Every Monday, the analyst team at Wells Fargo produces a note on the gaming sector looking at sector valuation comparators and recent share price performance.
It’s something of a financial analyst’s nerd paradise, packed as it is with PE ratios, enterprise value to sales metrics, and net leverage forecasts for the major names from the global betting and gaming sector.
As of January 7, foremost among them is DraftKings with 11.8% short interest. Red Rock Resorts aside, it is the only company on a short list of publicly-traded gaming companies with short interest that is into double figures.
The extent of short interest shows how much DraftKings has become a lightning rod for interest in the rise of regulated sports betting in the U.S. It is by far the biggest pure-play online-only gaming operator listed in the U.S. and as such, it is regarded as the bellwether for the nascent sector’s fortunes.
More than that, though, its status as the market leader also offers scope to short the stock.
The mechanics of shorting
For a financial actor – almost certainly a hedge fund – to short a stock, there needs to be liquidity in the shares for them to “borrow” the shares from an investor who is long that stock.
The hedge fund can then sell the stock, hoping that it will fall in price before buying it back at the lower price and giving the shares back to the lender, paying a small lending fee in the process.
In DraftKings’ case, the Wells Fargo table shows that the company has nearly 350m shares in circulation, most of which institutional investors include long-only mutual funds and exchange-traded funds.
In other words, there are more than enough long-only shareholders that would be willing to be the counterparty to a short-seller looking to borrow shares in return for a fee.
Not only are there ample shares going about, but the stock is also liquid in terms of trading volumes every day. As can be seen from the average volume column in the chart above, DraftKings is by far the biggest trading stock in the sector.
It means, as the Wells Fargo table shows, that the days it would take for the short sellers to cover their position (i.e. close out their positions by buying back the shares they previously borrowed) would be the equivalent of just over two days’ worth of activity.
This means the risk of being stuck in a short squeeze is relatively limited.
Why DraftKings?
As mentioned, what is important about DraftKings is that it is the only one of the top four or five operators in the sports-betting space that is a pure-play on U.S. sports-betting and iGaming.
The rest come with various other interests which would complicate the short angle. Flutter, the owner of FanDuel, is a global betting and gaming play with a wide spread of online and retail interests.
Both Caesars and MGM are largely U.S. land-based gaming plays while Penn National has regional gaming as its main revenue driver.
Each has a short interest of between 3% and 5.5%, but those shorts presumably look at the wider gaming picture.
The nearest pure-play peer to DraftKings, Rush Street Interactive, also has a high-ish level of short interest at 7% but it suffers from far smaller liquidity – trading volumes are just over 1m shares a day and the days to cover figure is 3.2 days.
Two sides of the same coin
DraftKings is, then, the proxy for an entire sector. It is the only truly liquid pure-play opportunity for any hedge fund looking to profit either from sector strength or sector weakness.
If your investment manager feels that sports betting has unstoppable momentum and will only expand from here – and there are good reasons to come to that conclusion – then DraftKings is the bet for you.
However, if you are at all unsure about that momentum and perhaps worried about the long-term profitability issue and cornered that igaming won’t expand at a fast enough rate to bolster the prospects of the sports-betting operators, then DraftKings is also your best bet.
With another chart in the Wells Fargo report showing DraftKings’ share price in 2021 down by 41%, it suggests the shorts are potentially winning the argument.
