Why I Sold Skillz
Summary
- The company will grow at a lower rate than the mobile gaming market, as Skillz is focused in a niche and does not have the power to encompass the whole industry growth.
- Revenue growth is already decelerating. Skillz projected -$14M in Adj. EBITDA for 2021 in their SPAC presentation. The company is already at -$31M in Q1.
- The stock trades at an expensive 16x forward sales multiple. My 10-year discounted cash flow model gives a reasonable price in which Skillz might be a buy.
- There are many options to invest in gaming or mobile gaming, hence, it makes no sense to be attached to Skillz unless you specifically want to invest in casual games.
Even though Skillz's (NYSE:SKLZ) shares have fallen over 60% since all-time highs, the company is still expensive. The mobile gaming industry is promising, but casual games are only half of it. I believe the company is too optimistic about its growth estimates and is not taking into account that they operate in a niche. Even after doubling its user acquisition costs, Skillz's MAU numbers seem to be stagnated. Q1 revenue growth numbers looked compelling; however, given the full year 2021 guidance disappointed me, it seems like revenue is already decelerating.
Analysts estimate positive earnings by 2025. Investors should consider whether Skillz's promising environment is worth the risks of a stagnated user base, decelerating revenue, and a possible 4 year wait for profitability.
Mobile Gaming
Source: Pew Research Center
Smartphone ownership is at all-time highs, the number of owners has more than doubled in 10 years from 35% to 85% of Americans. Nobody could deny that the mobile gaming market has potential. It is projected to grow by USD 63.66 billion, at a CAGR of 13% during 2021-2025.
However, the research suggests augmented reality (AR) adoption as a catalyst, along with very reliable players like Electronic Arts (EA), Tencent Holdings (OTCPK:TCEHY) or Ubisoft Entertainment (OTCPK:UBSFY). I believe Skillz will never be in that league. Perhaps they do not even want to. Games from the previous companies differ a lot from Skillz games, which the company itself defines as rather casual games, like Solitaire, Dominoes, Bingo or Tetris.
In fact, Solitaire, 21 Blitz (which is a mix between Blackjack and solitaire) together with Blackout Bingo accounted for 79% (table of contents number 15th) of the company revenue. Those are listed as the most popular games along with Pool Payday and Dominoes.
Therefore, I believe the company will grow at a lower rate than the mobile gaming market, as Skillz is focused in a niche (casual games) and does not have the power to encompass the whole industry growth.
Source: Q4 2020 Investor Presentation
Nonetheless, the casual games niche is much bigger than the usual niche. According to techjury, the most-played genre of mobile games is casual games. 59% of people who played mobile games in 2020 were casual gamers. Casual games are simpler, shorter, and require less learned skills to play. This makes sense considering that only 8% of mobile gamers are teenagers. Teenagers are used to other type of games. More complex, longer and skill-required like Call Of Duty or League Of Legends.
My conclusion about the mobile gaming industry is that it's an industry in which I want to invest. Concerning Skillz, the company has its market, though less than they claim. The quality of their games has to improve if they want to keep users on their platform. This is such an arduous task with casual games. The fact that they are simpler, shorter and require no skill makes them easy to rotate.
On the other hand, complex, longer and skill-required games keep clients. Not only during the ordinary season but also if the company releases new games. Similar to how Activision manages the Call Of Duty franchise. If people have already learned how to play a skill-required game, they are likely to buy the next one and do not rotate. The reason behind this is quite simple, no one enjoys losing. Winning feels good and people are not likely to abandon their comfort zone to learn how to play another game after all the time spent on dominating the previous one.
Skillz
Source: Q4 2020 Investor Presentation
Skillz's business model is simple. The company does not develop the games people play on their platform, developers do. Developers put their games on the platform expecting monetization, in this case, via competitive tournaments. Gamers pay a fee to enter the tournaments, which is distributed between the developers, the prize of the tournament, and Skillz.
It is important to clarify that despite Adj. EBITDA is positive in the photograph above, Skillz is far from having positive EBITDA. $0.04 is before UA marketing, which, as we are going to see in the article, is an enormous expense for the company.
In the investor presentation, they said:
More content leads to more engagement and more engagement leads to more revenue.
I believe this is not entirely true. More content can lead to more engagement in the short term, however, the quality of the content leads to more engagement in the long term. Skillz should always prioritize quality over quantity for casual games. I am also worried about the diversification of revenues. 79% (table of contents number 15th) of the company revenue came from only three games, made by two developers.
Solitaire, Dominoes, Bingo or Tetris are in the most popular category. These games are easily replaceable. Some computers even have the standard versions installed when you buy them. I believe Skillz has no moat for now. Games are not unique at all, and brand power is minimum.
