Is Skillz Stock a Buy?

Skillz (SKLZ 2.64%) has been a volatile but ultimately disappointing investment for many investors since it hit the market. The online gaming platform company went public by merging with a special purpose acquisition company (SPAC) last December, and its stock started trading at $17.89 before skyrocketing to an all-time high of $46.30 during the Reddit-fueled rally in February.

However, Skillz's stock subsequently tumbled to about $10 per share, even as Cathie Wood's ARK Invest -- which holds 23.7 million shares of Skillz in its ARK Innovation and ARK Next Generation exchange-traded funds (ETFs) -- stayed fiercely bullish. Let's review what Skillz does, how fast it's growing, and whether or not investors should consider buying the stock at these depressed levels.

Image source: Getty Images

What does Skillz do?

Skillz's cloud-based platform enables developers to easily integrate multiplayer tournaments, cash prizes, in-app payments, and analytics services into their mobile games with a few lines of code. Building those features from scratch can be expensive, time-consuming, and difficult to scale as a game grows, so outsourcing them to Skillz's platform is an attractive option.

Skillz's business model sounds disruptive, but there are four glaring weaknesses. First, it relied on just three games (Solitaire Cube, 21 Blitz, and Blackout Bingo) from two developers (Tether and Big Run) for 73% of its revenue in the first nine months of 2021. That customer concentration suggests that Skillz might not be as disruptive as the bulls believe.

Second, Skillz faces plenty of competition from advanced game engines like Unity (U 0.92%), which enables developers to create cross-platform games and integrate multiplayer, monetization, and analytics features.

Unity already powers more than half of the mobile, console, and PC games in the world, while Skillz generates most of its revenue from three tiny games. Analysts also expect Unity to generate about 2.5 times more revenue from its diversified base of over 1.5 million active creators than Skillz next year. 

Third, Skillz takes a whopping 50% cut of all the revenue generated by its hosted games. That's much higher than the 30% cut that Apple and Alphabet's Google retain from their in-app purchases, and could encourage larger developers to build their own multiplayer features instead of using Skillz.

Lastly, Skillz still can't generate a profit after retaining that cut. Instead, its net loss more than doubled year-over-year in the first nine months of 2021, and it's expected to post an even wider loss next year.

How fast is Skillz growing?

Skillz's revenue rose 92% in 2020, then grew 69% year over year in the first nine months of 2021. Excluding its recent acquisition of the advertising platform Aarki, its revenue would have risen 66%. It expects its full-year revenue, including Aarki, to increase 69% to $389 million.

Skillz's monthly active users (MAUs) only increased 4% year over year to 2.7 million in the first nine months of 2021, but its number of paid monthly active users (PMAUs) jumped 60% to 0.48 million. As a result, its average revenue per user (ARPU), average revenue per paying user (ARPPU), and gross merchandise volume (GMV) all outpaced its unimpressive MAU growth:

Source: Skillz Company Filings. 9M = 9-months.

However, that growth doesn't resolve Skillz's customer concentration issues, and indicates it's growing even more dependent on its top three games. Meanwhile, its widening losses reflect the painfully high costs of maintaining its platform and acquiring new users:

Source: Skillz Company Filings. 9M = 9-months.

Skillz's purchase of Aarki, which reaches more than 465 million users with its advertising network, for $162.3 million in cash and stock might significantly reduce its own sales and marketing expenses in the future. It could also enable it to add more in-game advertising features to its own platform.

That's a step in the right direction, but I doubt buying Aarki -- which generated just $5.4 million in revenue with a net loss of $2.8 million in the first nine months of 2021 -- will help Skillz break even anytime soon.

The weaknesses still outweigh the strengths

Skillz's stock trades at eleven times this year's sales, which might initially seem reasonable relative to its growth rates. Unfortunately, its customer concentration issues, sluggish MAU growth, and steep losses are all keeping me far away from this speculative stock.