DraftKings, Penn National Gaming downgraded by Morgan Stanley as coronavirus casts shadow over sports seasons

Morgan Stanley downgraded Penn National Gaming and DraftKings as the firm thinks much of the increased value in both stocks is valid, but adds that both have more than doubled in 2020 and investor expectations may be too high. Morgan Stanley cited 6 major risks, including additional legalization disappointments and the possibility of the NFL season being cancelled. Yahoo Finance’s Dan Roberts breaks down the details.

Video Transcript

MYLES UDLAND: Welcome back to "The Final Round" here on Yahoo Finance. Time now for our "Call of the Day." Today we are talking about Morgan Stanley's latest on the sports gambling name, specifically DraftKings and Penn National, downgrading both stocks. Downgrading DraftKings and Penn both to equal weight. Now the firm does note, both stocks have more than doubled since the start of the year.

Both of these names have really been part of the reopening anticipation trade. And of course, we have some sports back, so that's positive for both platforms. Of course, the football season is really where most of the money and most of the excitement around sports gambling comes. But there has definitely been an anticipation of what that environment may look like as we get into the second half of the year.

But Dan Roberts, I think this is a kind of a downgrade that we talk about from time to time, which is, well, if you listened to our upgrade, you probably made a bunch of money, and we are no longer, as analysts, going to stick our neck out there and say, hey, we think the stock is going to go even higher. We think that these names have probably hit some kind of an interim ceiling.

DAN ROBERTS: Yeah, I think these names just got too overvalued. That's how I interpret this call today. I mean, these stocks really ran high, and ironically, they ran high at a time when there wasn't sports. I mean, DraftKings and Penn and some of the casino names were a big in April and May when there were no live sports to bet on, and it was all the anticipation of how well they would do when sports returned.

Now sports have returned, but let's also add here, that DraftKings in particular, which has only been public since April, DraftKings has been a name that is very vulnerable day to day based on one sports headline. So when Major League Baseball had the first series of games since its return that had to be postponed or canceled due to a number of COVID cases, DraftKings stock fell big.

Then when the two conferences that have canceled fall college, college football conferences, that is the Big Ten and Pac-12, when they announced were not going to have football, DraftKings fell. Meanwhile, of course, speaking of news today, those two conferences now reportedly are trying to reverse their decision. So that's a mess. But also, lo and behold, I'm not that surprised, because the three that haven't canceled are full steam ahead, and now the Big Ten looks kind of silly.

The other thing about this note that I draw attention to, Morgan Stanley lists six reasons that they are a little hesitant on DraftKings now. One of them is, increased competition from Barstool Sports. Well, but they're also downgrading Penn Gaming and Penn is not the majority owner of Barstool Sports. About a month ago, we discussed on this show an upgrade of Penn that was based on the strength of Barstool on the thinking that Barstool Sports, which has mostly been a content site, is going to get into the gaming space.

So just kind of funny. It's kind of like these analysts can pick one thing to either use as a bullish or bearish reason at any given time. And suffice to say, the competition in this space is high. You've got FanDuel, which is now part of Flutter. That's publicly traded overseas. So a lot going on. But if those two college football conferences do reverse their decision, and even if that doesn't happen, come September 10 when NFL returns, I think you're going to see these names surge big. Because when NFL starts every year, that's a huge time for new sign-ups for these services.

MELODY HAHM: Dan, I think that Barstool point is quite humorous, because even in the section where they outline this potential risk for both DraftKings and Penn, the line here I want to quote directly is, "from DraftKings' perspective, we are concerned that Barstool is more successful than expected, potentially taking share away. The industry in general has also become more competitive. But unfortunately from Penn's perspective, we are concerned that the app is not as successful as hoped."

So right now they're just hedging their bets. We know that this analyst two weeks ago prior to DraftKings earnings report had been one of the most bullish on Wall Street. So Myles, to your earlier point, after pumping it up, saying, OK, now we hit sort of the ceiling at this moment in time. And another sort of component to this research note that I think has been a common thread, is a lot of

Analysts think about discretionary spending, is specifically stimulus checks. Where are people getting the extra cash to kind of dabble in online betting, online gaming buy kind of frivolous items, if you will? And so just thinking about that new audience base, who may not have as much in their savings or checking accounts anymore. And we were just talking in the break about furloughed employees. It's just not a fiscally responsible decision. So that is a headwind that could potentially be in the works, as we still do not have another package on the table yet.

JEN ROGERS: And I think the government is in play here in another part of the note as well. I thought the stimulus note and bullet was interesting, but also just how much legislation there is out there, talking about that in here. And I think I kind of took that for granted a little bit. Almost like when we talk about cannabis as well. Like, oh yeah, it's fine, it's out there, we jumped all those hurdles, or you can go cross the tunnel and go place a bet in New Jersey.

But in the note, they say the Louisiana legislature sent a ballot question to voters in November. There's also progress and hope, they say, but in places California, Georgia, Massachusetts, but none of those have passed. So this is still, look, it's still early days here. I just think it's worth noting, because sometimes I think, oh, well, this is done. Like people can do it. And there are still hoops to jump through.

MYLES UDLAND: Yes, well, we have Dan Roberts on staff, so we get every little incremental update on what happens in sports gambling. And I too, Jen, have thought many times, isn't it legal in all 50 states? And Dan reminds me it's legal in 17, fewer than that? I don't know. It's not many states. And it's less than half I think.

DAN ROBERTS: That's right. And I mentioned earlier, by the way, that DraftKings has been a stock very susceptible to just one day of news. Similarly, there have been days when oh, x state is closer and closer to passing legal sports betting, and the stock surges 8%. Well, it didn't happen yet. I mean, you're right, Myles. In one case, which is a month ago, people were saying, OK, Massachusetts is doing it. Well, it will do it when it does it, and it hasn't passed yet. And it is very, has big, big swings positive or negative. Down just today 7% because of the downgrade that you're talking about.

MYLES UDLAND: Yeah. Always tough when a big part of your investment thesis, if it is for other of these names, is regulatory change. Because that, very slow going. Maybe it happens all at once, and then, of course, there are challenges and lawyers lawyer, that's the one thing we know that they will do over time.