On April 28th 2021, the NFL and Skillz announced that the Game Developer Challenge was accepting proposals from the developer community. Through this collaboration, developers can create NFL-inspired and branded mobile games powered by the Skillz platform. The NFL deal is quite positive news for the company. It will bring diversity to the platform, and the NFL brand. The deal has attracted many gamers, and therefore, many developers. It is a unique opportunity for promotion.
Future Growth & Risks
Concerning the industry, I do not see many risks. I have a soft spot for industries such as streaming, gaming or EVs, where industry growth is almost guaranteed by device adoption, new habits, changes in technology, or governments.
Skillz recently reported record Q1 revenue, up 92% YoY. The company also raised its 2021 revenue guidance to $375M, which equates to 63% YoY growth. Far from its previous triple-digit revenue growth. Bottom line for me is that growth is already decelerating. Too soon.
The company will keep growing; however, SG&A (SG&A is Selling, General & Administrative Expense, it also includes marketing and other departments expenses) expenses are hurting the company's growth. Nobody can deny that Skillz is having problems to gain new users.
Source: Q1 10-Q (page 26)
User acquisition marketing costs, which are inside the sales and marketing expense, have doubled from $27M to $54M. SG&A expenses are growing faster than revenues.
| Q1 2020 | Q1 2021 | YoY change in % | |
| Revenue | $43,559 | $83,677 | 92.1% |
| Sales and marketing expenses | $46,825 | $96,323 | 105.7% |
| General and administrative expenses | $4,833 | $27,284 | 464.5% |
Source: Author and Q1 earnings
EBITDA is also being affected by these unexpected costs.
Source: SPAC presentation
Skillz projected -$14M in Adj. EBITDA for 2021 in their SPAC presentation.
Source: Q1 earnings
The company is already at -$31M. Only in Q1...
Look at the bottom of the appendix photograph, number (2):
Contribution is defined as Adj. EBITDA before User Acquisition Cost.
As I have shown you before, user acquisition costs have doubled and are delaying positive EBITDA. They were too optimistic or did not expect such difficulties to gain new users. The business is unprofitable and will be unprofitable on this scale. Management knows this and is heavily spending on user acquisition to increase the company scale, unsuccessfully for now.
The company spent nearly $100 million (115% of revenues) on sales and marketing without meaningful growth in MAUs for Q1.
Source: Q1 earnings
Non-paying MAUs have decreased from 2.342M (2.6-0.258), to 2.233M (2.7-0.467). This could mean that some non-paying users have become paying users or have left the platform. The second case would be worrying, Skillz cannot lose users this early. Non-paying MAUs growth is important because it's easier to gain a paying user (which is Skillz's end goal) from the non-paying users that are already on your platform than from new users from the outside.
Positive news is that pMAUs have almost doubled (I did not expect less, considering Skillz's heavy marketing expenses), and the ARPPU has increased proportionally. Many bullish theses mention the India expansion, and every expansion is a reason to celebrate. However, all that glitters is not gold. ARPPU is going to be seriously affected.
In my previous article about Disney (DIS), I explained how developing countries like India had lowered the overall ARPU of Disney+, as these countries' ARPU is so much lower than North America's or Europe's. Therefore, India is a reason to be bullish, but not too much. pMAUs will increase, but ARPPU is likely to decrease. In other words, not increase proportionally to the pMAUs as it has been doing lately.
Price volatility will happen; hence, I do not recommend buying Skillz to investors who are not used to it. Despite the $615 million cash position that the company holds, it is probable that Skillz will raise cash through share offerings to fund its operations. In addition, the cash position will decrease after the Aarki acquisition is closed in Q3 2021 for $150M.
We are still paying high multiples for the company. Therefore, investors will demand growth. The stock price will only increase if Skillz can beat estimates over the next several years.
Valuation
A picture is worth a thousand words. Skillz is utterly expensive compared to its competitors. It trades at 24x, 4.35x, and 3.9x its competitors' multiples. Though its competitors are not expected to grow at the same rate as Skillz will.
Still, 15.6x forward sales is an unjustified valuation for a stock whose user base is not growing despite wild UA (User Acquisition) marketing spending.
To get a fair value, I have done a 10-year discounted cash flow model under the following assumptions:
Concerning revenue, I took the 63% revenue growth from the full year 2021 guidance, and analysts' estimates (FY22 to FY25), which seem reasonable. After such high growth years, I expect revenue growth to decrease progressively from FY26 to FY30.
Regarding EBITDA, the company estimates at least 30% (page 38) EBITDA margin in the long-term and positive EBITDA in 2022 (page 36); we have already seen how far from reality were Skillz expectations concerning EBITDA; I estimate that EBITDA margin can be positive in 2024, not 2022. It should be an effortless task if they fix the expenses problem, which will take time.
The discount rate is 15%, which is my minimum required rate of return for companies like Skillz.
