A Mizuho analyst is encouraged by DraftKings’ ability to cut back on promotional expenses
DraftKings Inc.’s stock has been a big recent winner, rising nearly 170% over the past 12 months. But there’s still room to run, according to a new bull.
Mizuho’s Ben Chaiken launched coverage of DraftKings shares DKNG, +0.25% with a buy rating and $58 target price late Monday, with his target implying more than 22% upside from closing levels.
Chaiken called out DraftKings’ “underappreciated” earnings power, as the company has likely been cutting back its external marketing costs in states where it has a more established business. That’s “a very powerful sign for the model once state launches slow.”
Additionally, he estimates that broad promotional expenses equate to 32% to 35% of gross gaming revenue at the moment, meaning that there’s “significant operating leverage in the model as states mature and promotional expense comes down.”
He noted that promotional expenses are charged as a portion of gross gaming revenue, whereas DraftKings reports net gaming revenue, and the “delta” between those two is cost of goods sold (COGS).
“Implicitly this means as promotional expense comes down, COGS remains unchanged, and the model experiences dramatic operating leverage,” Chaiken said.
He sees room for DraftKings to show improvement in hold rates, or the portion of betting money that it retains. The company’s hold rate last year was 9.2%, or 9.8% when adjusted for sport outcomes, he said, but peers are at about 12%. DraftKings can up its game with enhanced pricing and data moves, as well as by getting more bettors to chose “higher-win products” like same-game parlays.
Further, he likes DraftKings’ free cash flow potential. Wall Street once saw DraftKings as unprofitable, though the company booked positive adjusted earnings before interest, taxes, depreciation and amortization in the fourth quarter and is expected to be in the black on an annual basis during 2024.
With that backdrop, the company could becoming “one of the more compelling” free cash flow stories among the companies Chaiken follows, as he calculates the company could convert 90% of Ebitda to free cash flow in time.
DraftKings shares were up fractionally in Monday’s extended session.