US sports betting and iGaming industry stock DraftKings (NASDAQ: DKNG) is heavily shorted, which means some speculative traders are betting on its downfall. This bearish case accelerates after a damning report was released last week. So, is DraftKings set to enjoy another short squeeze, or is its share price on a downwards spiral?
Black market ties
DraftKings went public via a special purpose acquisition company (SPAC) in April 2020. At which time it launched on the NASDAQ via Diamond Eagle Acquisition Corp.
However, on June 15, 2021, famed short research publicist Hindenburg Research published a paper alleging a DraftKings subsidiary may have ties to black-market gaming, money laundering, and organized crime.
DraftKings acquired Bulgarian SBTech through the SPAC merger, and it made up over 25% of DraftKings revenue last year.
The research firm estimates 50% of SBTech’s revenue comes from markets where gambling is illegal, such as Iran and China.
Hindenburg also drew attention to over $1.4 billion worth of share sales by company insiders since IPO. In fact, SBTech’s founder sold around $568 million in shares.
Who is Hindenberg Research?
Founded by Nathan Anderson in 2017, Hindenburg Research has rapidly built up a top activist short-seller reputation.
Now DraftKings has been added to the list, and shareholders are in flux.
Short squeeze meme stock
Caught up in January’s short squeeze momentum, DraftKings share price soared to almost $75. Achieving meme stock status, it became a favorite among Redditt’s retail investor community. But today, it’s trading around $49, down from $55 earlier in the month.
Rather than repel meme stock enthusiasts, Hindenburg’s report could act as a catalyst to drive the price higher and squeeze out the short-sellers. Short Interest in DraftKings is currently at 8.5%, according to Koyfin data.
But some of the claims are pretty damaging, and traders could well be wary of getting involved in something with the odds stacked against it.
DraftKings shares are already deemed expensive with an EV/Sales ratio of 21. Moreover, it’s not yet profitable and is unlikely to become profitable before 2026, according to Bloomberg.
Customer acquisition is expensive, and the landscape is hugely competitive.
A highly regulated operating environment
Unfortunately, being a gambling company makes it a sin stock which is potentially a less favorable sector to invest in during the age of ESG investing.
Its main areas of investment are daily fantasy sports, sports betting, and online casino gambling. Each of these has an existing and growing fanbase.
But the entire gambling sector is highly regulated, and each of these divisions faces varying legal restrictions depending on the jurisdiction. This makes predicting its outlook hard because regulatory goalposts can change at any time.
DraftKings subsidiary SBTech isn’t a gambling company itself. It has the leading technology to build the platforms gambling companies want to use.
So, if Ladbrokes wished to create an online casino, it could ask SBTech (among others) what casino games it has available to rent them via a white-labeled product, which would then launch in Ladbrokes name.
SBTech does have competitors, such as FSB Sportsbook, but it’s primarily seen as the best in the business.
SBTech’s clients include several of the world’s premier betting and gaming operators, state lotteries, land-based casinos, and horse racing companies, such as Mansion, Sky Bet, and Danske Spil.
There are three types of market when it comes to gambling:
White markets: Where gambling is legalized.
Black markets: Where explicit prohibitions exist.
Grey markets: Where the lack of clearly defined laws causes ambiguity.
Ultimately, SBTech’s technology is used in many territories where gambling is illegal, such as India and Africa, but demand is there, nonetheless. These are classed as grey markets, whereas Turkey, China, and Iran are black market territories.
A bullish take
Despite the Hindenburg Report, ARK Invest’s Cathie Wood sees value in DraftKings and is bullish on the outlook for US states deregulating their gambling restrictions.
In a March interview, an ARK team member gave an overview of their investment thesis. It’s based on the belief demand far outweighs supply due to the regulatory hurdles these companies have to jump.
Currently, sports betting is illegal in many US states, but that’s gradually changing. And with budget deficits soaring, Wood sees this as a way for US states to bring in much-needed revenues.
DraftKings technology is advanced and vertically integrated to hit the ground running. If states start lifting restrictions, players need to be ready to launch, and ARK believes this is where DraftKings has a clear competitive advantage.
After the Hindenburg Research short-seller report, the DraftKings share price fell around 9%. ARK immediately snapped up another 688,702 shares of DraftKings for its ARK Innovation ETF (NYSEARCA: ARKK), plus more in its ARK Next Generation Internet ETF (NYSEARCA: ARKW).
This shows ARK remains bullish on its future outlook.
And it’s not only ARK. Recent analyst price predictions for DraftKings range between $42.50 to $105. This may well change on the back of the report, but it shows the bull case has been strong.
Over the years, DraftKings has curated partnerships and collaborations with leading international sports brands. These include the NFL, NBA, NASCAR, UFC, and PGA.
It also recently hired supermodel Gisele Bundchen to advise on governance issues.
As Hindenburg’s report pointed out, there’s a risk these partnerships will crumble if it’s shady dealings prove true.
Takeover target or growth through acquisition?
Could DraftKings be a potential takeover target? Its sports betting platform is popular among users for its clean interface and ease of use. When users find a platform they like, they tend to stick with it for convenience.
DraftKings may also have a first-mover advantage with its daily fantasy sports technology, which sports fans love. In 2016, it almost merged with another daily fantasy sports leader FanDuel. But, unfortunately, the Federal Trade Commission (FTC) blocked the deal as it would lead the combined company to control 90% of the market.
Instead, Flutter Entertainment bought a stake in FanDuel in 2018, which Flutter topped up to 95% in December 2020. In March, Flutter said it’s considering spinning FanDuel out, but nothing concrete has been confirmed.
Large addressable market
People from all walks of life enjoy gambling and sports betting in particular. So while competition is fierce, it also has an extensive total addressable market (TAM).
At its March investor day, the company stated its TAM in North America could effectively reach $67 billion at 100% legalization. However, that’s an unlikely target, so it based its outlook on a TAM ranging between $22 billion and $36 billion.
But that’s only in North America. If DraftKings ventures further afield, its potential TAM could be much more significant.
DraftKings currently has a $19.6bn market cap. In light of the Hindenburg report, DraftKings remains a highly speculative investment.
Although large insider share sales don’t shed a good light, this doesn’t appear to have been illegal. The insiders adhered to their lock-up periods.
All-in-all, this could be a case of sensationalist research on the part of Hindenburg, who is striving to make a name off the back of many high-profile companies.
Therefore, DraftKings could go bankrupt or ride the volatility and prosper far into the future. At this early stage, its outlook is unclear.