Mentioned in Video:

😎 #CathieWood has made this stock one of the biggest positions across #ARKInvest despite Hindenburg Research coming out with a massive short report alleging criminal activities ranging from black market gaming to organized crime. Is DraftKings (#DKNG) a fraud, or could this gamble turn out to be one of the best stocks to buy now?

Video Transcript:



[00:00:00.000]
We got some breaking news right now. Draft King shares. They are plunging right now. Hindenburg Research is just out with a new short call on the stock. It's based on alleging that the merger with Bulgaria's SBTech brought exposure to extensive dealings in black market gaming money laundering and, organized crime.

[00:00:17.310]
I'm back with another drama filled and volatile tech company, and this time I'm raising the stakes. A little over a week ago, Hindenburg Research, the firm that helped expose the fraud at Nikola, released a short report about Draft Kings, ticker symbol DKNG, which is one of ARK Invest's top 25 holdings. They alleged all sorts of criminal activity ranging from black market gaming to money laundering and other forms of organized crime. What did Cathie Wood do in response? Buy another $42 million worth of shares. So in this episode, I'm shining a light onto one of ARK Invest's biggest bets so that we can decide whether or not this stock is worth the gamble.

[00:00:57.490]
If you enjoyed this type of commentary and analysis, consider liking this video and subscribing to the channel with all notifications turned on. That way, you'll be the first to know when I come out with new research, regardless of how YouTube tunes its algorithm. Let's roll the dice. ARK Invest has been buying massive amounts of DraftKings since the rotation out of growth stocks began. DraftKings is now the 19th biggest position in ARKW, ARK Invest's fund themed around the next generation of Internet applications. It's the 27th biggest position in ARKF, their fintech ETF and number 18 in ARKK,

[00:01:32.440]
ARK Invest's $22 billion flagship fund filled with their highest conviction stocks. If you combine their six actively managed funds, DraftKings is their 21st biggest position overall, with almost $600 million in it. Notably, about 7% of ARK's position or $42 million was bought in response to the short seller report put out by Hindenburg Research. Most short reports are published with one goal in mind: to scare investors with weak hands into selling their shares at bargain basement prices. They often do this by making big claims that either end up being misleading or insignificant.

[00:02:08.700]
Hindenburg Research reports are usually neither of these things because instead they often allege outright fraud like they did with Nikola. But this one doesn't do that. It mostly alleges some shady dealings by SBTech, a bedding engine that combined with DraftKings during their SPAC merger last year and focuses on DraftKings' high valuation despite the risks and regulatory hurdles associated with online gambling, while pointing out that they still have negative earnings. So that will be the outline for this episode. What do DraftKings and SBTech do today?

[00:02:40.320]
What is the deal with ARK Invest's crazy high conviction in this stock? And what do their future and finances look like based on trends in state regulations surrounding sports betting and gambling? Let's start with Cathie Wood's outlook on DraftKings, which she talked about on episode nine of Benzinga's Raz Report earlier this year.

[00:02:58.400]
What we do think sports betting actually is losing its taint, DraftKings is becoming a platform for sports betting. States in crisis with huge deficits are going to capitulate one after another and then one of the most mature betting States, New Jersey, DraftKings reported last week its revenues were up 100%. Again, this was another stay at home beneficiary. So people said, ah, you know, we're going to get back to life as usual. This is going to be part of life as usual. And so New Jersey was very telling to us, and we do believe that it is a platform strategy in the space.

[00:03:49.340]
Okay, so let's discuss the numerous tailwinds Cathie Wood's just mentioned. We're seeing a big cultural shift in the acceptance of sports betting in general and online betting specifically. We're also seeing states with big deficits loosen up on regulations about betting in order to access a new taxable revenue stream. This is on top of more and more forms of entertainment moving online in the face of the pandemic as real life options became more limited. We all get that. But that's on top of adults spending more time per day on their mobile devices each and every year, even before the pandemic began.

[00:04:22.280]
Sure that growth rate will soil in the future, but only because all of that growth moved up to 2020. The reason all of these matters is because DraftKings is a leading mobile online betting platform and all of those words are contributing to their massive growth rate. I agree with Cathie Wood (surprise, surprise) that a lot of these factors will become a part of life as usual. Even as things open back up. However, I'm trying to be better about backing my opinion with data instead of just putting my biased pro technology views on stay at home stocks out there.

[00:04:55.030]
So let's listen to DraftKings' CEO Jason Robins talking about these same factors and how DraftKings' future is affected by the reopening economy on CNBC's Tech Deck.

[00:05:05.910]
And the season at large, as this economy reopens, I guess, can you put into perspective the tailwinds that you're expecting for the rest of the year relative to where we thought we were going to be, say, about six months ago?

[00:05:19.060]
Well, you saw some of that in Q1. We had an incredible quarter, really just hit on all cylinders and so happy with all the metrics and results that we deliver. We also did a ton on the strategic relationship side. A lot of products that we released. We have some upcoming social features which I think are going to be game changing… So, as far as the rest of the year goes. I think that as you see, people hopefully return to more of whatever normal looks like. We haven't seen any adverse impact so far as more vaccinated people get out and about.

