DraftKings Inc. (DKNG.US) and Flutter Entertainment PLC (FLUT.US), two major U.S. online gambling operators, saw their stock prices plummet after Bank of America unexpectedly downgraded their ratings. The downgrade was attributed to multiple risks facing the gambling market, including the growing global popularity of prediction markets like Polymarket, which could overshadow DraftKings and Flutter in the evolving betting landscape.

Analysts led by Shaun Kelley at Bank of America downgraded both DraftKings and Flutter from "Buy" to "Neutral," citing concerns over "structural hold" (the implied win rate for specific betting portfolios) and long-term pressures from taxation. The bank also highlighted emerging threats from paid prediction markets, warning that evolving business models could introduce significant headwinds.

Kelley noted, "The near-term path for prediction markets is highly challenging, with competitive marketing and potential price wars escalating. Meanwhile, online sports betting (OSB) operators face strict regulatory and legal constraints."

Prediction markets, such as Kalshi Inc. and Polymarket, have gained traction among bettors, allowing users to wager on outcomes ranging from sports events to political elections and even the Nobel Peace Prize. In late September, retail trading platform Robinhood Markets and prediction platform Kalshi reported surging activity in prediction markets. Even former President Donald Trump’s media company has entered the space.

The rise of prediction markets has pressured valuations and business models in traditional gambling. DraftKings’ stock fell 6.4% on Tuesday, hitting a two-year low, while Flutter dropped 3.9%. Investors have been offloading shares of these gambling operators amid concerns over competition from prediction platforms, with both stocks experiencing prolonged declines.

Kelley warned, "Unfortunately but unsurprisingly, OSB stocks are now reacting negatively to major prediction market announcements." He added that risks could intensify with Polymarket’s U.S. expansion, Kalshi’s new funding rounds, and new entrants from traditional finance and crypto sectors.

While DraftKings and Flutter’s FanDuel have yet to see significant market share erosion, Kelley expects prediction markets to create headwinds in news cycles and business models. "Without clear legal resolutions, the trajectory and unit economics of prediction markets could remain a major uncertainty for the next 6-9 months, or even years," he wrote in a Tuesday report.

DraftKings and FanDuel have attempted to enter prediction markets—DraftKings acquired CFTC-licensed exchange Railbird Technologies, while FanDuel partnered with CME Group. However, Kelley cautioned that the current legal environment complicates risk-reward assessments.

"State regulators in Nevada, Illinois, Ohio, Michigan, and Arizona appear to be boxing in traditional gambling operators, giving an edge to disruptors and newcomers," Kelley noted. "We see this as a response to recent developments."

DraftKings is set to report Q3 earnings after Thursday’s market close, while Flutter will release its results on November 12.