U.S. sports betting stocks have struggled for most of 2021. DraftKings (Nasdaq: DKNG), Penn National Gaming (Nasdaq: PENN) and PointsBet Holdings (OTC: PBTHF) are all down more than 50% from their all-time highs (-52%, -62% and -62.5%, respectively). But Jed Kelly (executive director for equity research, Oppenheimer & Co.) does not believe the market correction is indicative of an investor pool that has soured on the sports betting opportunity. Instead, he points to several short-term headwinds contributing to the snapback in valuations. “One, you’ve had New York [collecting a 51% tax rate],” he said. “Two, you’ve seen a lot of marketing from the land-based casino companies. Three, October wasn’t great. And then four, these high-growth, higher-risk names are just not in vogue right now.”
JWS’ Take: While DKNG, PBTHF and PENN have all lost more than half of their market cap, the sell-off has not been limited to those three companies. Roundhill Investments’ sports betting and iGaming ETF is down -26.5% from its all-time high (posted in April 2021). DKNG, PBTHF and PENN have been the biggest losers among U.S. operators.
It is hard to argue that the market has soured on sports betting when one considers where some of these names were trading prior to pandemic. “PENN was a single-digit stock [$7.89] in March of last year. The DKNG SPAC was at $10 [as late as Q4 2019]. So, maybe the valuations got a little bit ahead of themselves,” Will Hershey, co-founder and CEO of Roundhill Investments, said.
That seems like an understatement. DraftKings’ share price has been cut in half over the last eight months, and yet the company still maintains a $28 billon market cap. “You could make the case that is still pricing in some pretty lofty assumptions for a) market share, b) how big the market will be and c) margins,” Hershey said.
Sports betting companies have suffered from the risk off trading environment that has emerged in 2021. Of course, they are not the only ones. “A lot of the higher beta industries have had huge sell-offs this year as the market has shifted more toward value,” Kelly noted (see: Zoom, -62% off ATH; Lemonade, -70% off ATH). “The cannabis stocks have sold off too.”
Hershey also acknowledged that the ongoing shift from growth to value has hurt the sector and pointed out the change in investor sentiment has coincided with the trend of dumping out of “stocks seen as COVID-19 beneficiaries.” Online sports betting operators certainly fall into that category. “[We have] also started to see the market [largely] move away from companies that are unprofitable to those that are,” he said.
In addition to the macro headwinds cited, there are several industry-level developments that have driven investors to sell. Perhaps most notably, New York’s decision to tax licensed operator revenues at a 51% rate. “It’s a reminder that at the end of the day, the states believe they own gambling. [Sports betting] is not untethered growth,” Kelly explained.
Hershey agreed that New York’s tax-heavy approach has weighed on investors. “The week the New York bids were awarded was the first time the market didn’t just blindly bid up the betting stocks on what was [perceived to be] a positive headline,” he said. “You can attribute it to investors really starting to understand these businesses and how each state is different.” Concerns about the legislation that could come down the pike in states like California and Texas could have pushed some to exit their holdings.
Lower-than-expected October holds (a result of favorites winning out more frequently) has also perhaps dampened share prices—albeit mildly. Stocks trade on quarterly earnings “and [Q4] may be impacted now because of a bad month in October. The really sharp traders will potentially get ahead of that and sell it off,” Hershey explained. That said, Kelly expects the November hold numbers “to be strong” after an upset-heavy month in the NFL.
Increased spending by the land-based casino operators (think: Caesars, MGM)—along with the losses reported by several of the online operators including DraftKings—may have some investors increasingly worried about customer acquisition costs. Those concerns, Kelly says, are warranted, but as a sports betting bull, he does not see it as a reason to sell. “[Investors] just don’t have a ton of visibility in terms of how profitable” the business can be because we have yet to see a fully mature state market. The OpCo research analyst said his firm has “taken all our outer year estimates up. The state data has been strong [from a tax revenue standpoint]. And the thing that no one is really talking about is, iGaming in New Jersey has been live for seven years and is growing 40% [YoY],” Kelly said. “So, [operators] are doing a good job [of growing the customers’ lifetime value and developing the market].”
That last point is a key one. “Long-term investors, at least savvy ones, understand the name of the game here is iGaming and same game parlays,” Hershey said. “The core [sports betting] product is so competitive and not where the money is going to be made.” Instead, operators will work to acquire sports betting customers and convert them into iGaming customers (a higher-margin business with more predictable LTVs).
While the state revenue data has been promising (at least in places with a competitive marketplace and low taxes), a ton of growth potential still remains within the sports betting business. “New Jersey has been live now for three years, and NFL betting is up 40-50% YoY. We’re still so early in this thing,” Kelly said. Remember, this is really the first NFL season with advertising, and micro betting has yet to take off.
Some have suggested investors will need sportsbook operators to successfully introduce ancillary businesses, beyond iGaming, for their investments to pan out (think: NFTs). But both Kelly and Hershey insist these companies can be viable investments as just sports betting and gaming companies. “If you’re looking at less than $1 billion in gross gaming revenue in 2019 to wherever [the sports betting and iGaming industry] ends up, you’re talking about a 20-plus X-ing of top-line growth,” Hershey said. “You’re not going to find that anywhere else in the entire market.”