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Skillz - The API for enhancing game monetization

Skillz - The API for enhancing game monetization
By Pursuit of Return • Issue #2 • View online
This newsletter is intended to provide investors with a certain amount of background knowledge when evaluating investments. It regularly discusses individual companies and occasionally deals with topics such as the structure of different industries and dominant competitive forces in those industries.

Almost 1,000,000 mobile gaming apps are available across app stores, only a fraction of which generates enough revenue to reach profitability. According to mobile data and analytics platform App Annie around 1,100 mobile apps were grossing at least $5 million in 2019 across Apple’s App Store and Google Play, which corresponds to about 0.11% of all available gaming apps. The explosion in content makes it hard to get discovered.
Source: App Annie State of Mobile 2020 Report
Source: App Annie State of Mobile 2020 Report
Mobile games are currently monetized mainly in two ways: via in-app purchases and via advertising. One type of in-app purchase is the sale of virtual items. To earn money with virtual items, the game must be regularly updated with new content to keep the players engaged and to get them to spend money on a game that can also be played for free. Another type of in-app purchase is the paid deactivation of ads, which you might be familiar with if you play casual games like Candy Crush. Alternatively, monetization can be done through advertising only, which can be intrusive to the player. Furthermore, most games are designed from scratch according to the type of monetization targeted. Therefore, it is easier said than done to monetize some of the users via in-game items and the non-paying users via advertising. In short, it is hard to successfully launch a game and make money from it, as illustrated in the following slide:
Source: Skillz Investor Presentation September 2020
Source: Skillz Investor Presentation September 2020
Skillz tries to solve this problem by offering a monetization service, that allows developers to deliver multi-player competition to their end-users with the aim of improving user retention and engagement. Basically, they enable the developers to easily integrate competitions into their games, where each user can wager a certain amount of money and win a certain reward based on the outcome of the competition. Skillz provides developers with a software development kit (SDK) that they can download and integrate with their existing games, which according to some clients is fairly simple. The SDK acts as an application programming interface (API) enabling communication of data between Skillz and the game developers, which when integrated with the developer’s game content, facilitates end-user registration into competitions, managing and hosting end-user competition accounts, matching players of similar skill levels, collecting end-user entry fees, distributing end-user prizes, resolving end-user disputes in connection with their participation in competitions, and running third-party marketing campaigns. The SDK allows for over-the-air upgrades and even if Skillz doesn’t take care of the game development, they still approach the developers with suggestions for adapting the game. Also, developers can monitor their game performance through sophisticated dashboards, which allows them to fully concentrate on building great games. And the best thing is, while you have to keep bringing updates for games monetized through in-app purchases, the competitions are an ongoing source of income for which you theoretically don’t have to make changes except for some one-time adjustments to the game (like putting in a timer).
That’s the story. On the website for developers, you can see two examples of increasing average revenue per daily active user (ARPDAU) and conversion. However, I am not sure if any games make money from partnering with Skillz right now, as will be discussed in the section “Business Model”. 
When a game launches on the platform, it starts being free-to-play. To apply for prize competitions, a game has to fulfill certain defined criteria to ensure a great user experience. The most important aspect is that it is skill-based (meaning the outcome of a competition is mainly based on skill and not on chance), which is determined by Skillz’s patented algorithm. Other criteria are a minimum amount of daily active users, a certain level of stability, and an app store rating of at least 4.
Management and Culture
Skillz was founded in 2012 by Andrew Paradise and Casey Chafkin with the vision to “make eSports accessible to everyone possible”. It is certainly a special form of eSports and the business model is reminiscent of gambling, as will be discussed later under “risk factors”. Andrew is the holder of all Class B shares, which gives them the majority of the voting rights and with that, he will retain majority control of the company. So, if you were to buy Skillz shares, you would be essentially investing in Andrew’s integrity and skill, which is why this section is focused on him. Andrew Paradise is recognized as being a visionary and a thought leader and seems to be quite demanding. There are some criticisms on employee review portals, but most of them relate to being underpaid, having a fast-paced culture, and a heavy focus on numbers and goals. At the same time, many highlight the culture positively, so as an employee you might have to deal with the pace. According to former employees, Andrew is very hands-on and knows every part of the business quite well. He is a serial entrepreneur and has built up several companies and successfully sold some of them to larger players, even though he is just 38 years old. According to him, his goal with Skillz is not an exit, but to define a new form of monetization for mobile games on a 100-year journey. He seems to be really focused on hitting the targets in an “underpromise overdeliver” style while building the business for the long term. This can also be seen in the unusually long lock-up period of 24 months. To conclude, I would give Andrew the benefit of the doubt.
