Rush Street Interactive Stock: Cautiously Optimistic (NYSE:RSI)

Rush Street Interactive, Inc. (NYSE:RSI) has been growing revenue over the last year, as the online sports betting market continues to grow, albeit hampered some by economic concerns associated with high inflation and the Federal Reserve’s response to getting it under control by raising interest rates.

Consequently, the share price of RSI has been getting crushed in 2022 because of being in what is considered a high-risk, high-growth market sector. That’s important to take into account, because analysts use the discounted cash flow (“DCF”) model to project future earnings, and when taking higher interest rates and contracting margins into account, it points to lower earnings and a decline in free cash flow (“FCD”).

The company has a 52-week high of $21.70 but has fallen off the cliff since then, dropping to a low of $3.34 on October 13, 2022, before slightly rebounding to about $4.00 per share as I write.

In this article, we’ll look at the major thing the company needs to focus on and why, some of the latest numbers, and how 2023 looks in a tough economic environment.

Latest earnings

In the third quarter, RSI generated $148 million in revenue, up 20 percent from the $122.9 million in revenue it generated in the Q3 of 2021. The company noted that higher attrition in its online casino segment, along with the impact of foreign exchange from a higher U.S. dollar, resulted in an estimated impact of approximately $6 million on earnings. Without those headwinds, management noted that it would have been in line with Street expectation. Net loss in the reporting period was $22.7 million, up from the $18.9 million net loss year-over-year. Adjusted EBITDA in the quarter was $12.5 million, up $300,000 from the $12.2 million loss in the same reporting period last year. The company believes it can achieve to be EBITDA profitable in the second half of 2023. In the U.S. and Canada, real-money monthly active users increased to 130,000, up 31 percent from the same quarter of 2021. Average revenue per monthly active users (ARPMAU) was $345, up 6 percent from the prior quarter.

On the advertising side, spend was $44.7 million during the reporting period, down slightly from the $45.4 million spent in last year’s third quarter. As it enters new markets and focuses on shoring up its online casino business, the company said it expects to boost marketing spend, but not to the level it did in Q4 of 2021 or Q1 2022.

Its balance sheet remains strong, with unrestricted cash and cash equivalents of $195 million and no debt outstanding.

While there was some underperformance in the reporting period, taking into consideration the macroeconomic environment it’s operating in, Rush Street Interactive’s quarter wasn’t too bad.

Share price movement over last year

I want to briefly revisit some of the movements of the company’s share price over the last year. As mentioned earlier, it had a 52-week high of $21.70 and a 52-week low of $3.34, with the low occurring on October 13, 2022.

Since November 18, 2021, the share price of the company has been in freefall, finally starting to level off on June 16, 2022, when it found some support at about $4.00 per share. It bounced from there to around $6.50 on August 16 and pulled back to its 52-week low on October 13, 2022, before clawing its way back to $4.00 per share.

The significance of all that in light of its recent earnings report is the company appears to have found a double bottom at approximately $4.00 per share. That doesn’t mean it can’t fall further, only that I think it’s not likely to plummet a lot more unless the ongoing recession goes deep into early 2023, which would cause its customers to tighten their wallets. This could result in the company’s average customer spend dropping significantly. That would put pressure on revenue and earnings, pushing Rush Street’s EBITDA positive results further out into the future. This means it would take until 2024 before it achieved that goal, depending on the length of the recession.

During that time gross margins, which have been widening, would probably start contracting.

Under that scenario, the share price of RSI would continue to drop below its current $4.00 level. In my opinion, this is the worst-case scenario Rush Street Interactive faces.

Online casino

My view is that the online casino is probably the most important area the company needs to focus on going forward, and how it is able to improve its hold on that customer base will determine how the company performs over the next year or so… and further out.

The significance of the online casino business is that it is larger than its sports betting segment, and more profitable as well in the markets they operate together. For that reason, it is a concern that Rush Street’s attrition rate in its online casino business was higher than normal. Not only does that need to be remedied, but the company has to find a way to make its platform even stickier in the months and years ahead.

With that in mind, it’s going to prioritize on marketing spend in that segment in the remainder of 2022 and 2023.

If Rush Street Interactive falters in its casino, it will underperform through 2023, which will lower revenue and gross margins, again, which would result in its failure to become EBITDA positive by the end of 2023. The failure to hold in the quarter just recorded resulted in a decline in revenue of about $4 million.

The good news is that Rush Street Interactive stated its cost per player in Q3 was slashed by over 50 percent year-over-year. The bad news is in the case of the online casino, its ability to retain them has fallen.

Management stated during the earnings call that:

“We won’t target market share. Rather, we continue to focus on earning and retaining customer loyalty by treating them well, being thoughtful, developing seamless experiences, and reducing friction at every possible interaction point.”

I definitely agree that that is the proper way to think concerning marketing spend. One of the things the company is doing is developing a new patent-pending squares game that is set to launch in the latter part of the current football season.

This should increase player enjoyment by providing “unique ways to engage, win and have fun with our platform. Players will be awarded squares based on their activities and bets and will win prizes when their numbers hit.”

If players embrace this, it will make the site stickier and should result in better customer retention.

In its sports betting segment, markets where the company has already operated in require less marketing spend, which frees up advertising capital to focus on new market launches, as well as in the online casino segment.

How casino performs will determine the length of time it will take for the company to become profitable.

Conclusion

Rush Street Interactive, even though its share price has been under a lot of pressure over the last year, has actually been performing fairly well in growing revenue and increasing gross profits while maintaining a strong balance sheet.

There are concerns over the macroeconomic environment it’s now operating in, as the increased attrition in the online casino business could point to consumers pulling back on spending. Whether or not its squares game will help mitigate that and make the site stickier has yet to be proven.

The fact the company recognizes it must focus more on its casino business in order to accelerate its path to profitability is good news, now it remains to be seen whether it’ll be able to execute on its strategy.

Management’s flexibility in its marketing strategy, along with its strong financial position, is a positive for the company. I like the fact there isn’t a lot of hype in a business sector that has had a lot of that.

The company is taking a patient, long view concerning growth, and in this type of business, that bodes well for investors.

While the business plan looks solid and achievable, the macroeconomic environment still must be taken into consideration. So far, the company has been managing that well, but depending on decisions by the Federal Reserve in the near future concerning interest rates in response to inflation, along with the depth and length of the recession, is something outside the company’s general control.

If consumers do cut back on spending because of focusing on needs rather than wants, Rush Street Interactive will struggle throughout 2023, and possibly further. On the positive side, the company is continuing to launch in new markets, and if it can hold serve and grow it online casino business under these difficult economic circumstances, Rush Street Interactive could surprise to the upside in the near term, while being positioned for solid long-term growth as economic conditions improve, along with consumer sentiment.