DraftKings Named Top Gaming Idea by Morgan Stanley

Morgan Stanley named DraftKings (NASDAQ: DKNG) one of its best ideas in the gaming and lodging market on Monday, giving the company's shares a much-needed boost.

Analyst Stephen Grambling reaffirmed his "overweight" rating and $51 price target on DraftKings in a letter to clients. That price prediction suggests a 38.3% increase from the close on June 7. The shares of the gaming stock had dropped 13.7% in the previous month when Grambling made his bullish call.

According to Grambling, it is promising that DraftKings has reiterated its 2024 guidance despite recent tax news from Illinois. T ese state recently enacted a progressive tax rate on sports betting, which is especially onerous for the biggest operators. The two biggest online sportsbooks there, DraftKings and FanDuel, will begin paying taxes at an average rate of 36.5% on July 1st, instead of 15%.

T Here's some conjecture that Illinois may eventually allow iGaming after the tax rise on sports betting, which would be advantageous to DraftKings. Although it's unclear whether and when that will occur, the likelihood that any states will introduce online casinos or sports betting this year is increasing as 2024 draws to a close.

Legislative Prospects for DraftKings Are Good

There is some good news on the legislative front for DraftKings and its competitors, even though it is unlikely that the number of states allowing iGaming and sports betting will increase in the US this year.

Grambling thinks it's unlikely that any other states will follow Illinois' lead and increase taxes on sports betting, especially if New Jersey doesn't make the commitment in its next budget. That might dispel worries about the contagion risk associated with the Illinois tax increase. Strong revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) outlooks may also help the gaming stock's short-term gains.

"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).”

On August 1, Boston-based DraftKings is anticipated to release its second-quarter earnings.

Potential Capital Return for DraftKings

DraftKings is still a relatively young company, having just been publicly traded for four years or so. Nonetheless, there is growing discussion among sell-side analysts that a return of money to shareholders may be announced soon due to the gaming company's free cash flow.

DraftKings has not responded to Grambling's statement that the firm operator's second-quarter results would be accompanied by such an announcement.

Analysts haven't favored any one of DraftKings' capital return strategies, and it's uncommon for businesses of DraftKings' age to start quarterly dividends. However, such a move may take the shape of a repurchase, quarterly dividend, or one-time special payout.