Business Model
Once a game is live on Skillz and has been approved for prize competitions, a player can enter a prize competition by paying an entry fee. Even though tournaments with up to 32 users can be managed, the majority are head-to-head competitions with an average entry fee of $3.1 per tournament in 2020. Those entry fees added up across 1.4 million paid entry tournaments per day on average in 2020, which leads us to the gross merchandise volume (GMV) of $1.59 billion last year. Usually, around 80% of this GMV will be paid out as a prize to the winner, with the remaining 16%-20% withheld as a commission by Skillz. That commission is theoretically shared between Skillz and the game developers. In fact, in 2020 Skillz achieved a take rate (Revenue / GMV) of 14.5%, which would leave 1,5%-5,5% to the developer. But sadly, it is even less, which is due to the following two reasons:
1) Skillz only pays the developers if the entry fees come from cash deposits. Last year 82% of total entry fees came from prior cash winnings, hence from cash that had been brought to the platform at an earlier stage and turned around at least one time. A further 7% of GMV resulted from end-user incentives, for example, a cash bonus that Skillz pays to the player to incentivize him to make a deposit. Only 11% of GMV came from cash deposits in 2020 and therefore had to be shared with the developers. So, in 2020, Skillz paid at best a tiny $18 million (11% of 1,502m GMV with 20% commission shared 50:50 with developers) to the developers, that is 1,1% of total entry fees or GMV. Skillz pays the end-user incentives which are booked as sales & marketing expenses, so it seems fair that the developer doesn’t get any money from this part of the entry fees. However, the fact that Skillz pockets the entire commission on reinvested prize money reveals an extremely attractive business model in my opinion.
2) If the company classifies user-incentives as being paid in representation for a certain customer or game developer, those costs are being recorded as a reduction of revenue and hence reduce the payment to the developer. For 2020, those costs were $51 million or around 3,2% of GMV. So probably Skillz didn’t pass on much to developers last year, because the $51 million in user incentives are theoretically deducted from the $18 million mentioned above if these user incentives are paid for the revenue-generating games. In the long term, the management targets a take rate of 20%, driven mainly by brand partnerships, which will be discussed in the “Growth opportunities” section.
User Stickiness
A non-paying user is more likely to churn while paying users to stick around for a very long time and are therefore very valuable. The average paying user has downloaded 10 Skillz-hosted games, although this is put into perspective by the fact that ads exist within games incentivizing users to download other Skillz titles in exchange for tokens. Since you make money when you are very good at a game, I think it makes sense to only play one game actively. Skillz does not provide churn data but it provides a measure that is helpful for us to get our arms around the loyalty of acquired users, the “3-Yr LTV/UAC”. 3-year Lifetime value (LTV) is defined as cumulative gross profit from a paying user over 3 years. User Acquisition Cost (UAC) is defined as total user-acquisition marketing spend divided by new paying users acquired in that period. As reported in September 2020, the LTV/UAC ratio based on the average of 2018, 2019, and 1H 2020 cohorts was at 4,7x. In Q3 2020 it worsened a bit to 4,5x and at the end of the year, it continued to decline to 3,8x, driven by rising advertising costs. While this trend seems a little worrying, Andrew Paradise promised to have a “clear plan to improve it”. Actually, the measure above does not take into account the end-user incentives recorded in sales and marketing expenses. After taking into account those costs, the LTV/UAC is expected to be 2.5x.