[00:05:51.830]
Obviously, we think we had some benefit from more of stay at home and things like that. But so far we haven't seen any loss of momentum. So we're certainly being appropriately cautious about what that could look like. But everything we're seeing in the data suggests that strong momentum is continuing, and we feel like we are all lined up to have a great last few quarters of the year.

[00:06:12.540]
My expectation is that these trends will continue and as investors, that's what we should look for in future earnings reports. So let's talk about SBTech, which is DraftKings' betting engine and the major focus of the Hindenburg Research short report. SBTech allows DraftKings to have their own predictive betting engine instead of having to rely on an existing outside service. This isn't really about cost cutting. It's about being vertically integrated and having the ability to offer tailormade bets that are unique to DraftKings and can hypertarget individual users.

[00:06:43.180]
This is about adding market differentiation and increasing user retention. And it sounds great, on paper. But just how important is SBTech to DraftKings' longterm success? Here is some much needed context from none other than Jim Cramer on a recent episode of CNBC's Market Alert.

[00:07:00.100]
Did you look at DraftKings, by the way, since we talked about it yesterday? Right.

[00:07:04.000]
We had the Hindenburg report, and then we had another report that Cathie Wood…

[00:07:09.200]
900,000 shares, $42 million worth?

[00:07:11.900]
How many divisions?

[00:07:12.650]
Not insignificant in this, I think may not look again. I worked with Jeff King. I think Jason office runs an outfit where he literally could take this one division and just sell it to somebody for dollar. And then Hindenburg the vision. And then Hindenburg would have to say, you know what? No harm, no fail, stop goes hard. All Jason has to do is get rid of that one division.

[00:07:34.630]
But you could.

[00:07:35.400]
I think that what matters with DraftKings is gambling, whether more people gamble and whether they have a low cost of acquisition, that's what matters, not a division that they can get rid of tomorrow. So Cathie Wood, I think ultimately is going to be right. If you have an NFL season, when more people want to gamble, do you think we're going to remember this little division, that's 8% of their business? No.

[00:07:58.280]
I actually think that Jim Cramer is spot on here. Hindenburg Research is alleging that SBTech is involved in black market gaming, money laundering and organized crime. These are serious accusations, as both Jim Cramer and the report itself point out, SBTech accounted for about 25% of DraftKings' revenue at the time of their merger in April of 2020 and accounts for less than 10% today, just a little over one year later. By DraftKings' own projections, it could be less than 4% of their total revenue when they're fully up and running.

[00:08:29.910]
Even if these allegations were true. Unless we find out that Draft Kings knowingly profited from these illegal activities and the government gets involved or DraftKings' partners start to leave, I don't really see these allegations as meaningful. If something extreme does happen, I'll be sure to update my own investment thesis and make another episode to update you as well. The Hindenburg report also included some points that make me feel like it's much more designed to tank DraftKings' stock price than to expose serious criminal activity.

[00:08:58.400]
Here's the second to last bullet point in the intro. We spoke with several industry experts and competitors who questioned the viability of DraftKings' model of aggressively burning cash on promotion and marketing to acquire customers in the near term, despite a lack of evidence of longterm customer brand loyalty. In a recent episode, I talked about Skillz, ticker symbol SKLZ, another online gaming company that recently had several short reports tanking stock price just like with DraftKings. I also shared my research about how I concluded the findings in those short reports were pretty insignificant.

[00:09:32.850]
I'll leave a link to that episode in the top right hand corner of your screen right now and in the description below as well. The reason I'm mentioning skills here is because both companies have the same kind of unit economics. They spend money on marketing to acquire new customers. Those are customer acquisition costs or CAC, and they end up being paid upfront. Separately, they spend money to incentivize existing customers to spend more money over time. Those are customer retention costs, and they accrue with every little promotion and cross sell.

[00:10:03.270]
So all customer acquisition costs are marketing costs, but not all marketing costs are customer acquisition costs. In my opinion, all of these short reports for DraftKings and Skillz are making the same big mistake. As a result, I really agree with what Jim Cramer thinks investors should be focused on: how many states legalize online sports betting and casino gaming? How many of the people in those states DraftKings can acquire with their first move for advantage and their actual customer acquisition costs in doing so? Here's a clip from CNBC's Squawk Box from mid June where Jason Robins talked about their rapidly expanding total addressable market and their declining customer acquisition costs.

[00:10:43.340]
What are you doing to try and make sure that you don't see a slow down? I know your marketing budget soared in the first quarter. That was something that was a little offsetting to some investors who worried about that. I thought maybe you guys would turn more profitable earlier. Are you spending more on marketing because you want to make sure sure you hold on to your customers that you picked up during the pandemic?

[00:11:02.370]
No, not at all. We spend on marketing primarily for customer acquisition. It's all data driven. We look at customer acquisition on a horizontal basis. If we can acquire customers with the right ROI and the right payback periods that we feel are appropriate for our stage of business, then we'll do it. We actually are way under our target for CAC, so we actually are trying to find more ways to spend marketing profitably. It's really amazing that we've been able to increase spend so much and are acquiring customers more efficiently than before.

