Skillz Stock: A Unique, yet Speculative Opportunity

© Reuters. Skillz Stock: A Unique, yet Speculative Opportunity

Skillz (SKLZ), simply put, offers a platform for all gamers to compete in any game.

Take the various casual games such as scrabble or solitaire, for instance. Despite their huge popularity, they have historically lacked an esports platform, as they are largely played by casual gamers, and because setting up a competitive platform at scale from scratch is challenging, and expensive.

The developers of such games ordinarily monetize through ads in between menus, or in-game items, such as cosmetics and skins.

However, this creates a problem. First, ads usually dilute the gamer's experience. Second, suppose the in-game items go beyond cosmetics into more powerful ones that affect gameplay. In that case, they can lead to a "pay to win" environment, in which players who are spending real money almost always defeat the free-to-play players. This isn't very pleasant for the latter group.

Skillz offers a compelling solution. Its platform enables game developers to monetize via paid tournaments. These tournaments are fair for all players, and add a very fun twist, since players get to play their favorite games while competing to win real money.

Therefore, Skillz is able to significantly increase the ARPU (average revenue per user) of virtually any compatible game. I am bullish on the stock. (See SKLZ stock charts on TipRanks)

Stock Is Tanking, but Revenues Keep Growing

Skillz recently reported its Q2 results, with rather impressive numbers. Despite that, the stock kept sliding lower, as has been the case for months now.

On the one hand, revenues increased 52% year-over-year to $89.5 million, signifying Skillz' 22nd consecutive quarter of higher revenues. Paying Monthly Active Users (PMAUs) increased 53% versus the prior-year period, to 463,000.

On the other hand, bears noted two significant shortcomings.

While PMAUs increased year-over-year, the number decreased quarter-over-quarter. As well, rapidly growing advertising expenditures led to record net losses of $79.6 million. Hopes for a sustainably profitable future slightly faded as a result.

However, there are two counter-arguments to these points.

Firstly, the previous quarter's PMAUs expansion was a one-off, lifted by the seasonally lower Cost Per Install (CPI). As management wrote in Q2's shareholder letter, Q1 has historically been a prime time to buy digital impressions (ads), since they are cheaper.

This explains why user growth wound up slightly bloated in Q1, which makes a small sequential decline in Q2 quite acceptable.

As far as widening losses go, Skillz CRO Casey Chafkin specified in the earnings call that ad costs should start declining. Specifically, he stated that Skillz is beginning to notice the velocity of previous ad pricing increases starting to stabilize.

Moreover, Aarki, one of Skill's two recent acquisitions, should lower CPI costs, on top of adding $13 million in incremental revenues this year. Through synergies, Skillz' DSP marketing spend should gradually migrate to Aarki, saving some costs.

Wall Street’s Take

Turning to Wall Street, Skillz has a Moderate Buy consensus rating, based on three Buys, two Holds, and zero Sells assigned in the past three months. At $19, the average SKLZ price target implies 71.4% upside potential.

Bottom Line

Overall, Skillz is, without a doubt, a speculative play.

However, considering that shares currently trade at around 12x management's FY2021 guidance ($375 million to $376 million), estimates that revenues should keep growing at around 50%, and Skillz' own gross margins, which surpass 95%, it's a bet with decent odds.

Disclosure: On the date of publication, Nikolaos Sismanis had a beneficial long position in the shares of Skillz through stock ownership.

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