Sports betting emerging as ‘big long-term trend,’ Needham managing director says

Needham & Company Managing Director Bernie McTernan joins Yahoo Finance Live to discuss the sports betting business, the price target for Draft Kings, Super Bowl betting, and gambling on Peloton.

Video Transcript

JULIE HYMAN: One of the stocks that is down today-- one of the many, many stocks is down today-- is DraftKings. Among other things, we saw an analyst cut his price target this morning on the stock to $46. But still, obviously, that's well above where it is right now. He still has a buy rating. That analyst is Bernie McTernan of Needham & Company, he is joining us now. Bernie, it's great to see you. Good morning. So you're still--

BERNIE MCTERNAN: Hey.

JULIE HYMAN: --bullish on DraftKings long term, but cut the price target. There's some interesting movement in the sports betting business. What led you to do this price cut?

BERNIE MCTERNAN: Yeah. It was really us, you know, recalibrating how we're looking at our stocks, frankly. Our methodology prior, which we still incorporate to some extent, was looking out at a out-year, adjusted EBITDA number, putting a multiple on it, and discounting it back. Clearly the way the market is trading right now, and the amount that unprofitable tech is selling off, the market's not willing to look at stocks like that, it's much more focused on near-term. So what we did is that we focused on what the near-term growth and adjusted margins are over the next two years, and weighted that higher in the way that we-- you know, in our price-target multiple for the stock. And that's really what drove the target change.

Because everything that we're seeing from the estimate side seems really strong. I know we want to talk about the New York launch, but New Jersey numbers are still really strong. December data came out last week. That market opportunity still implies, on a per-capita basis, implies a $27 billion US market opportunity for online sports betting given if there's 100% legalization. That's our above our $22 billion expectation. So again, we're still really bullish on the space, but clearly the market is changing in terms of what they're valuing, growth versus profitability, and we wanted to update our price target accordingly.

BRIAN SOZZI: Bernie, you just think the market is just too concerned about higher interest rates, and their impact on growth stocks like DraftKings? Just listening to you, it sure sounds like there are some positive catalysts to companies like this.

BERNIE MCTERNAN: Yeah. Well, one of the big questions is, will these guys ever make money? And that goes across the space, in general. We don't have DraftKings achieving profitability until 2024, and it's really because all these new state launches are-- it's a new market, so they're going to go in, like New York, invest a lot of money, acquire customers, and they hope that those-- and they've given this data last year at their investor day, showing that that relationship they establish is sticky, but there's just an investment cycle that has to go on as all these new states launch. If the company never launched in another state, we would see that profitability tick up a whole lot quicker, except the tame would be a lot smaller, too.

So we see a real reason for the lower-- or, negative profitability now, or lack of profitability now, and the reason why it can change in the future. The company has already said that they're profitable in New Jersey. And then BetMGM had an investor update last week and said, they're already profitable in New Jersey and profitable in Michigan as well, given their success in iGaming. But again, this isn't a market that wants to look at some of the parts or over-year profitability, or really, any jump through any hoops to get through what the price targets are. It's what are you earning right now. And because of how new the online sports betting and iGaming markets are, these companies aren't generating profits.

BRIAN SOZZI: Bernie, I'm like many. I was up late last night watching a lot of football games. It was a tremendous weekend for the NFL. But look, no Tom Brady in the Super Bowl, no Josh Allen in the Super Bowl. Do you think that will have an effect on Super Bowl betting? And then, by extension, on the likes of DraftKings?

BERNIE MCTERNAN: I mean, there's still Patrick Mahomes, who's probably the biggest superstar in his space. And I think they are 6 and 1/2 point favorites to go to the Super Bowl. So, no-- I mean, I don't know. I mean, if the ratings are down a little bit or not, this is a big long-term trend that's happening. And that's one of the most exciting trends in this industry, really, is the convergence between sports betting and sports media. It's continuing to happen, you're seeing it in the broadcast more.

I mean, ESPN has really changed the way that they're viewing sports betting within the organization, which I think is emblematic of how this industry is changing and that relationship. So long-term, we think, you know-- we're not concerned in terms of one Super Bowl or not. It's just one day for these companies, but it really highlights the long-term convergence between the two is going to be a big driver of that. And I think one of the reasons, too, why you're seeing the Arizona launch was the fastest launch earlier this year, then New York's faster. I think that the reason why these states are launching so quickly is because more people are being introduced to sports betting because they're seeing on their TV screen or on their phones.

