“DraftKings has a history of losses and we may continue to incur losses in the future.”
So runs the warnings section of DraftKings’ SEC results document. It is a standard line, but it is worth bearing in mind, all the same when looking at the company’s bottom line.
For 2021 as a whole, DraftKings notched up an EBITDA loss of $676.1m, up 72.5% on the figure from 2020. This was on revenues that rose 101% to $1.3bn.
The losses were caused by a 129% increase in the cost of revenue to $794.2m, a 98.2% rise in sales and marketing expenses to $981.5m, and a 50.4% uplift in spending on product and technology to $253.7m.
The company made a loss from operations of $1.56bn. So, how do we get to an EBITDA figure that is less than half that?
Share-based rewards
Well, the company adds back $683.3m of stock-based compensation which itself rose 110% year-on-year.
That is, the company lavished on its employees almost three-quarters of a billion dollars of stock-based largesse.
This is far more than the shared-based rewards at any of its rivals. According to Entain’s 2020 annual report, share-based payments totaled £14.8m. At Flutter, the total for 2020 was £52.1m.
These levels of share-based payments are familiar to all high-growth companies, and even non-high-growth companies.
In 2021, PayPal dished out $1.2bn of stock to employees. Snap gave out $1.1bn. Meta (formerly Facebook) handed out a whopping $9.2bn.
The theory behind stock-based compensation
Stock-based compensation refers to the payments of options and stock awards to employees.
For those working at the company, as much as for investors, the appeal of a business such as DraftKings is what it could be in, say, five years.
It is often sold as being one of the perks of the job. You get to share in the company’s success and the harder you work, so the theory runs, the better the company performs and the better the company performs, the better the share price performance and, ultimately, the better the compensation.
To use the dreaded f-word, it is the flywheel effect in motion.
The accounting treatment issue
However, issues start to arise when it comes out to how such compensation is accounted for.
While stock awards have value, they are a non-cash item. As such, a company gets to add back the value of the compensation at an EBITDA level.
Hence the difference between net losses and the EBITDA losses.
Any CFO would validly point out that it is not paying out any actual money for these awards.
But, that stock-based compensation is still instead of pay and bonus awards i.e. actual cash.
Why this matters
Moreover, that flywheel effect only works if the stock is on an upward trajectory. It doesn’t work so well as an incentive when the stock is heading in the wrong direction.
All those people working away at DraftKings will rightly say they have held up their end of the bargain; they have sweated the hours and their success is there for all to see in the rising top-line.
But part of their reward is now sunk below the waterline. Indeed, the employees will have been eyeing the share price decline in the lost year with some dismay. Over the past 12 months, the stock has fallen by over 71%.
Given the competitive nature of the sports-betting sector – not to mention the obvious attractions of other high-growth sectors – it is not hard to think that DraftKings employees might be tempted to go elsewhere if their current rewards package is less than what they bargained for.
All this before the Golden Nugget transaction
Employees won’t be the only ones eyeing the ongoing share price issues. DraftKings will soon complete its acquisition of Golden Nugget Online Gaming, an all-share deal which, as the 10-K also confirmed, comes with an “implied equity value” of ~$1.56bn.
In other words, equity to the value of ~one-fifth of the current depressed market cap of $7.02bn is soon to come onto the market.
The GNOG deal will, it might be surmised, represent an unwanted injection of liquidity for those already holding DraftKings shares.
Taken with the stock-based compensation, it also gives the impression of a company that is hooked on using what it considers to be largely cost-free paper.
(It is worth recalling, at this point, that when DraftKings made public its interest in buying Entain for $22bn, it was also predicated on a large element of paper-based calculations. That bid came when the DraftKings share price was trading at around the $50-a-share mark, well more than its current level of around $17.30.)
Position open – confidence builder
As was evident from the share price reaction to the earnings on Friday, the markets appear to have lost confidence in DraftKings’ ability to deliver the promised bounty from the sports betting and iGaming opportunity in the U.S.
It’s a situation it needs to remedy, not least because if it fails to do so, it might lose the confidence of an altogether more important constituency – its staff.
