Cost of Capital at DraftKings Custom Case Solution & Analysis

Case Evidence Brief

1. Financial Metrics

Capital Structure: Post-SPAC merger with Diamond Eagle Acquisition Corp and SBTech, the entity holds approximately 2 billion in cash and no significant traditional long-term debt.
Revenue Growth: Revenue increased from 226 million in 2018 to 435 million in 2019, representing a 92% growth rate. Projections suggest continued triple-digit growth as new states legalize sports betting.
Profitability: Operating losses are substantial. Net loss in 2019 was 211 million. Marketing expenses represent the largest cost driver, often exceeding 50% of revenue.
Market Valuation: Equity market capitalization fluctuated significantly post-listing, reaching over 12 billion in 2020 despite negative earnings.
Beta and Risk: Comparable companies like Flutter Entertainment and Penn National Gaming show levered betas ranging from 1.2 to 2.5, reflecting high sector volatility.

2. Operational Facts

Business Model: Operates across three segments: Daily Fantasy Sports (DFS), Sportsbook, and iGaming.
Technology: Acquisition of SBTech allows for vertical integration of the backend betting engine, removing reliance on third-party providers like Kambi.
Geography: Operations are restricted by state-level regulations. Expansion depends entirely on legislative progress in individual US jurisdictions.
Customer Acquisition: High reliance on digital marketing and high-profile partnerships with sports leagues (NFL, NBA, MLB).

3. Stakeholder Positions

Jason Robins (CEO): Prioritizes rapid market share capture over immediate profitability, arguing that early movers secure long-term loyalty.
Institutional Investors: Seeking a clear path to positive EBITDA while tolerating high burn rates for top-line growth.
State Regulators: Focused on tax revenue and responsible gaming mandates, influencing the variable cost structure through tax rates.

4. Information Gaps

Specific terminal growth rate assumptions for the US sports betting market beyond the five-year horizon.
Detailed breakdown of Customer Acquisition Cost (CAC) vs. Lifetime Value (LTV) at the individual state level.
The exact impact of potential federal excise tax changes on net margins.

Strategic Analysis

1. Core Strategic Question

How should DraftKings calculate its cost of capital to justify aggressive customer acquisition spending in an environment of rising interest rates and delayed profitability?
Does the current valuation reflect fundamental intrinsic value or speculative growth expectations that ignore the weighted average cost of capital (WACC)?

2. Structural Analysis

The sports betting industry suffers from high supplier power and intense rivalry. Professional sports leagues demand data fees, and state governments extract high tax percentages (e.g., 51% in New York). Rivalry is driven by low switching costs for bettors who chase promotional bonuses. DraftKings lacks a traditional moat unless it can achieve scale that lowers its cost of capital relative to smaller entrants.

3. Strategic Options

Option A: Aggressive Market Share Capture. Continue high marketing spend to dominate new states. This assumes LTV will eventually exceed high CAC. Trade-off: Requires constant capital raises, diluting equity if the cost of capital remains high.

Option B: Pivot to Operational Efficiency. Reduce marketing and focus on the SBTech integration to improve margins. Trade-off: Risks losing the top-two market position to FanDuel or BetMGM, which may be fatal in a scale-driven industry.

Option C: Strategic Consolidation. Use equity as currency to acquire smaller regional players or media assets. Trade-off: Integration risk and potential overpayment during periods of high stock volatility.

4. Preliminary Recommendation

DraftKings must adopt a high WACC—likely 12% to 15%—to reflect its equity-only capital structure and high beta. It should pursue Option B, prioritizing the integration of its proprietary technology stack. Ownership of the tech stack is the only path to margin expansion that can offset the high cost of equity capital. Market share without a path to margin is a value-destructive pursuit.

Implementation Roadmap

1. Critical Path

Month 1-3: Complete SBTech migration to eliminate third-party revenue shares. This is the primary lever for margin improvement.
Month 4-6: Implement a tiered marketing spend model. Categorize states by maturity; reduce promotions in mature states while funding new launches.
Month 7-12: Establish a dedicated investor relations program focused on unit economics (LTV/CAC) rather than just user growth.

2. Key Constraints

Regulatory Volatility: Changes in state tax laws can instantly invalidate WACC assumptions and NPV calculations.
Engineering Talent: The speed of tech integration depends on retaining key SBTech personnel post-merger.

3. Risk-Adjusted Implementation Strategy

Execution must be sequenced by state-level profitability. If a state does not show a path to contribution-positive status within 24 months, marketing spend there should be capped. This contingency prevents the organization from burning cash on low-margin jurisdictions while the cost of capital is high. Success depends on shifting the corporate culture from a growth-at-all-costs mindset to one of capital discipline.

Executive Review and BLUF

1. BLUF

DraftKings must transition from a growth-obsessed SPAC narrative to a capital-disciplined operational model. The current cost of capital is high because the market perceives the business as a speculative bet on legalization rather than a sustainable cash-flow engine. Using a WACC below 12% for project evaluation is irresponsible. The priority is vertical integration via SBTech to capture the margin currently leaking to vendors. Failure to pivot will lead to a liquidity crunch or forced consolidation at a depressed valuation.

2. Dangerous Assumption

The analysis assumes that customer loyalty exists in sports betting. If bettors are purely price-sensitive and move wherever the best odds or bonuses are, the high CAC will never be recovered, regardless of the cost of capital used in the models.

3. Unaddressed Risks

Cost of Debt: While currently debt-free, any future transition to a traditional capital structure will be expensive given the lack of collateral and volatile earnings.
Regulatory Backlash: High-profile marketing may trigger restrictive federal legislation similar to the United Kingdom, capping the total addressable market.

4. Unconsidered Alternative

The team should consider a joint venture with a major media conglomerate to subsidize CAC. Instead of buying customers through ads, DraftKings could trade equity for permanent integration into sports broadcasts, structurally lowering the cost of acquisition and the risk profile of the cash flows.