It is apparent that mobile gaming is an industry that have seen huge growth within the last years, and the trend seems to continue with constantly increasing market. But with the increased mobile gaming market, mobile game developers have also gone from 30.000 in 2009 to more than 10.000.000 in 2021, and you start wondering who is winning and who can actually monetize their games in this competitive market.
Into the public market came an IPO (actually it was done in a SPAC deal) in December 2020 that shows one of the opportunities to monetize the growing mobile gaming industry.
The Idea, Product and Potential
Skillz is an online e-gaming platform that enables players to participate in competitive events. The idea, when co-founders CEO Andrew Paradise and CSO Casey Chafkin founded the company in 2012 was, that the competition would make the games even more exciting and engaging. The numbers that Skillz are displaying is indicating, that that is exactly what is happening. Gamers compete and put wagers against each other, and the winner will win a cash prize. The unit economics for Skillz is further detailed later in the review. End of 2020 investor presentation indicates that more than 2 billion tournaments are executed on the platform each year.
The mission statement of Skillz is: "At Skillz, our mission is to connect the world through competition. We have invested deeply in the technology necessary to provide fair and secure competitive gaming experiences for our users. The trust we foster with our users is the foundation upon which our community is built." Even though the mission is not simple, super clear or even overly inspirational, it depicts what Skillz is really trying to do, which is create an engaging and fair competitive gaming experience. Referring to engagement, it is obvious that Skillz is doing something right. The below figures are from the Q4.2020 investor presentation and indicates that users are spending more time on the Skillz platform, than many of the other time consuming products in the market.
The whole business model becomes very interesting, when one really understands that Skillz is actually "just" connecting developers and gamers in a way, that we have already seen many extremely successful e-commerce companies do before. For gamers it the competitive aspect of the gaming and to earn an extra buck, but also the reduction of nuisance from in-game adds etc., that makes this a compelling platform. For developers it is the chance to finally be noticed in the world of excessive game development and monetize their creations, that makes the Skillz offering powerful.
In 2016 there were 7 games on the platform grossing annualized Gross Marketplace Volume (GMV) over 1 million USD, and in 2020 that number was up to 36, which indicates the increased success of the platform, also for developers.
Being the first mover, providing this business model, can be a very valuable asset for Skillz in the future, and the figures quarter over quarter will show whether they can further monetize this competitive advantage. Another aspect of the model that is emphasized by CEO Andrew Paradise is the fairness of the gaming experience. Skillz have developed a patented proprietary method for detecting cheating and other forms of fraud. Furthermore they have patented player matching algorithms to fairly match gamers at equal levels. Both parts important for the players' gaming experience.
The concept is that mobile game developers can add their game to the Skillz platform, where Skillz will provide them a Software Development Kit (SDK). The SDK will enable all Skillz features to the game on the platform, and Skillz will manage everything from payments, prize fulfillment, analytics, user support etc.
The games market in 2020 is around 175 billion USD according to NewZoo, and mobile gaming is approximately 50% of that. NewZoo also expects the market to grow to around 220 billion USD in 2023, and out of that we can expect the mobile share to be even greater than 50%, as mobile gaming has been taking share consistently over the last decade. (CAGR of 23% over the last 5 years)
Financials
To start with the unit economics, here a simple example. Two gamers will each pay an entry fee of 0.6 USD to play against each other for the prize. Out of the 1.2 USD, 1.02 is spend on prizes, incentives and the developer profit share. Hence 0.18 USD will be kept by Skillz, which means that Skillz will book revenue of 0.18 USD. With a current gross margin of 95%, there is an obvious route for significant operational leverage, when Skillz succeeds growing the top line continuously into the future.
No doubt, the expectation is, that Skillz will spend all of their profits the coming years on user acquisition, research and development, and potential in-organic growth which was lately mention by Andrew Paradise, but for the long run the unit economics of this business is very strong.