However, historically each acquired user cohort contributed to revenue over its life, which makes the model predictable. Each year the acquired cohort contributed more revenue than the previously acquired cohort and the revenue contribution of each cohort didn’t decline that much. For example, the 2016 cohort contributed $6.0 million in revenue in the first year, $5.5 million in the second year, $5.5 million in the third year, $6.6 million in the fourth year, and $7.2 million in the fifth year. The 2017 cohort contributed $9.9 million in revenue in the first year, $10.3 million in the second year, $9.6 million in the third year, and $9.5 million in the fourth year. The 2018 cohort contributed $33.2 million in revenue in the first year, $36.1 million in the second year, and $31.5 million in the third year. The 2019 cohort contributed $65.2 million in revenue in the first year and $64.3 million in the second year and the 2020 cohort contributed $115.8 million in revenue in the first year. According to the CEO, they’ve never had a cohort stop paying in for seven years now. Nevertheless, (expected) LTV per cohort is declining since 2019, as you can see in the following graph:
Source: Skillz Investor Presentation Q4 2020
Source: Skillz Investor Presentation Q4 2020
Competition and Moat
Skillz has had competitors since the beginning, but some of them have already failed. CashPlay ran out of money three years ago and Amazon and Sony abandoned similar efforts. Some smaller players like WorldWinner and PROVEIT are still active, although the focus is a bit different. While Skillz is, as far as I know, the largest player, the attractive business model could attract more competitors. The business has two types of moat:
1) Technology and Data:
Skillz invested heavily in developing their proprietary platform and many inventions have been patented. The company has a total of 58 patents, 15 of which are still pending. They analyze over 300 data points per gameplay session, representing over 1.5 billion distinct data points each day, that can be used to enhance the data-driven algorithms, which improves the platform and strengthens the position as the leading provider. Besides determining if a game is skill-based, the most important functions of the data science technologies are anti-cheat, anti-fraud, player matching, and user experience personalization. The anti-cheat component is important to build trust, as the users play for real money after all. As stated in the agreements with developers, Skillz receives the user data, that they can use to build statistical maps to predict users’ probable next outcome, which enables them statistically detect anomalies, which are escalated for further review and, if appropriate, remediation. Player matching is key to engage the player and built a fair environment. Again, feeding the algorithm with data should lead to better matching. And lastly, using the data, Skillz identified 65 player behavior sets, which it leverages for personalization. So, the bottom line I think is that with the right resources, such a platform can be copied in a couple of months or a year, but the data collected should give Skillz an advantage.
2) Network Effects
As of the end of last year, there were over 9,000 registered game developers that have launched game integration on the Skillz system. Those will create more content, which attracts more users and thus increases the reach, which in turn attracts more developers to create new games with Skillz. This network effect should support growth, and once it’s in full swing, it should create a competitive advantage over smaller providers. Theoretically, this sounds a lot like what I wrote about Roblox two weeks ago. However, for Roblox, this network effect leads to marketing expenses of just 4% of bookings, while Skillz spends more on sales and marketing than it realizes as revenue. Hence the network effect is not that convincing here, although Skillz is only in the eighth year of a journey that the CEO puts at 100 years. It makes sense to spend large amounts on sales and marketing, as at this early stage it is key to drive user growth. With brand and sponsor partnerships the marketing spending will hopefully be partly outsourced. Skillz recently reached a partnership with the NFL and convinced the developers of the popular arcade game “Big Buck Hunter” to integrate the SDK, although they tried it 7 years ago without much success presumably.
 
According to an industry participant, preferential treatment could be the strongest moat. Since Skillz is the biggest player, it is easier for developers to use this platform as they are likely to receive less scrutiny from the app stores and therefore face fewer obstacles. So that’s a definite advantage in attracting new games to the platform.
Number of users, engagement, and monetization
In 2020, Skillz had an average of 2.4 million monthly active users (MAU), +63% more than in the previous year. Even more relevant is the development of the paying MAUs, i.e. those MAUs who spend money on the platform, as the games can also be played without wagering. The paying MAUs increased by +101% to 324,000 in 2020, which was the main reason for the jump in sales of +92%. Notably, this has been achieved although the average revenue per paying user (ARPPU) declined a bit from $62 to $58. In the first investor presentation in September, Skillz disclosed the very strong monetization in comparison to traditional monetization methods. Skillz earned average revenue of $6.3 per MAU in 2019, vs. $1.51 at Zynga and $1.89 at Glu Mobile. In 2020, Skillz’s ARPU increased to $7.5, Zynga’s to $ 1.85.
