DraftKings Named Top Gaming Idea by Morgan Stanley

Shares of DraftKings (NASDAQ: DKNG) got a much-needed jolt Monday after Morgan Stanley anointed the stock as one of its top ideas in the gaming and lodging space.

An image from a DraftKings office. Morgan Stanley called the stock a top gaming/lodging idea. (Image: Bloomberg)

In a note to clients, analyst Stephen Grambling reiterated an “overweight” rating and $51 price target on DraftKings. That price forecast implies upside of 38.3% from the June 7 close. Grambling’s bullish call on the gaming stock arrived as the shares traded lower by 13.7% over the past month.

Grambling said DraftKings reiterating its 2024 guidance, even in the face of recent tax news out of Illinois, is encouraging. That state recently signed into law a graduated tax rate on sports wagering that is particularly burdensome for the largest operators. Starting July 1, DraftKings and FanDuel — the two largest online sportsbook companies there — will be taxed at an average rate of 36.5%, up from 15%.

There’s some speculation that in the wake of the tax increase on sports wagering, Illinois could eventually approve iGaming, which would benefit DraftKings. It remains to be seen if and when that will happen, but with 2024 nearly half over, the odds are lengthening that any states will add internet casinos or sports betting this year.

Legislative Outlook Not Bad for DraftKings

While it’s unlikely the US iGaming and sports wagering landscapes will grow this year in terms of the number of states permitting those activities, there is some positive news on the legislative front for DraftKings and its peers.

Grambling believes the odds are long any states will follow Illinois in raising sports betting taxes, particularly if New Jersey doesn’t commit to doing so in its upcoming budget. That could allay concerns that the Illinois tax hike carried contagion risk. That could be supportive of near-term gains for the gaming stock as could solid earnings before interest, taxes, depreciation, and amortization (EBITDA) and revenue outlooks.

Our FY24/25/26e Adj. EBITDA estimates move modestly to $570mn/$1,311mn/$2,108mn (vs. $570mn/$1,306mn/$2,111mn prior),” observed Grambling. “Our unchanged 12-month price target of $51 is based on an unchanged 50/50 weighting of ~14x 2026 enterprise value (EV) EV/EBITDA discounted back at a ~13% cost of capital ($45 value) plus our discounted cash flow of $56 using a terminal growth rate of 2.5%, weighted average cost of capital 9.25%, and long-term leverage of ~2x (~30% of EV).”

Boston-based DraftKings is expected to deliver second-quarter results on August 1.

DraftKings Capital Return Possible

DraftKings is about four years removed from becoming a standalone publicly traded company, meaning it’s still a young firm. However, there’s increasing chatter among sell-side analysts that with free cash flow inflecting at the gaming company, return of capital to shareholders could be announced over the near term.

Grambling said such an announcement could accompany the firm operator’s second-quarter results, but DraftKings itself hasn’t commented to that effect.

Such a move could be in the form of a buyback, quarterly dividend, or one-off special dividend, but analysts haven’t leaned into a particular form of capital return by DraftKings,and it’s rare for companies of DraftKings’ age to initiate quarterly dividends.

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