Is Latest Deal a Bad Bet by DraftKings?
Fourteen months ago, I commented on the special purpose acquisition company (SPAC) deal that made DraftKings (NSDQ: DKNG) a publicly traded company overnight. With the economy shut down due to the coronavirus pandemic, demand for online gambling skyrocketed.
As I noted then, DKNG had tripled in price over the previous 10 weeks. I felt the company was overvalued and likely to fall once a major casino made the jump to online gambling.
That didn’t happen, and the stock continued to move higher. Five months ago, DKNG peaked above $74 to cap a remarkable run during its first year of trading.
Since then, DraftKings has steadily drifted lower to fulfill my premature prophecy. As I expected, competition in the online gaming space has intensified dramatically.
The case I made was simple: “There are a lot of casinos bleeding money at the moment. Some of them may feel compelled to add online gambling to their revenue streams to hedge against a second wave of the coronavirus pandemic later this year.”
I felt DraftKings’ “early mover” advantage would fade quickly once the major casinos started to move in on its turf. It wouldn’t be long until the upstart gambling sites would begin partnering with the casinos.
That expectation proved true this week. On August 9, DraftKings announced that it will “acquire Golden Nugget Online Gaming in an all-stock transaction that has implied equity value of approximately $1.56 billion.”
The press release went on to note that DraftKings will immediately gain access to Golden Nugget’s database of more than 5 million customers. In addition, the combined businesses expect to realize significant financial synergies by consolidating their operating systems and leveraging their advertising budgets.
Raising the Stakes
The day that deal was announced, DKNG nudged slightly higher. Either Wall Street had been expecting this announcement or it was not at all impressed by it.
Either way, the stock market’s tepid response to this development reflects a deeper concern regarding online sports gambling. The same pandemic that gave rise to DraftKings startling success last year could be its undoing this year.
Last week, DraftKings released its fiscal 2021 Q2 results. The numbers were good. Total revenue increased 320% compared to the same period last year.
The company also raised its revenue guidance for this year from “a range of $1.05 billion to $1.15 billion to a range of $1.21 billion to $1.29 billion.” The midpoint of the new estimate is almost double last year’s result.
The company went on to note, “This guidance assumes that all professional and college sports calendars that have been announced occur as scheduled.” Right now, that assumption might be in trouble.
The daily case count for COVID-19 is rising sharply in the United States due to the Delta variant, especially within southern states where several of the top college football teams are located.
Already, several large universities are reconsidering their decision to reopen this fall. Nobody wants a repeat of last year when many college football programs played only a partial season or postponed all games until the spring.
But if it becomes necessary to do that again this year, DraftKings may have to revise its guidance downward for the fourth quarter of this year. And if that happens, look out below!
The easiest way to profit from a big drop in DKNG is to buy a put option on it. A put option increases in value when the price of the underlying security goes down.
A few days ago while DKNG was trading near $52, the put option that expires on January 21 at the $50 strike price could be bought for $6. For that trade to be profitable, DKNG would have to fall below $44 within the next five months.
That works out to a decline of 15%. Under normal conditions, that would be a long way for a stock to fall in a short period of time.
These are not normal conditions. The Delta variant of COVID-19 is a potential game changer. Not only is it more contagious than the Alpha variant of the disease, but it may be more harmful to younger people, too.
Effectively, DraftKings has become a proxy for the Delta variant of COVID-19. Its share price is inversely correlated to the spread of the disease in the U.S.
If the daily case count begins to come down soon, DKNG should be able to live up to its increased guidance for this year. In that case, the option described above will most likely expire with no value.
But if the daily case count continues to rise to the point that college and professional sports leagues must delay or postpone their seasons, DKNG could take a dive.
That makes buying a put option on DraftKings a 50/50 proposition. Guess right, and you could win big. But guess wrong, and you could lose it all.
I don’t like those odds. Instead, I prefer an asset class that generates steady income in all types of market environments.
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