Currently the Annual Revenue Per User (ARPU) at Skillz is 7.49 USD, while for Zynga and GLUU the average is 2.35 USD. So Skillz are already displaying the ability to monetize the users. Furthermore the figures how that the gamers are spending more and more on the platform, while new gamers are more rapidly increasing the spend, which is a hot cocktail.
The business model, with the mentioned strong unit economics, shows that Skillz revenue will increase proportionally with the platform GMV. That connection between GMV and revenue is a very powerful mechanic, as the success of the developers' games are also Skillz' success. Something that cannot be underestimated.
End of 2020 there is cash of 262 million USD on the balance sheet to fund coming quarters' investments and negative cash flows, and very pleasantly zero debt. With a negative operating cash flow in the -50 million USD range, it will naturally not hold forever.. Revenue is currently at 230 million USD growing in 2020 at a 92% clip. With current growth rate and increasing ARPU, the company is in a strong financial situation to balance growth with cash position.
Management and Culture
Co-founders Andrew Paradise and Casey Chafkin is still at the helm of the company sitting on the CEO and CSO positions respectively. This provides comfort for the years to come, as founders generally outperform their colleagues in non-founder-led companies. The management of the company still owns and amazing 25% of the company shares, even after the IPO, which indicates a huge "skin in the game", which is usually one of the core ingredients of a multi bagger. On top of that Andrew Paradise still has 81% of voting rights in the company, due to a huge amount of B-shares, so this company is widely run by CEO.
Taking a look at the Glassdoor ratings, they seem fairly sound with a 4.3 overall score, and 83% recommending the company to a friend, and 87% approving of the CEO.
All in all a strong management team that it will be interesting to follow.
Stock
Skillz recently IPO'ed at a USD 18 price in December 2020 and is still in early stage development. It has had a little bit of rough ride since IPO, shortly going into the 40's, only to plunge back to IPO level. (at time of writing USD 16,5)
Currently the stock trades at a P/S of 28, which of course is a hefty valuation, but if they can execute on high growth rates (>50%) for the next several years, they would have many doubled their revenue. Imagine what that would do to the P/S if the price stayed at current levels. Combined with strong unit economics I wouldn't be surprised to see this company significantly outperform the market over the next 5 years. There are many ways this story can play out, and we will have to see how they execute.
Risks
Generally there are competitors that could come into the market with solutions that could disrupt Skillz' leading position. We are talking about the likes of Xbox, Sony etc. On top of that major game developers or even Unity, could build a similar platform. I do believe though, that Skillz have a significant lead, after building this platform over the last 10 years.
In some states and countries gambling is prohibited. In general Skillz' market themselves as not having games depending on luck, but games decided by skills. But overall there is a natural risk of regulation that Skillz will need to proactively handle.
The regulation is also important for the perceived moat that Skillz have, as many proprietary games will have a sense of luck, power-ups, special abilities etc. that cannot exist in a "100% skill game". This makes the moat for Skillz somewhat smaller in relation to sustaining the games on the platform.
More than 80% of the company's revenue stems from the top 3 games. This is naturally a huge risk, and they need to secure broader monetization in the future.
MoGeBat Score: 65
Concluding on the research made Skillz looks as a very interesting opportunity, and I might take a position in the company soon. I strongly believe that the business model of connecting players and developers is very powerful, and I believe it will be the driver of Skillz' future success. Coupling the increased user engagement, increased user base and the strong unit economics, it is obvious that this company has the potential to be a superb investment over the coming decade.
I will be following GMV trend and the conversion of MAU (monthly active users) to MAPU (monthly active paying users) to secure that Skillz' are performing as they are set out out to do.
Usually a MoGeBat Score of 65 is somewhat lower than usual investment range, but as this is a new company, and as I do see many traits of a multibagger, this is atleast moving into the top of the watchlist.
As usual comments are more than welcome...
Disclosure: Morten Gerdes Bach might own shares of Skillz. The information expressed herein are opinions and not financial advice.
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