Investment Thesis
Skillz Inc. (NYSE:SKLZ) operates an online multiplayer mobile gaming platform that matches similar skilled users to compete in games for rewards. The company’s core business has declined precipitously amidst falling revenue, poor user retention, and platform concentration issues.
While Skillz is attempting a turnaround through product improvements, organizational changes, and marketing optimization, its long-term prognosis looks unfavorable without dramatic improvements reviving user engagement.
However, with shares trading below net cash value and substantial near-term catalysts from buybacks, debt reduction, and short squeeze potential, a potential short squeeze in the stock is completely possible. Over the long run, however, Skillz must demonstrate sustainable traction in reviving its core platform to warrant a bullish view.
Business Overview and Sequential Decline
Skillz operates a proprietary gaming platform that lets users compete in casual multiplayer games by matching players of similar skill levels. The platform monetizes by taking a share of entry fees paid for its paid contests.
The company grew rapidly post-IPO as demand surged for mobile gaming amidst the pandemic. However, revenue growth began decelerating in 2021 before turning negative in 2022. TTM Revenue now stands at $190m, down 50% from $380m in 2021
A world of hurt (Seeking Alpha)
Paying monthly active users have plunged ~65% from 610,000 in 2021 to just 200,000 as of Q2’23.
This erosion is driven primarily by concentration in a handful of games like Solitaire Cube and 21 Blitz which accounted for the majority of its revenue. As CEO Andrew Paradise noted on the Q1 2023 earnings call, “We’ve always seen concentration in the top few games, like other media platforms.”
But as users moved on from these top titles, Skillz failed to replace the lost engagement and revenue. The platform simply couldn’t retain users anywhere close to its peak. The substantial decline in paying users indicates structural weaknesses in Skillz’s value proposition and competitive position.
Turnaround Efforts
To revive growth, Skillz has focused on four strategic pillars:
1. Improving platform engagement and retention
2. Upleveling the organization with new talent
3. Increasing marketing efficiency
4. Demonstrating a path to profitability
On the product side, Skillz aims to boost retention with features like daily challenges and an improved league system. The company believes based on early data that these could drive double-digit improvements in key performance metrics.
To attract more developers, Skillz launched a new revenue share model in May of this year based on game entry fees rather than net revenue. The change provides developers with real-time revenue data and aligns incentives to drive traffic.
Early feedback has been positive, with some developers investing more in the platform. But meaningful diversification of game concentration will take time.
To improve marketing efficiency, Skillz slashed user acquisition spending by 86% year-over-year in Q1 2023, leading to a 74% reduction in Q2. While this hurts user growth, it’s a fair move to improve unit economics.
For profitability, Skillz aims to reach positive adjusted EBITDA by end of 2024. The market has its concerns about the company’s ability to staunch losses before running out of its current $230 million net cash balance, but it looks like the company has pulled all appropriate cost levers and now estimates 6 years of runway on its balance sheet at current burn.
Near-Term Catalysts
Despite its long-term struggles, Skillz has potential upside from its extremely low valuation and other near-term catalysts.
With a market cap of just $102 million, Skillz now trades below its $230 million net cash position. This gives a substantial margin of safety even if the business deteriorates further.
In August, Skillz announced a $65 million share repurchase program, representing over one-third of its then market cap. CEO Andrew Paradise said on the Q2 2023 earnings call that the repurchase authorization along with its ability to buy back debt provides “contractive liquidity which allows management and the Board to immediately evaluate opportunities to deploy capital to enhance shareholder value.”
Buybacks at current prices would be highly accretive for remaining shareholders. Skillz has already repurchased $160 million of debt this year to strengthen its balance sheet, with only $130 million remaining.
The relatively high 18% short interest also leaves Skillz exposed to potential short squeezes on positive news, especially considering the low trading volume. Even marginal improvements in metrics or user engagement could spur a surge amidst bearish sentiment.
Doomsday Valuation
Skillz currently trades at a pedestrian 0.4x tangible book value, priced for obliteration.
The company ended Q2 2023 with $328 million in cash against just $130 million of debt, giving it a robust net cash position.
This gives very substantial downside protection for investors even if Skillz continues burning cash while struggling to turn itself around. With its net cash exceeding the market cap and the rate of cash burn going down to a manageable rate, shareholders are essentially getting the core business for free.
The low valuation also gives management extensive flexibility to pursue strategic options, including additional buybacks, strategic acquisitions, or even going private. With a runway covering 6 years of cash burn, Skillz has time to right the ship.
Conclusion
In summary, Skillz faces deep-rooted issues with its core gaming platform, raising long-term concerns about its growth prospects absent a dramatic turnaround. But with shares trading below net cash and substantial near-term catalysts, a hold rating is appropriate for opportunistic investors.
Skillz’s massive user engagement decline indicates structurally weakened competitive positioning within mobile gaming. But the company’s strong balance sheet provides a hedge even if the business continues deteriorating.
For long-term investors, signs of stabilization and execution on the profitability goal will be key to warranting any type of long-term bull case. But in the near term, Skillz’s cigar-butt return potential from its strategic capital deployment, depressed valuation, and high short interest warrant a neutral view.
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