Skillz Stock: Bear vs. Bull

Skillz (SKLZ -2.09%) burned a lot of investors after it went public via a merger with a special purpose acquisition company (SPAC) in Dec. 2020.

Skillz's stock started trading at $17.89 on its first day, then skyrocketed to an all-time high of $45.55 during the Reddit-fueled rally in "meme stocks" in Feb. 2021. Cathie Wood also aggressively accumulated shares of Skillz for her Ark Innovation (ARKK 1.05%) and Ark Next Generation (ARKW 0.45%) exchange-traded funds (ETFs) throughout the year.

But today, Skillz's stock only trades at about $4 per share, and Wood's ETFs have also sold most of their shares since the beginning of the year. Let's see why the bears overwhelmed the bulls, and whether or not this battered tech stock has a shot at recovering over the next few quarters.

Image source: Getty Images.

What the bears will tell you about Skillz

Skillz's cloud-based platform enables developers to easily integrate multiplayer features, cash prizes, in-app payments, and analytics features into their mobile games with just a few lines of code. Outsourcing those features to Skillz can save developers a lot of money, time, and resources.

That approach sounds disruptive, but Skillz actually generated 73% of its revenue from just three games (Solitaire Cube, 21 Blitz, and Blackout Bingo) from two developers (Tether and Big Run) in the first nine months of 2021.

The company's audience is also small and its growth rates are unimpressive. It served 2.7 million monthly active users (MAUs) in the first nine months of 2021, up slightly from 2.6 million MAUs a year earlier. That's a tiny percentage of the 2.2 billion mobile gamers worldwide.

Skillz also takes a 50% cut of the revenue generated by its hosted games, which is significantly higher than the 30% cut Apple and Alphabet's Google retain from direct in-app purchases. That gap could easily convince developers to create their own in-house multiplayer and in-app payment features instead of paying Skillz's hefty fees.

Even after charging those high fees, Skillz can't turn a profit. In the first nine months of 2021, Skillz's operating loss widened year-over-year from $56.4 million to $183.1 million, while its net loss widened from $78.5 million to $82.4 million. All that red ink makes Skillz a very risky stock to own as rising interest rates punish unprofitable companies.

Skillz also faces competition from Unity (U 3.47%), a top game engine that helps developers easily create cross-platform games with multiplayer, monetization, and analytics features. Developers already use Unity to create more than half of the world's mobile, console, and PC games, while Skillz is stuck in a corner with just three games.

What the bulls will tell you about Skillz

Meanwhile, the bulls believe that Skillz is undervalued relative to its growth potential, even if it doesn't evolve into a disruptive platform like Unity.

Skillz's revenue rose 92% in 2020, then grew 69% year-over-year (66% after excluding its acquisition of the advertising platform Aarki) in the first nine months of 2021. Including Aarki, it expects its full-year revenue to grow 69% to $389 million. Analysts expect Skillz's revenue to rise 41% to $549 million in 2022 -- and the stock trades at just three times that estimate.

That price-to-sales ratio is ridiculously low relative to its growth rate and its industry peers. Unity expects its revenue to rise 34%-36% in 2022, but its stock already trades at roughly 21 times that forecast.

In addition, Skillz's average revenue per user (ARPU), paying MAUs (PMAUs), and average revenue per paying user (ARPPU) all continue to grow at much faster rates than its total MAUs. As a result, Skillz's gross merchandise volume (GMV) and revenue continue to rise at robust rates:

Data source: Skillz. YOY = Year-over-year. 

As for its widening losses, Skillz's $150 million purchase of Aarki should gradually reduce its sales and marketing expenses (68% of its total costs and expenses in the first nine months of 2021) by giving it direct exposure to the advertising network's 465 million monthly active users. Skillz could also generate additional advertising revenue from Aarki's existing customers, or offer its advertising services to its own gaming customers.

Lastly, Skillz's insiders have actually bought more than twice as many shares as they sold over the past six months -- even as the stock plummeted about 66% and Ark Invest liquidated most of its positions.

Skillz looks interesting -- but it's still risky

I've told investors to avoid Skillz before, but it's finally starting to look undervalued. If we tune out the exaggerated forecasts in its SPAC presentation and Cathie Wood's overly bullish comments, we'll see that Skillz is still growing and squeezing more revenue from its limited audience.

However, Skillz still needs to gain new customers and reduce its dependence on Big Run and Tether before I consider it a worthwhile investment. Investors should carefully review Skillz's upcoming fourth-quarter report for some signs of improvement before siding with the bulls or bears.