Investors have kicked mobile gaming competition company Skillz (SKLZ 3.07%) to the curb; shares are down more than 80% over the past year, and even more if you went back to the company's high of $46 early last year.
Skillz seems to be having a hard time showing a clear path to profitability, which isn't good in a market that's become tougher on growth stocks. Whether or not Skillz can win over the long term remains to be seen, but here are three concerns to consider before buying shares.
1. Too little, too late?
Skillz emphasized in its 2021 Q4 earnings and again at its 2022 investor event that it's seeking "profitable growth" after spending so heavily on marketing over the past couple of years. While the effort is appreciated, it could be too little, too late. Skillz has dug itself a financial hole, and share price struggles only put management further into the weeds. Consider that Skillz's operating losses, the cash it burned from running the company, were $181 million in 2021.
CEO Andrew Paradise noted that the company is cutting engagement spending as a percentage of revenue from 49% in 2021 to 39% in 2022. Suppose you go by management's 2022 revenue guidance of $400 million. In that case, investors can expect engagement marketing to cost the company $156 million this year, which is $31 million less than it spent on engagement in 2021. That's good, right?
Is knocking $31 million in marketing costs enough when the whole company burned through $181 million in 2021? Skillz has $743 million in cash and short-term investments at the end of 2021, but it also has $300 million in debt at a 10.25% interest rate. So in reality, the company has $443 million in funds, and the interest on that debt will virtually eat up the savings from cutting back its engagement spending.
Skillz might need to raise cash by the end of 2022 (or shortly after) if everything goes according to plan, and potentially sooner if expenses come in higher than last year. The stock's low price means that fund-raising could be highly dilutive to shareholders (new shares make the existing stock worth less), and the existing debt's 10.25% rate came before rates began rising in the broader markets, so any new debt would have an even higher interest rate.
2. Can Skillz grow organically?
Operating leverage would be the ideal solution, where Skillz's revenue grows faster than its spending, making the company more profitable. However, it's unclear how effectively Skillz can grow without spending so much on marketing.
Before Skillz went public, its investor presentation had called for $555 million in revenue in 2022 while producing a positive non-GAAP EBITDA of $8 million. Fast-forward to now, and clearly, that hasn't panned out. The company's losing a ton of money, and its 2022 revenue guidance of $400 million is well short of its former goals.
Skillz began referring to a non-GAAP metric called "revenue after engagement marketing (RAEM)." It separates engagement money that Skillz gives users from the money that users deposit, so investors can see how much "real" money users are spending on the platform. Management is guiding RAEM to grow 24% year-over-year in 2022, showing that money spent by users is growing faster than engagement spending, but it's not growing nearly fast enough. The business is burning way too much cash too quickly for how much money is left on the balance sheet.
3. Time is not on Skillz's side
The company's financials create an urgency for Skillz to grow in the short term. However, a lot of what the company's accomplished has a long way to go before impacting the business. For example, the NFL partnership was announced in early 2021, but hasn't brought a game to market yet. The final winning games will launch during the 2022 NFL season, but by the time the game begins generating meaningful revenue, it could be sometime in 2023.
Meanwhile, the company partnered with Exit Games to give developers the ability to use its multiplayer game engine to build real-time multiplayer games. This technology upgrade makes more popular game genres possible. For example, Skills can now offer battle royale games, which are combat games that often feature more than 100 players in the same match. However, the company hasn't announced any games in this genre yet.
Skillz has long-term potential and seems to be steadily putting the building blocks together to build a complete platform for mobile gamers to compete. If Skillz had a better balance sheet, the stock might be attractive after falling to such a low price.
Unfortunately, buying the stock today is likely to come with either more high-interest debt or an extensive share offering to raise money, which hurts investors. Without better financials or a more straightforward path to profitability, Skillz has become too risky, in my opinion.