The tax ripple effect could make sports betting companies riskier bets.
It’s a good news/bad news situation for the U.S. sports betting business. DraftKings (No good -1.93%)Apparently so. The good news is that gambling intermediaries have been making a lot of money lately. The bad news is that state governments may be taking notice and want a bigger share of the revenue.
The size of the cuts, at least in some states, might spook would-be DraftKings millionaires, and is something to consider for anyone thinking of putting down $100,000 for a 10x return, but in the long run, owning a small stake in the company could be a much smarter bet.
DraftKings shares fall amid tax furor
If there’s one thing the market hates, it’s uncertainty, and unfortunately, it’s completely unclear what the long-term impact of Illinois’ tax hikes on sports betting operators will be.
DraftKings shares fell 11% on May 28 after the Illinois Legislature approved a 2025 budget that includes a progressive tax provision that would more than double the top tax rate on sports betting operators like DraftKings. The current tax rate is 15%, but the new bill would raise the tax rate on these companies’ adjusted gross income to as much as 40% for the largest operators, a tax that could exceed the companies’ actual profits from doing business in the state.
Returning to the topic of uncertainty, it’s still not clear exactly how much Illinois’ tax hike will cost DraftKings, or whether other states will follow Illinois’ lead and increase taxes on sports betting operators.
The immediate selloff in DraftKings shares suggests that some traders were fearing a worst-case scenario that I call “tax bill contagion.” The company’s future is so uncertain that it probably wouldn’t be wise to bet $100,000 on DraftKings shares right now (assuming you’re not running a Warren Buffett-sized portfolio).
This isn’t to say that DraftKings stock couldn’t rise 10x over the long term, turning $100,000 into $1 million one day. As far as I’m concerned, a massive rally like the one we saw in 2020-2021 could happen again if the tone of the conversation changes. To quote Needham analyst Bernie McTernan, “I expect the discussion will shift to how much of the tax increase can be offset by investing less in customers.”
It’s not just a state or country issue.
What’s comforting for DraftKings investors is that the company has revenue from multiple states and multiple countries. DraftKings currently offers iGaming in five U.S. states and mobile sports betting in 25 states. It also offers sportsbook and iGaming products in Ontario, Canada, and is in the process of launching a sportsbook product in Puerto Rico.
But as the saying goes, “more money, more problems.” DraftKings recently raised its revenue guidance for fiscal 2024 from $4.65 billion to $4.9 billion to $4.8 billion to $5 billion. That’s encouraging, but with the tax ripple effects looming, the increase in guidance may not be a morale boost for investors.
Then there’s another, highly relevant issue: It’s certainly no coincidence that DraftKings shares made a notable multi-bagger move in 2020 and early 2021, when interest rates were relatively low and inflation wasn’t a top priority in the U.S. If anything could turn a $100,000 investment in DraftKings shares into a position worth $1 million, it would be a shift in Federal Reserve policy, not a change in state-by-state tax laws.
If central bank policies end up providing a tailwind for DraftKings and the company can continue to grow revenue as rapidly as it did in Q1 2024, shareholders should have a pretty good chance of hitting the jackpot. But these are big “ifs,” and it would be unwise to put all your chips on one bet. So avid high rollers should consider scaling back their positions, tempering their optimism with a healthy level of realism, and staking much less than $100,000 on DraftKings shares.
David Moadel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
