Mobile-gaming platform Skillz (NYSE:SKLZ) has taken shareholders on a wild ride. After it announced it was going public via a special purpose acquisition company (SPAC), the stock price of the acquiring SPAC surged 300%. But currently, the merged company is almost 65% below its February highs.
The ride is indicative of what Skillz has become: a polarizing investment. Clearly, the bulls see how fast the mobile game market is growing and like how engaged Skillz's user base is -- the average paying user plays for one hour per day. But the stock has also attracted bears and some prominent short-sellers. They allege that Skillz management is exaggerating its long-term prospects in order to enrich insiders.
Skillz stock plummeted in response to increasingly vocal short-sellers. Then something unusual happened. Skillz founder and CEO Andrew Paradise wrote an open letter to retail investors so they could "better understand the facts about Skillz."
Here are three of the biggest points Paradise tried to make in his letter.
1. How Skillz justifies marketing spend
Two metrics you need to know are lifetime value (LTV) and user acquisition cost (UAC). With LTV, companies measure how much revenue they can expect to generate from customers over a long period of time. With UAC, they measure how much it costs to get customers in the first place. If LTV exceeds UAC, it suggests that sales and marketing expenses are worth it.
Skillz spends more to acquire users than it spends on anything else. In 2019, the company spent over $111 million on this line item -- a whopping 93% of revenue. In 2020, it spent almost $252 million, which was more than the $230 million it generated in revenue. On the surface, this appears excessive and unsustainable.
Paradise disagrees. Looking at the LTV-to-UAC ratio, he pointed out that for every $100 it spent (UAC) it generated $380 in revenue (LTV) from 2018 to 2020 -- a ratio of 3.8. Therefore, from management's perspective, its heavy spending is supported by the data.
This is undoubtedly true when looking back. However, it seems less true recently.
|Sales and marketing expense||$111.4 million||$99.2 million||$73.2 million||$79.6 million|
|Monthly active users additions or (losses)||N/A||600,000||100,000||(300,000)|
For what it's worth, Skillz appears to be growing monthly active users (MAUs) again after a drop in Q4. For its upcoming first quarter, it expects to report 2.6 million MAUs. This would be flat year over year, but up about 8% from the previous quarter.
2. Skillz has never lost a cohort
The LTV-to-UAC ratio Paradise presented is a three-year metric. However, Paradise said, "It's worth noting that we apply a three-year measurement period even though we've never had a cohort stop paying over the last seven years and counting." This means that its MAUs are actually more valuable than the previously presented metric would have you believe.
In Skillz's annual filing, it gave a breakdown of what revenue generation has looked like for its 2016 cohort.
|Cohort||Year 1||Year 2||Year 3||Year 4||Year 5|
|2016||$6.0 million||$5.5 million||$5.5 million||$6.6 million||$7.2 million|
The 2016 cohort is exemplary of the rest. Paying users tend to continue paying for years. This is important for two reasons. First, the longevity of its cohorts further supports Skillz's spending to acquire users. But second, this also seems to suggest that the games on Skillz's platform are addicting and engaging.
Critics point out that the platform doesn't have any true hit games. And that may indeed be the case. But it doesn't seem to matter -- Skillz users are nonetheless engaged and that bodes well for the company moving forward.
3. Intriguing growth ideas
Finally, Skillz refers to itself as an esports company, which may limit investors' imaginations for how it will grow. But Paradise gave investors some interesting ideas. First, he mentioned "non-intrusive advertising." Remember that the Skillz platform is ad-free. Just 16% of its 2.4 million MAUs are paying users. Perhaps Skillz could introduce advertising to monetize its larger non-paying user base.
More intriguing, Paradise presented the idea of "gamifying other industries and experiences." Some possibilities include education and fitness. This is an aspect that I certainly hadn't previously considered and, once introduced, could significantly broaden the appeal of Skillz's platform.
This article doesn't explore all the concerns with a Skillz investment today or other reasons why it could be winner. These are just three important points from the perspective of Skillz's founder. But don't neglect to do more research before deciding what to do with Skillz stock.