[00:11:34.240]
I do think that itself might be a little bit of a function of the stay at home nature, the pandemic. So we'll see if that continues. I don't necessarily think there'll be any impact to the retention side, but I could see a little bit of a slowdown customer acquisition, but there's so much growth right now in the industry. New states are opening up. Five or six states have already passed laws this year. I I don't think anything is really going to be noticeable. Maybe instead of growing triple digits it's 80-90% or something like that, but I don't think that we're going to see anything material.

[00:12:03.500]
We can see this in DraftKings' data as well. It always costs more to acquire a customer who doesn't know your business than it does to retain a customer once they've already spent money with that same business. Customer acquisition costs are going to be high in states that have just legalized these activities because everyone in them will be new to legal online sports betting in general and drafting specifically, as more and more people become returning customers over time, customer acquisition spend goes down and customer retention spend goes up.

[00:12:32.570]
So overall marketing spent per person goes down over time. As it turns out, a customer that's been with DraftKings for one year or four fiscal quarters ends up paying back about 70% of the money it costs to acquire them. A customer that's been with them for two years or eight fiscal quarters pays back over 250% of that customer acquisition cost. One call out I want to make is that DraftKings only has two cohorts that are over eight quarters old, so we should really pay attention to how these numbers change in the next few quarters because two isn't exactly a huge sample size.

[00:13:06.160]
Jason Robins also talked about new game changing social features. In the near future, users will be able to make a profile page, got a friends list, receive notifications, comment on the activities of other users, and, of course, record and share the bets they make across the DraftKings platform. In my opinion, words like platform and ecosystem are incredibly important to ARK Invest because they can leverage powerful advantages. For example, DraftKings has built a suite of integrated apps for paid fantasy sports, online sports betting, or OSB, and igaming, which are casino games like Blackjack and Slots.

[00:13:41.560]
One reason there are three separate apps is because those activities might be regulated differently in each state, so there are nuances when it comes to what DraftKings can offer, promote, cross sell, and so on within each app. The thing is, they only have to spend money to acquire a user on one of those offerings, then they can pay much less to get them to spend over time, including having them try the other offerings since they're already on the platform. The DraftKings integrated platform allows them to use data from each one of these apps to target ads and personalized experiences on any one of them.

[00:14:14.230]
For example, if a young man in New Jersey has $20 in his DraftKings wallet and DraftKings knows he likes UFC fighting and football, DraftKings can offer him entry into a UFC themed prize pool in fantasy sports, a specific sports bet on Connor McGregor's upcoming UFC fight, and for him to try a football themed Black Jack Game while he's waiting for that fight to start, and tactics like that are working. 57% of online sports betting users also placed a casino bet in 2020, largely because of these types of cross sells from one app to the other.

[00:14:46.330]
DraftKings currently has 26 games that were built in 2019 and 2020 and are planning to launch another 20 games in 2021. Going the other way, being able to offer taylor-made online sports bets to people inside their casino games is probably going to be just as beneficial to Draft Kings in the long run. Their third app, Daily Fantasy Sports, or DFS, is also a significant source of data for opportunities for future cross selling. Their DFS paid user database has over 5 million unique users over 43 states, and DraftKings expects to cross sell more than 50% of them as new states legalize online sports betting or casino gaming.

[00:15:24.700]
For many states, their cross sell rate is closer to 60%. This is another very powerful platform effect when it comes to the vision of Draft Kings future, which I usually talk about up front, I think it will be just more of the same and that's not a bad thing. DraftKings is a pure play platform. They offer a very niche set of activities with strict rules and regulations that vary state by state and country by country. As more parts of the world pass favorable legislation, Draft Kings will create new sets of tailored content for the new demographics that come with entering these new markets.

[00:15:56.660]
As more sports leagues and competitive games find themselves increasingly focusing on interactive experiences and mobile content, which is the current trend, DraftKings offers a serious avenue for partnerships and licenses similar to Skillz' stock. They can also partner with other companies to offer joint rewards or cross promote services. If you win your next bet, your next Uber Eats delivery is on us. Ultimately, the thing I like most about DraftKings is they're a digitally native, data driven company that's disrupting a primarily in person industry just like Square is doing with banks and Teladoc is doing with traditional healthcare.

[00:16:30.890]
DraftKings could one day do with casinos and betting rings. It's still pretty early in the race, but as time passes, DraftKings could really be a horse worth betting on. I hope this episode helped you learn a little bit about what DraftKings and SBTech do today. The tailwinds that are causing ARK Invest's crazy high conviction and what their future could hold despite Hindenberg's short report. If it did, let me know by investing in the like button and subscribing to the channel with all notifications turned on, that's a great way to invest in the channel that invests in you. Until next time.

[00:17:02.030]
This is Ticker Symbol: You. My name is Alex, reminding you that the best investment you can make is in you.

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Alex Divinsky

πŸ’° Investing in our future through disruptive innovation, β˜• lover of coffee, πŸ“Ί host of Ticker Symbol: YOU on YouTube

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