Source: Author
I have not been conservative at all with multiples and margins. Still, my model cuts the price in half. Skillz has potential, but not at this price. The stock is too expensive and will probably deliver poor returns to investors who buy at today's price.
I have done another 10-year discounted cash flow model for the most bullish Skillz investor on the planet. With positive EBITDA in 2022 and revenues growing at 30% CAGR until 2030, instead of the 24% CAGR I used previously, which is already optimistic.
Source: Author
Still, in the most bullish model I could do, the company continues to look overvalued by 23%. I totally understand that companies like Skillz deserve a premium valuation for its growth. However, 2x my PT is not an option for me. It's too much.
Management
I have a soft spot for family businesses, CEOs who are also founders or CEOs who are actually present in the company life and hold a large % of the company ownership. Mark Zuckerberg, Warren Buffett, Bernard Arnault, Jeff Bezos, Steve Jobs, and Elon Musk are famous examples. I want to know who is managing the business in which I am investing and if he/she has skin in the game.
In Andrew's Paradise case, yes, he has, he holds 10% of Skillz. This was one reason that made me invest in the business early. However, Paradise has already made mistakes. On 19th March 2021, Skillz made an offering of 32M shares at $24. This did not please investors but was expected.
What investors were not expecting was that 4 days after Andrew Paradise and his executives were selling 10M shares pre-lock up at $23.34. I sold that same day. Skillz was a little % of my portfolio and I had doubts about the company, but I was willing to hold the stock. However, I do not tolerate management trying to fool investors.
The rest is history; the stock has decreased by 35% since then.
Takeaway
I sold all my shares at $24; Skillz's business model is interesting, but its product has not convinced me yet. I am looking forward to buying the stock again when its price comes down to my PT.
There are many options to invest in gaming or mobile gaming, hence, it makes no sense to be attached to Skillz unless you specifically want to invest in casual games. Even if this were the case, the company is priced for perfection and presents too much uncertainty and risks for little upside potential.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (82)
a) I bought the stock when it was a SPAC, hence, there weren't any ER of Skillz where I could see how SG&A expenses were progressing (or MAUs and ARPU), valuation was a lot more difficult to calculate, no offerings had happened and no insider selling. We just had the SPAC presentation, I believe I attached some photos of it in the article. When several months passed, I realise estimates were too optimistic. In addition, I like to hold stocks and not sell unless I see too much uncertainty. This said, the company looked promising when the SPAC released the agreement (the stock price and also the company itself), sad it didn't end well (imo, of course).
b) That's not really my fault. I started to write articles here in July, so I couldn't have told you.
So you don't know what the product is but you're unimpressed with it. Great, thanks.
Then why are you asking what the company's mission is??I would call entering a skill based video game tournament gambling, and neither would U.S. law. Daily fantasy is far closer to gambling and still is not gambling under U.S. law (hence its legality long before igaming and online sports better)
And no mention of plans for India - here, or in the conference call.......s26.q4cdn.com/...
SKLZ in 2020: $230M rev, $122M net LOSS, FCF -$60M --> valued at over $5B mkt cap
GRVY in 2020: $350M rev, $67M net PROFIT, FCF +$57M --> valued at $700M mkt capI have a hard time believing $SKLZ can scale so well, because so far it sure seems they don't and thus do not merit this valuation imho. I hope for everyone in it they I'm wrong. But it's an expensive bet.
until the game-changing strategic investment today that blows up any bear thesis.
Sorry bob, GRVY is not comparable to SKLZ and RBLX. GRVY is comparable to EA, ATVI, and TTWO. SKLZ and RBLX are comparable, maybe U as well. Perhaps your lack of understanding of the industry and SKLZ business model is the reason your baffled by valuations. They dont develop games like GRVY, they're disrupting the indsutry for game developers overall, allowing them an opportunity to better monetize their hard work on the SKLZ platform and providing a new avenue of reaching gamers that didn't exist before, all while utilizing proprietary mobile tech. It's disruptive a technology company which is exactly why Cathie Wood got involved. You can love or hate her, i don't really care I'm not championing her work, I'm just telling you why shes buying SKLZ while you're comparing it to companies with completely different business models. She sees the opportunity that many do not.
Was wondering if today's news on Skillz' minority stake in Exit Games mitigates your bearish view. While it doesnt change the valuation, but it opens up new synergies and steady their timelines of supporting multiplayer synchronous content for developers - i believe they were targeting Q4 for support of this feature. This news came a day after your article so its possible that it would be news for you as well.
Also IMHO bearish articles quite some times have a bullish bias, because they indicate that the overall selling process can be near to an end. Much more troubling to me is a descending stock to which 'everybody' is bullish about. In fact I wouldn't wonder if we soon would see some reaction to the upside.
