DraftKings Ups the Prediction Market Ante With Railbird Deal

DraftKings (NASDAQ: DKNG) announced that it is acquiring Railbird, a prediction markets platform. This deal is part of the sportsbook operator's efforts to launch its own event contracts exchange.

Shares in the company have moved higher on the news. As you may recall, the stock previously took a big dive, on rising concerns about prediction platforms like Kalshi and Polymarket threatening its business model.

However, two questions now linger. First, is DraftKings' prediction gambit going to prove profitable? Second, is DraftKings pursuing these efforts because it honestly believes prediction markets are the future, or is management simply trying to calm the market's "disruption" fears related to this stock?

Let's explore both questions and determine what this means for investing in DraftKings at current prices.

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DraftKings' rapid move into the prediction markets space

When the Railbird acquisition news first broke during after-hours trading on Oct. 21, investors reacted positively to the news, sending shares 3% higher through the following trading day. Not exactly a big rally for the stock, but still, an acknowledgement that the market perceived this as positive news for the company.

Previously, I noted how entering the prediction market space itself could be one way DraftKings could mitigate the impact of this newfound competitive threat. However, upon further thought and analysis of this deal, I've taken a more skeptical view regarding DraftKings' chances of success with this venture. Namely, in terms of how much the "house" collects as a sportsbook versus when it operates as a "prediction market exchange."

DraftKings' sportsbook bakes into its betting lines the traditional vigorish, or "vig." This creates a hold on sportsbook wagers of just under 5%, and in the case of other popular wagers like parlays, the hold can be considerably higher. On multi-leg parlay wagers, the house's hold can exceed 20%.

Platforms like Kalshi, on the other hand, only make money from transaction fees. These make up a much smaller percentage of the overall volume. If DraftKings were to fully convert into a prediction market, it would likely have a serious effect on gross margins.

A real pivot, or just some window dressing?

Sure, I may be jumping to conclusions when stating that DraftKings' prediction markets pivot could prove to be a disaster. For one, DraftKings isn't planning to offer prediction contracts on sporting events in markets where it is already a licensed sportsbook.

This move, which should also help to avoid conflicts with state regulators, would enable DraftKings to enter U.S. states where traditional sportsbooks are not yet legal, such as California and Texas. That said, if DraftKings' plan is to only operate as a sports prediction market in some parts of the U.S., reaching profitability with its DraftKings Predictions venture could prove elusive.

Moreover, this also brings up the above-mentioned second question about this deal. Does DraftKings want to move into prediction markets? Or is the company just putting up some window dressing to appease investors? If a prediction market made a market on this question, I'd take a position on the latter.

Nevertheless, while DraftKings' "pivot" into prediction markets may not necessarily be a game-changer, there is still a silver lining here when it comes to DraftKings' long-term prospects. It remains unclear how long prediction markets will be able to operate as de facto sportsbooks in the United States.

Is DraftKings a Buy?

So far, the Commodities Futures Trading Commission (CFTC), which regulates and licenses prediction markets in the U.S., has yet to explicitly state whether these platforms can make markets in sporting events. These platforms have instead self-certified that they can offer these contracts, and go to great lengths to avoid referring to them as related to "gaming".

However, if individual U.S. states, which generate billions in tax revenue from licensed sportsbooks, as well as other stakeholders like Native American tribes, which in states like Florida have the exclusive right to operate legal sportsbooks, increasingly apply pressure to the federal government, lawmakers and regulators may change the current status quo.

Long-term, platforms like Kalshi and Polymarket could lose the ability to offer sports-related contracts, eliminating much of their business overnight. This, in turn, would bode well for sportsbooks. They could continue to operate using the traditional, higher-margin business model.

So, does this make DraftKings a buy today? Yes, but only for investors who can ride out possible further short-term volatility. As before, I believe that DraftKings, which currently trades at a forward P/E ratio of 16, could rise on both earnings growth and valuation expansion. At least, if the results in the coming quarters indicate that prediction markets are not having a serious impact on the company's bottom line.

Thomas Niel 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.