JULIE HYMAN: Hey, Bernie. You were just talking before about investment that these companies are making, and I know a lot of that is in the form of promos to get customers in the door. I'm also curious about M&A. There was a report in the New York Post that Wynn Resorts is trying to sell its Wynn Interactive unit at a big discount to where it was valued just about a year ago. Could DraftKings be one of the takers for something-- for a property like that?

BERNIE MCTERNAN: Well, the historical precedent for DraftKings is that they look at everything, right? And so there was the rumor that they were going to buy-- or, not the rumor, that they were holding talks with Entain. That was kind of the original sell-off in DraftKings shares. They bought Golden Nugget Casino. There was-- I think, the information or the New York Post reported that they were looking at the Athletic, too, that was bought by The New York Times. So DraftKings, I think, their model is to look at everything.

What I think that the asset is that WynnBET is really could it be their customer database, and that was so interesting for DraftKings with the Golden Nugget acquisition is to get their hands on these customers, who spend money gambling at the Golden Nugget Resorts. And then DraftKings is a tech company that uses a lot of big data and analytics to go out, like they do with their daily fantasy customer base, to go convert those into online sports betting customers. So they bought Golden Nugget to convert the brick-and-mortar customers into iGaming.

So if there could potentially be that same opportunity for WynnBET, I haven't seen-- I don't know how much they have in terms of a database, but I think databases are really-- you know, they're a huge asset in this space. So I think that would be a reason why they could potentially be an M&A target of a company out there.

JULIE HYMAN: Finally, Bernie, I do want to switch gears for a second, and talk about betting of another sort. And that is whether cust-- whether traders, investors want to gamble on Peloton right now, and come in and buy the stock.

BERNIE MCTERNAN: Nice segue, yeah.

JULIE HYMAN: I tried, I tried. A little tortured, but I tried. The stock is up a little more than a 1 and 1/4% this morning on this report that there is this activist that is pushing for changes at the top of Peloton. How likely do you think it is the black whales will get their way in that? And is that a catalyst for the stock? Would that be something that could push Peloton higher?

BERNIE MCTERNAN: Yeah, it's certainly a great question, and getting a lot of focus right now. You know, John Foley, founder, CEO of the company, I don't know if, you know-- if they, you know-- what his intentions are or not. I think we'll learn a whole lot more in a couple of weeks here when they report earnings. And I think the challenge for the management team is that they need to really pivot from being a hyper-growth company to now where they're not in that part of the S-curve anymore. At least, it seems like that way, and certainly near-term, they're not going to be that way.

So what does that mean for cost cutting? This is a company where you've really had the cost structure balloon over the last few years, in terms of R&D and G&A. And so now the company currently is adjusted EBITDA negative. We think they're going to get to profitability in the second half of this fiscal year and into '23. But there's-- the company is trading about 20 times our fiscal '24 adjusted EBITDA estimate. That drops down to 15 times if we just hold our R&D and G&A budgets flat. So moving from valuing this company on a sales multiple to an EBITDA multiple, I think, is something that they need to work through. And that transition from being a growth stock to a value one is never an easy one.

We kept our buy rating on shares just because we thought the risk-reward for valuation was just way too-- way too encouraging. We think the absolute floor should be about 1 times revenue. That would put the stock at $15. But that 1 times revenue is where hardware comps are trading, like where Fitbit got taken out by Google, or where GoPro is currently trading. Really, the upside for the stock is that they have a a billion dollars of trailing 12-month subscription revenue. Those subscribers are like-- it's like postpaid wireless with the churn, it's sub 1%. So if you look at software comps, even though those comps have come in quite a bit, you know, our peer group that we value it against are trading at 15 times. That would be a $15 billion company if it had that-- if it was trading at those ranges, which would still represent substantial upside from here.

BERNIE MCTERNAN: Yeah. Well, we'll keep watching it to see where the rerating stops. It's paused for today, at the very least. Bernie McTernan, thank you so much. Good to see you. Needham & Company managing director, Bernie McTernan. And we're going--