Engagement on the platform is remarkable. The daily average time spent per user was at ~60 minutes in 2019 and 2020, which is more than people hang out on Facebook, Youtube, Snapchat and the likes. However, this estimate is based on the time allowed to complete a tournament in the top three games for paying users featured on the platform. Growth initiatives that we will talk about later could further increase engagement. In 2020, 2 billion tournaments were hosted, 0.5 billion of which were paid entry tournaments. That equals an average of 1.4 million paid entry tournaments per day and 5 million tournaments per day overall. As we saw with the ratio of paying MAUs/MAUs, the share of paid entry tournaments as a percentage of all tournaments increased significantly, which reveals an improved monetization of Skillz games.
In the following table, you can see the evolution of those metrics on a quarterly basis. Notably, the number of paying MAUs increased further in Q4 whereas total MAUs declined vs. Q3.
Souce: Company Filings; Own computations
Souce: Company Filings; Own computations
Financials
Since Skillz does not pay platform fees to app stores, it generates a very high gross margin of 95%. The management is mainly focused on growth and as a result invests very high amounts of money into marketing, which is the main reason for the deep losses. In 2020, marketing costs comprised 109% of revenue or 80% of total operating expenses, 40% of which was “engagement marketing” and 55% user acquisition costs. User acquisition costs include expenses incurred in the period to acquire new users, including digital advertising costs, affiliate marketing costs, third-party vendors, and software tools used by the user acquisition marketing team. Engagement Marketing costs are investments in programs that provide rewards and awards for players engaging on the platform. Players earn loyalty currency (“Ticketz”) every time they play a paid entry competition. They can also earn trophies as awards for performing certain actions or achieving milestones in games for which they receive Ticketz or credits to be used towards future paid entry tournaments. Tickets earned through the loyalty rewards and awards programs can be exchanged for various prizes ranging from Skillz-branded apparel to luxury goods and vehicles. R&D includes the costs for product and platform development as well as the associated server, software, and rent. G&A mainly consists of salaries, SBC, and in 2020 additionally a one-time impairment charge related to a lease deposit and transaction-related expenses. The management guided the GMV and Gross Profit for 2021 and 2022, so I included that in the table:
Souce: Company Filings; Own computations
Souce: Company Filings; Own computations
If you adjust the EBIT for SBC and one-time costs, which is a common “non-GAAP” measure, the margin is still at -30% for 2020. If you would want to calculate a “contribution margin” it would make sense to adjust the Non-GAAP-EBIT for user acquisition costs, which leads to a margin of 30%. The management wants us to look at the Adjusted EBITDA, as this is the metric for which we even get guidance for 2022, which I listed in the table below. The metric is derived by adjusting the EBIT for SBC, impairments, transaction costs, and other one-off costs and then of course adding the D&A. They target an Adj. EBITDA margin of 1,4% in 2022 and long term they think 30% is possible. Finally, the company sits on a net cash position of $196 million as of the end of 2020. The recent stock offering delivered net proceeds of approximately $392.5 million, which further bolsters Skillz’s firepower.
Souce: Company Filings; Own computations
Souce: Company Filings; Own computations
Growth opportunities
Skillz targets six areas for future growth. In this section, I will present them and give my opinion on them.
1) Growing the home market by investing in marketing: The company says it only reaches 2% of mobile gamers in North America, which at first reads like the goal is to reach 100%. I think Skillz can continue to grow in North America. Having said that, surveys indicate that only 10% of US gamers are interested in wagering. Platforms like Skillz are still in a relatively early stage of acceptance and the surveys may not be representative at all. Even so, the addressable market for Skillz is presumably only a fraction of all mobile gamers in North America.
