth is comping one of the greatest OSB launches in recent history – OH and then MA a few months later. Usage and Time Spent data will be more valuable leading indicators moving forward, we think, especially given the size of the installed base, and those indicators remain growthy on a YoY basis. Since we have a good chunk of January GGR data, we’ll be more focused on that for today and for good reason. In the reporting season to date, GGR trends are accelerating against massive comps and judging by the guidance it sounds like February is off to a strong start as well.
PARTING THOUGHTS – DKNG REMAINS A BEST IDEA LONG
There might be a doubter or a nitpicker or two coming out of last night’s print and guidance. Near term stock performance suggested buy-side expectations had moved higher – so there could be some sell on the news today. And like any print, there’s always something you could point to as a negative, but for DKNG, the overwhelming majority of the Q4 print and outlook is encouraging and should inspire the next leg higher in the stock. Industry momentum, company momentum, an inflection to material EBITDA growth, Free Cash conversion and production, and finally, some strategic tuck-in M&A make this DKNG story a compelling one.
Sure, the stock has done well, but as evidenced by the guidance increase and managements’ reiteration of their long term targets, the stock should continue to push higher. Street analysts should have been busy raising estimates last night, but our suspicion is they won’t raise estimates enough. That’s ok – as bulls on the stock for over a year now, we welcome that setup as it’s helped the company put together a winning formula.
For the investors focused on the 2nd derivative… not to worry, this story still has ample growth ahead. Q1 revenues should accelerate from a hold impacted Q4, and revenue growth for the rest of the year should trend 20-30% YoY. More importantly, the YoY change in $’s of Adj. EBITDA should accelerate from ~ +570MM to ~ +650MM and FCF should accelerate by a comparable margin in $ terms. Transitioning from an accelerating top line story to a massively accelerating bottom line story while at the same time managing growth >20%... now that’s a winning formula.
We have said this before, but we’ll say it again… Pull back the timeline on your stock charts and recall that three years ago this was a 70 stock, it’s 43 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 an evolving target, but our analysis supports a higher stock price from here, and much higher over a longer term horizon. Note our valuation analysis excludes the impact of the Jackpocket acquisition.
