DraftKings’ Illinois-Induced Sell-Off Exaggerates Contagion Risk, Says Analyst

Following a Tuesday decline brought on by the announcement that Illinois will enact a progressive sports wagering tax that will place the greatest financial burden on the state's top operators based solely on revenue, shares of DraftKings (NASDAQ: DKNG) saw a modest decline on Wednesday.

This implies that the current 15% Illinois tax rate for DraftKings and FanDuel parent company Flutter Entertainment (NYSE: FLUT) might increase to 36% and 37%, respectively. Although investors are alarmed by the possibility of other states adopting similar policies, it was generally anticipated that Illinois, which is facing a severe budget deficit, would raise sports wagering taxes. According to some analysts, "contagion risk" is minimal.

"While we acknowledge accelerating regulatory headwinds, we believe the initial pullback overstates risk of ‘contagion’ while efforts to raise tax revenues read favorably for potential renewed iCasino expansion momentum,” wrote Stifel analyst Jeffrey Stantial in a note to clients.

With a $50 price target—down from $51—Stantial maintained his "buy" rating on DraftKings, indicating a 39% increase from Wednesday's closing.

 

Illinois Tax Law Targets FanDuel and DraftKings

Although DraftKings and FanDuel are not specifically being targeted by Illinois, the way the state's new sports wagering tax is designed puts the biggest operators on the defense.

These are DraftKings and FanDuel, which according to some estimates own between 70% and 75% of the US market for online sports betting. The new Illinois regulation, which will take effect on July 1, mandates that the sportsbook operators with the highest revenue will have to pay the state larger percentages of their adjusted gaming revenue (AGR), while smaller competitors may have their tax obligations lowered.

“Under the new regime, operators would pay 20% on AGR up to $30M; 25% on $30-50M; 30% on $50-100M; 35% on $100-200M; and 40% on >$200M,” added Stantial.

The analyst noted that DraftKings and FanDuel are "disproportionately impacted" by the new tax laws in the Midwest state, and that operators will probably cut their promotional spending in response to the tax hike. Stantial added that Illinois casino companies facing higher tax payments might choose to cut back on their marketing expenditures.

 

Greater Odds Not Likely

Gaming industry trade associations vehemently opposed the Illinois tax plan, arguing that players would bear the consequences as operators would probably have to provide longer odds on games in order to cover the increased fees. Some organizations, however, criticized that business strategy, labeling it questionable and pointing out that bettors have not suffered when sports wagering tax rises have been put into place in developed economies.

Stantial cited Europe and a few US states as proof that there is little data to support the claim that odds get worse when sports betting tax regimes change.

“Bottom line, we see material, but manageable, direct impact from the proposed tax system change to DraftKings/FanDuel. We forecast only modest impact for other operators in the state, with the progressive tax system limiting derivative offsets from market share consolidation historically observed around tax rate hikes,” concluded the analyst.