2) Expanding the content on the platform: Currently, mostly “casual games” such as solitaire, puzzle games, and bingo can be found on the Skillz platform. The management is striving for an expansion into other genres and speaks of “everything from first-person shooters to racing to real-time strategy games”. It was recently announced that Big Buck Hunter would be adding the Skillz SDK, described as “Skillz’s expansion into the first-person shooter (FPS) genre”. You might want to take a look at the game. In my opinion, the game does not belong in the FPS category and so this step does not convince me that real shooters like Call of Duty or Battlefield will be successfully integrated on Skillz, especially since they are already operating very profitably. It has also to be said that there was a comparable partnership with the developer in 2014, so the deal is a “second attempt. Another obstacle to attracting larger successful games is the condition that Skillz owns the data, as data are seen as an important strategic asset in the industry. If I were wrong here, I would also underappreciate the potential under (1). Also, Skillz recently announced a partnership with the NFL, under which game developers can now apply to develop a game under the brand with appropriate financial support from the NFL. The game is expected to launch in spring 2022 at the earliest.
3) International expansion: Skillz generated approximately 90% of 2020’s revenue from users in North America, while the international market would be approximately four times larger than the North American. According to gaming research platform Newzoo, North America makes up about a quarter of the global gaming market, which equals $40 billion in revenue across all platforms. Another quarter comes from China and I can’t imagine a platform like Skillz’s going to get approved in China. Around half of global gaming sales come from mobile games, although the platform is slightly less penetrated in the USA and more penetrated in China. However, Skillz is aiming to enter the Indian market in 2021, where the monetization of mobile games is comparatively low due to the lower disposable income. Around 440 million smartphone users live in India and around 140 million of those play mobile games versus 210 million in North America. The market growth in India exceeds the US market by a wide margin. In India, there are already some companies that focus on skill-based games. Tencent-backed Dream11, for example, focuses on fantasy sports such as cricket, hockey, football, kabaddi, and basketball and has over 80 million users. The average ticket size on their platform is 30 IRN (~$0.35), while in the average Skillz tournament, each player wagers $1.55. The company’s business model looks a bit different than that of Skillz. Winzo, another Indian player in the field, reaches 30 million users with 70+ games and is comparable to Skillz in terms of the type of business model. On Winzo, users pay even smaller sums of INR 2 - INR 25 to participate in real-time multiplayer games and win prize pools, although that can be a result of the focus on lower Tier cities. However, the potential in India seems to be very large, as Winzo users are clocking over a billion gameplays a month vs. ~170 million on Skillz. It must be said that these are startups that are less well funded than Skillz and Winzo was founded as recently as October 2016 with raising $18 million in the Series B round in September 2020. The regulatory environment in India will be captured in the section “risk factors” as well.
4) Increase brand and influencer partnerships: Management sees a significant opportunity to build partnerships with brands to sponsor tournaments on the platform. As the example of the NFL mentioned in (2) shows, brands are seeking new ways to engage with existing and potential customers online. As noted above, more than 80% of GMV was paid out in prizes in 2020 and if brand advertisers were to be sponsoring those prizes, that would drive reach and profitability for Skillz. Given the business model, I would expect brands to be cautious, but there will certainly be some interest in partnering with Skillz if it fits the brand’s image, which should mostly cater to sports brands. If you’ve ever played Fifa Ultimate Team you will know that the FIFA doesn’t care about gambling.
5) New monetization models: As the games on the platform can also be played for free, just 16% of the users entered paid contests in 2020. Skillz added monetization through advertising in their SDK as recently as September 2020 to monetize the remaining 84% of the user base. The management targets a monetization at the industry level, where the average revenue per daily active user from advertising ranges from $0.03 to reach $0.15.
6) Acquisitions: Although Skillz develops the platform organically for the most part, smaller acquisitions could be made every now and then, e.g. to incorporate new features more quickly.
There is an opportunity for another decent growth spurt. The company currently earns the majority of its sales on Apple’s App Store. That is due to Google Play’s terms of service, which treats games with prize money as gambling and does not allow such apps to be distributed through the Google PlayStore. Skillz is available on alternative app stores such as the Galaxy App Store or can be downloaded directly from the browser. As already got clear from Epic’s lawsuits against Google, the user is shown security risks several times on the way to such a download. However, on the Q4 earnings call CEO Andrew Paradise pointed out that “even without the Play Store, we’ve been growing Android revenue and our installed base are at twice the rate of iOS on alternative app stores.” I suspect legalizing the Skillz platform on Google Play would still provide a certain upside as Galaxy Store app downloads overall are around 5% of those of Google Play. It looked like the tide was turning here, as “Google has hired a head of US sports betting in a newly created role as it considers opening up the Google Play Store to real-money gaming (RMG) apps in the States.” However, Google recently updated the Developer Program Policy and still does not allow “games that accept money and offer prizes of cash or other real world value”.
