Why Skills might be a High Growth Stock in 2021:
Most of you have probably heard of Cathie Wood and either adore her or hate her. However, one of Cathie's highest conviction plays as of late has been $SKLZ - Skillz as ARK now holds over 22M shares, representing one of their top growth stocks for 2021. In this analysis I will dive deep into Skillz business and see if this investment has merit, and if it is one of the best growth stocks to buy right now. If you would like to continue to see similar analyses of hype stocks, make sure to follow my account to be updated! With that being said, let's dive in.
This is a little snippet from Skillz's 10-K filing that explains their business, “We operate a marketplace that connects the world through competition, serving both developers and users. Our platform enables fair, fun and competitive gaming experiences and the trust we foster with users is the foundation upon which our community is built. We believe our marketplace benefits from a powerful network effect: compelling content attracts users to our platform, while the increasing size of our audience attracts more developers to create new interactive experiences on our platform”
Skillz aims to build a competitive layer of the internet through re-inventing the competitive mobile gaming space. Skillz has created their own proprietary platform, which they intend to use to revolutionize and democratize the mobile gaming industry, and they believe that they will also have a key role in expanding the mobile gaming market.
Skillz has 2 main users, game developers, and the game players. Firstly, Skillz has a platform that lets everyday game developers create games that can be played on their platform. These developers will make money for their time/efforts through Skillz's developer profit sharing plan. The more popular the games that these developers make, the more paid games will be played on them, and the more money these developers will make. Next, Skillz provides a platform for gamers to play against each other and make some off their own money in their paid games and tournaments.
Skillz is differentiated from their competitors through their platform and monetization plan. Skillz believes that the traditional methods of monetizing mobile apps (primarily through in-game purchases and advertisements) are unfavourable for the player as in-game purchases create friction in the user-experience, and as a result of this their levels of engagement and retention are negatively affected.
Skillz monetizes their user engagement (rather than other methods) through prizes. Skillz does this by giving their players an option to play-in to some paid game modes, in which players each pay an entry fee. These players than play against each other, and the winner is awarded with most of the money generated from the entry fees. An example of this is a head-to-head match, where both Player 1 and Player 2 will pay their entry fee of $0.60, whoever wins will walk away with $1.02 (minus the developer profit share), and the remaining 18 cents is revenue for Skills.
By using this business model Skillz incentivizes both their developers, and their users to have fun on their platform. This approach lets game developers be their own boss in a way and gives them creative freedom. The only other way for these developers to get creative freedom is by working on their own projects, however we know that it is extremely difficult to get discovered, and Skillz can help them get exposure, so it is a win-win.
Skillz also has an algorithm that matches players against other players of similar skill and experience levels. This helps to keep the matchmaking balanced and protects players against losing money by playing players that are way better than them.
Lastly, Skillz has created a “gaming for good” campaign, in which they run mass video game tournaments, and harness the power of their community to raise money for charities. This year Skills beat their fundraising estimates by over 23% and donated to companies such as WWF, American Red Cross, American Cancer Society and many more.
- Financial Performance (Good): Skillz increased their revenues by 92% YoY, their interest expense decreased by 47% YoY, and their gross margin is 95%. If Skillz can keep growing their revenue by these increments, they might be able to post a profitable quarter in the upcoming years, which would help the stock greatly.
- Financial Performance (Bad): Skillz's cost of revenue increased by 115% YoY, their sales and marketing costs increased by 126% YoY, their General and Admin. Costs increased by 159% YoY, and their net losses increased by 418.8% YoY. This year's financial performance was not good at all, however Skillz is a rapidly growing company, so it is quite normal to be performing like this in the early stages.
- Liquidity: Skillz increased their cash position by over 900% YoY, and now their cash position sits at $262.7M. This large cash position should be able to help Skillz meet their financial obligations, and undergo the necessary investments required to continue to grow their business.
- Stock-Based Compensation: In 2020, Skillz paid out $23.757M worth of shares to employees of their business. Based on their share prices during 2020, we can assume that this resulted in 2M shares being compensated to their employees, if this were the case, then this compensation would have resulted in a share dilution of 0.7%.
- Authorized Shares: Skillz has been authorized by their board of directors to have the ability to sell up to approximately 63M shares. If they were to offer these shares evenly over the next 3 years, it would dilute the existing shares by 6.67% per year (total dilution of 21.36% over the 3 years).
- Earnout Shares: In January of 2021, the conditions required for the release of earnout shares were satisfied, meaning that 10M shares (5M Class A, and 5M Class B shares) are eligible for release. This will cause dilution of 6.49% and 1.71% of the Class B and Class A shares, respectively.
- Option Awards: In 2020, Skillz awarded some of their highest-ranking management members the CEO, CRO, and CFO, with $99M, $21M, and $24M worth of stock options, respectively. Furthermore, we know that the weighted average estimated fair value of options for 2020 is $17.68, and each option allows for the exercising of 100 shares. By doing some quick math, we can assume that these high-ranking members could be holding up to 8.15M shares in these options, and if all of these options were to be exercised, the existing shares would be diluted by approximately 2.73%.
- OmniBus Incentive Plan: This plan provides various stock-based awards to their employees. This plan has reserved 54.25M Class A shares and 12.08M Class B shares for issuance. If these shares were all to be issued it would cause a dilution of 18.52% and 15.78% on their Class A and Class B shares respectively.
