Is DraftKings (NASDAQ:DKNG) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies DraftKings Inc. (NASDAQ:DKNG) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for DraftKings

What Is DraftKings's Debt?

As you can see below, DraftKings had US$1.25b of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$1.38b in cash, so it actually has US$132.2m net cash.

How Healthy Is DraftKings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DraftKings had liabilities of US$1.29b due within 12 months and liabilities of US$1.47b due beyond that. Offsetting these obligations, it had cash of US$1.38b as well as receivables valued at US$41.0m due within 12 months. So it has liabilities totalling US$1.33b more than its cash and near-term receivables, combined.

This deficit isn't so bad because DraftKings is worth US$5.11b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, DraftKings boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine DraftKings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, DraftKings reported revenue of US$1.9b, which is a gain of 62%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

So How Risky Is DraftKings?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months DraftKings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$768m and booked a US$1.5b accounting loss. Given it only has net cash of US$132.2m, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, DraftKings may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for DraftKings you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.