Risks factors
Skillz is at an early stage in the company’s history and the still young category should have enough growth potential globally. However, there are quite a few risk factors to consider when thinking about an investment in the company.
Concentration: Skillz generates a large part of its revenue with a few games and developers. If any of these games fell in popularity, or if a development studio took one of these games from the Skillz platform, it would seriously affect the company’s success. As you can see in the table below, only three games were responsible for 79% of sales in 2020 and since two of these three games come from the game developer “Tether Studios”, the dependency on this studio is also very high with 59% of sales. Agreements with those studios include exclusivity and restrict the removal of the applicable games from the platform for at least 12 months following termination. The agreement with Tether can be terminated by either party on 30 days’ notice, that with Big Run Studios on an annual basis. The good news is that Tether games grew despite falling as a percentage of revenue and both Tether and Big Run are hiring while focusing on Skillz-enabled games. Big Run’s team includes game industry veterans who have worked on franchises such as Star Wars, Indiana Jones, FarmVille, Harry Potter, and Madden NFL and they raised $8 million in a funding round in August last year. Even though the concentration among few games is very high, it is encouraging to see that the number of games that generated over $1 million of annualized GMV has grown from 15 in 2018, to 23 in 2019, and to 36 in 2020. However, we must be aware of the fact that $1 million in GMV is small compared to the overall GMV generated by Skillz.
Souce: Company Filings; Own computations
Souce: Company Filings; Own computations
Regulation: First of all, I would like to emphasize that Skillz games are only accessible from the age of 18. Nevertheless, there is a regulatory risk. In the majority of US states, wagering on games of skill is permitted, while wagering on games of chance is not. There are three specific things involved in the definition of gambling: (1) the award of a prize, (2) paid-in consideration (meaning entrants pay to compete), and (3) an outcome determined based on chance. Without all three of these elements, a competition that rewards real prizes is not gambling. Since skill and chance often both play a role in determining the outcome of a game, there are two common tests, the “predominance test” and the “material element test”, that are used to determine the classification, as can be further read here. Management claims that Skillz has an advanced statistical model that determines whether a game is based on skills. The model is said to have been validated by legal experts in the field of gambling and received a US patent. Skillz only enables games for paid entry-fee contests in states in which skill-based gaming is permitted and not required to be licensed as gambling under applicable state law. As of 2020, cash prizes were enabled in 41 states and the District of Columbia, covering approximately 90% of the U.S. population. Skillz enables cash prizes in all states except for Arizona, Arkansas, Connecticut, Delaware, Louisiana, Montana, South Carolina, South Dakota, and Tennessee. But that doesn’t mean that Skillz is licensed in the other states! The compliance of the platform is solely based on their interpretation of existing state and federal laws. The bottom line is, the determination of a skill-based game is not clear, which continually harbors the risk of new regulation, especially with the increasing size of the category.
The regulatory environment in India is comparable to the US, as gambling is a state subject also in the big country of South Asia. Some states excluded card games and some states decide on a case-by-case basis and issue licenses. In general, the regulation is relatively soft, but it also harbors risks for the modernization of law if the paid contests get bigger. I found this article helpful: Click.
Finally, the regulatory environment in Europe seems to be comparable. Different jurisdictions differ in their ruling of skill-based games. Europe’s #1 real money skill-based gaming platform allows cash prize tournaments in Austria, Belgium, Cyprus, Czech Republic, Denmark, Germany, Luxembourg, Monaco, Netherlands, România, Spain, United Kingdom, Sweden. However, Skillz has not yet spoken about expanding into Europe extensively.