- Employee Stock Purchase Plan (ESPP): Skills has and ESPP in place, which offers Skillz employees the option to buy common shares at a 15% discount from market value. In total, there are 7.85M common shares available in this plan for repurchase this year. If these shares were all bought up by the employees, then there would be dilution of roughly 2.68% on existing shares.
- User Engagement: In 2020, Skillz managed to garner 60 minutes of playing time per playing user per day. This is higher than almost every single app that is on the app store right now, and 58% higher levels of engagement than the #1 mobile game (Candy Crush). Skillz plans to keep their users engaged by releasing more content, which will lead to more engagement, which will lead to more revenues, which will help the share price.
- User engagement is important to building long-term recurring revenues, and if Skillz can continue to garner these levels of engagement, they will be positioning themselves to be a top player in the industry.
- Mobile Gaming: Skillz is attempting to dominate the mobile gaming space, currently the mobile gaming space has a market of $86B, which represents a big opportunity for Skillz given their market cap of $9B. Furthermore, the mobile gaming industry grew at a CAGR of 23$ between 2015-2020, which is the largest in the entertainment industries. This industry is also forecasted to grow at a CAGR of 13% over the next 5 years.
- Target Demographic: Skillz target demographic is the market as a whole. This is because their users are both male (43%) and female (57%), and they are both old (46% over 46) and young (54% under 45) Furthermore, they have users of all levels of income, as 70% of users make under 75K annually, and 30% make over 75k. As a result of this, Skillz has a unique advantage over many of the other companies in their industry, that being a diverse demographic, which enables them to target the whole gaming industry rather than a niche. This may help Skillz to gain market share in the future, which will help their financial performance and stock price.
- Game Development Platform: Skillz has created a platform in which game developers can create their own games and release them to the community of Skillz gamers. Skillz's development platform offers payments, support, hosting, marketing, optimization, testing, personalization and analytics to simplify the process for their developers. These developers get paid according to the amount of plays their game has out of a developer profit sharing plan. The profession of game development is rapidly growing, as there is now over 10M game developers today (from 30,000 in 2009), this makes the market saturated and hard to get discovered on. This is great for Skillz as their platform will be able to attract developers because they are able to get discovered more easily, and they are able to get paid for their hard work, this will help Skillz to keep up with the demand for new games.
- Total addressable Market (TAM): Skillz has determined that if they are able to capitalize on their opportunities in the iOS, Android, and international markets, as well as expands into new genres that their TAM could be upwards of $125B. Given their market cap of $9B, their demographic being the market as a whole, and the growth rates of these markets, there is a lot of room for Skillz to grow into, which may help investors to get excited for the future.
Sources (company and financial info):
Skillz Inc. 2020 Annual report 10-K/A (sec.report)
There are a couple of other companies in the public markets that are considered competitors to Skillz. Each of these companies is of similar market cap, and majority of them are also based out of the USA. These companies include Zynga ($ZNGA), Take-Two Interactive Software Inc. ($TTWO), Roblox Corp. ($RBLX), and SciPlay Corp. ($SCPL).
Skillz is seen by many as a better investment compared to these stocks, because they have more room to grow, their target market is larger, they have created a new business model which could be more lucrative than previous/standard business models, and they are experiencing more growth.
Given the available financial information of Skillz, the only method of valuation that I could use to find a fair value for Skillz is through comparable analyses.
In order to get an unbiased and rounded view of Skillz's valuation, I used 3 different comparable ratios. These 3 ratios are the only ratio's that were positive from Skillz. These ratios are EV/Assets, EV/Revenue, and P/B.
By comparing Skillz's EV/Assets ratio to that of their competitors (listed above) I was able to find Skillz's fair value to be $16.70. If this was the case, there would be an implied downside of 31.54%.
By comparing Skillz's EV/Revennue multiple to that of their competitors I arrived at a fair value of $11.47 per share, which would imply a downside risk of 53%.
By comparing Skillz P/B ratio to that of their competitors I arrived at a fair value per share of $47.75, which would imply an upside of 95.67%. Since there is large variability in all of the comparable analyses, I decided to take the average result to avoid any biases.
The average of all 3 comparable analyses undergone came out to be $25.31, this would imply an upside to an investment into Skillz of 3.73%.
By no means am I calling Skillz one of the most undervalued stocks, rather I am implying that it could be near fair value, implying that it is an undervalued growth stock, that shows a lot of promise.
- Financial Performance: If Skillz can find a way to continue their growth rate and slow down the growth of their cost of revenue, then there will be more investors who would be willing to invest. Furthermore, look out for their first quarter where they report a net income, as that will be seen as a potential turnaround and their share price is likely to jump.
- Inflation Data: Inflation data being released has the largest impact on high growth stocks. If new inflation data comes out and inflation is stagnant or even decreasing, then this stock could rally higher.
- Dilution: This is the largest risk that comes with this investment. This is because Skillz has multiple ways in which they can and have been diluting shares, these include stock-based compensation, earnout shares, authorized shares, option awards, their Omnibus Program, and their ESPP. The worst-case scenario of dilution (adding all of the possible shares to be diluted) would cause an existing share dilution of Class A shares of 47.87%, and a total dilution of their Class B shares of 22.28%. This represents a lot of share dilution to come and should scare any investor regardless of how bullish you are on the company.
- Financial Performance: Skillz's 2020 financial performance was not the best, as a variety of their costs increased by over 100%, and their net losses increased by nearly 5x. This is not favourable for investors, and if Skillz fails to fix their net losses, or at least slow them down dramatically, then their share price will be negatively affected.