As with a lot of the original hot SPACs, Skillz (NYSE:SKLZ) came out of the gate red hot based on massive revenue growth projections. Unfortunately, the market didn't fully research the factors driving those high growth rates. My investment thesis is far more Neutral on the stock now, but my view needs the company to improve user numbers before turning fully Bullish.
The big hype surrounding Skillz was the concept of winning money playing competitive mobile games. The concept of winning money based on skills allows the platform to get past the concept of gambling.
The main issue is that the Skillz platform doesn't offer high quality games to play. The 2 Minute Football game uses helmets to signify players while top mobile games have long moved beyond such rudimentary graphics.
Where Skillz would really become exciting is with some of the top mobile games as part of the competitive platform. Games that gamers already play would drive traffic without all of the massive marketing spending requirements. Imagine playing the Call of Duty or Madden franchises against other gamers for money, but alas the actual option is the above football game with basic graphics.
In addition, the company deals in small volume tournaments with the average entry fee of only $3 per player. For a real eSports platform, Skillz could probably attract millions in prize money for the top competitions of leading mobile games. Instead, the company is entirely reliant on small time game developers to create games for their mobile platform.
Co-Founder and CEO Andrew Paradise even confirmed the concept of low quality games on the platform when talking about the recent addition of Big Buck Hunter: Marksman at the Citi 2021 Global Tech Conference.
And you can see that in terms of the content quality that's launching, I'll give you an example. Big Buck Hunter: Marksman launched with us earlier this year. I'd say it looks really promising and just from a look and feel if you've tried the title the graphics are very next gen for our platform.
Even the decision to acquire Aarki for $150 million in cash and stock screams the play is based on user acquisition versus development of top games. Otherwise, Skillz wouldn't need to invest in an advertising business when the company doesn't even utilize in-app advertising to monetize users.
Now, the promise of the technology from Exit Games allowing the platform to start hosting battle royale and fighting games would elevate the platform to the next level, assuming these games are competitive with the likes of Fortnite. Skillz only invested $50 million in Exit Games, so one shouldn't expect any major technology jumps in the near term. The CEO was clear a multiplayer synchronous game running on top of Exit and Skillz might not top the platform for a couple of years.
One of the keys is watching where MAUs go compared to the spending levels on marketing. Skillz must show the ability to grow users without having to equally ramp up marketing.
Over the last year, Skillz has spent far more on sales and marketing than revenues in those periods. Of course, the company will claim the UA spending has a quick payback, but the company spent $44.9 million on engagement marketing in the last quarter alone.
Skillz spending 50% of revenues to just keep existing payors engaged says a lot about cohort retention. The company had to spend a nearly equal $47.0 million on UA marketing to just get these MAUs on the gaming platform, but apparently the ability to win money via tournaments doesn't keep users coming back.
The numbers suggest to us that users just don't stay engaged for $3 competitions on low quality games. The CEO even suggested at the Citi conference that people winning money don't always stay engaged due to possible boredom.
While a lot of the questions about the long-term viability of the company exist, the stock is far more appealing down here at $9. My original bearish article occurred when Skillz traded over $25.
The stock now has a fully diluted market cap of $4 billion based on 448 million shares outstanding after the valuation once hit $20 billion. With nearly $700 million in cash on the balance sheet before the recent acquisitions and investments, Skillz has a far lower enterprise valuation compared to the opportunity.
If the company can generate the $555 million in 2022 revenues and the substantial growth that comes along with hitting that analyst target, the stock will start turning appealing here. Right now though, the stock is a falling knife and investors shouldn't touch Skillz until a bottoming out process occurs, at possibly much lower levels.
The key investor takeaway is that Skillz has to spend far too much on marketing for the revenue potential of those users. One possible reason is the low quality games on the platform.
Either way, the stock has been crushed due to these issues making an investment more appealing here. But first, Skillz needs to prove the Aarki investment and constrained UA spending will lead to better economics versus the Q2'21 adjusted EBITDA loss of $31.6 million. Next, the company needs to show higher quality games such as Trivia Crack lead to better economics.
Once the company accomplishes these goals, Skillz would have substantial opportunities to reward shareholders with a more reasonable stock valuation along with a valid growth platform.
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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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