 
Apple: Following the App Store policy, Apple does not take any share of the end-user deposits on Skillz’s platform. Apple does receive a fee for end-user deposits made through Apple Pay, but as Skillz uses its own payment infrastructure and third-party payment processing fees are included in the cost of revenue, which are only 5% of sales, payments to Apple cannot be significant. Therefore, there is a risk that Apple will come up with something here to participate more in Skillz’s success. Currently, the risk of a rule change at the expense of Skillz does not seem significant since Apple’s monopoly practices are currently under scrutiny. I have read that some argue that the implementation of ads with the non-paying users would change that, but Apple does not take a commission on advertising revenue in my understanding. As far as I know, only the introduction of virtual goods would generate app store fees under the current rules.
 
Management: Andrew Paradise holds the majority of voting rights and therefore has a lot of power over the company. Despite some stockholders including him agreed to a 24-month lock-up period in which they don’t sell shares (with the exemption of 1.5 million shares per quarter), last week Andrew sold 8.4 million shares or 11% of his holding. However, he still owns 18% of the outstanding shares. Co-founder Casey Chafkin sold 1,7 million, but you could argue that this is within the agreement. Furthermore, Andrew guided quite a long way into the future and in the appendix to the first investor presentation, there was even a slide in which he compares the valuation based on his 2022 forecast with rapidly growing quality companies such as PayPal, Square, and Tencent. In my opinion, the goals are not set too high and they at least give us a feeling for the future growth algorithm. Nevertheless, it seems a bit dubious and I don’t like too much focus on analyst’s expectations in the short term. Finally, the comments about the future potential of the platform are misleading in my opinion. Neither the $180 million gaming market nor the 2.7 billion global gamers represent the addressable market for Skillz.
 
Competition: There is some competition in the space and I’m not sure how strong the moat is. I would not expect bigger companies like Unity to implement a skill-based gaming platform, as they would have to start from scratch and steer through the regulatory landscape state by state. Skillz also protected a lot of what they have built by patents, but I am not sure how much the 58 patents really prevent someone from building a similar platform. 
Valuation
Skillz was listed on the stock exchange last September via a “SPAC”, which is essentially a faster IPO process under the guidance of an experienced partner. I recommend this explanation for those interested. Since the deal was announced, the stock has traded in the low teens for months until it started to rise beginning in December to a high of $46 in early February. Since then, the hype has subsided somewhat and a short report by Wolfpack Research didn’t help. In my opinion, the report was misleading and actually, the Q1 outlook brought up last week devalues some arguments.
The stock offering last week put the stock down significantly. Skillz issued 17 million new shares, which dilutes current stockholders. Another 19.8 million shares were sold by stockholders, including the CEO. The new shares went public at $24 and the broader market moves put further pressure on the stock.
Last week they gave guidance for the first quarter of 2021, which is expected to show an elevated level of revenue growth of 83% year on year and a sequentially increasing number of paying MAUs to 0.45 million (+15% q/q; +74% y/y). Less encouraging is the Adjusted EBITDA forecast of -$37 million vs. -$24 million in Q4 2020. However, Skillz tends to significantly increase the sales and marketing investments in the first months of a year as they usually see lower acquisition costs per user in those months. I was not able to determine the Adjusted EBITDA on a quarterly basis except for Q4 2020 and Q4 2019, but elevated S&M expenses could be a reason for the deep loss expected in Q1.
To calculate the market capitalization, I would rather use the fully diluted share count, which should be around 445 million as of the recent offering (outstanding shares should be 384m). The current price of $18.5 per share would correspond to a market capitalization of $8.2 billion. Hence, the stock is trading on ~22x forward sales or - as Andrew Paradise would say - on 14.8x 2022 sales forecast.
It is difficult to give a serious assessment here, as the business model is still very young and there is no way for me to make reliable forecasts. To justify a price of $24 per share, in my DCF-calculations the company would need to grow at 30% per year and reach an EBITDA margin of 30% in 2030. Further assumptions are a terminal growth rate of 1.5%, a discount rate of 8%, and a share count of 445 million. Since I think the business model is attractive and I expect sustained high growth rates for the coming years, the risk/reward ratio looks attractive to me at this point, considering the broader market movements, so I recently bought the stock (too early…).
How did you like this? I would appreciate any feedback as I want to make this great.
Thanks for Reading.
Danny
Disclaimer
Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.
Disclosures
The author has a position in Skillz. The author has no business relationship with any company mentioned in this article and the author is not receiving any form of compensation for this article.
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