Skillz: A Coming SPAC IPO That Could Disrupt The Gatekeepers Of The Video Game eSports Sector
By: Howard Jay Klein
Oct. 05, 2020 2:25 PM ETSkillz Inc. (SKLZ)DKNG51
Summary
Skillz is a mobile gaming/esports platform where users can compete and game developers share revenue.
Our Q&A with management responses below.
Wellington, Fidelity, Franklin Templeton and Newberger Berman already are investors in an IPO expected to debut this year.
Last April Flying Eagle (FEAC) launched the Draft Kings (DKNG) IPO at $9. We liked the stock as the first pure play in sports betting and still like its basic business model. We did question and continue to question the rocket ride the stock has taken to close at more than $63 last week. But one learns that Mr. Market has an irrational as well as a wisdom of the crowds gene in its complex DNA. So who are we to argue with those investors who rushed into the stock madly, seeing a unicorn romping around the sports betting field amid money growing on trees? Good for them, sometimes blind faith pays off and it surely did on DKNG—so far.
Whether DKNG’s share price faces a sudden reckoning with reality and takes a dive down or continues its climb toward a triple-digit valuation can’t be reasonably forecasted by anyone yet. The emperor of all headwinds. i.e. the pandemic, will make the final ruling. Online sector shares won't be immune from a powerful second wave if it materializes and takes down the entire market.
Sports betting already is a crowded sector. I see a rough and tumble marketing war heating up. Last week, newly merged gaming powerhouse Caesars Entertainment Corp. (CZR) made what appears to be a successful run at legacy UK sports betting giant, William Hill PLC (OTCPK:WIMHY) for $3.7b.
The combined marketing leverage of CZR/ERI’s 62m customer rewards database is formidable because it creates a single wallet potential of estimable size. Their customer acquisition cost will be lower than peers, their national reach through 60 casino properties the biggest of all (Penn has 41 properties).
But the sector is getting messy in the flood tide of the rapidly-increasing number of states legalizing sports betting. According to Legal Report, there are now 19 legal - or in the process of implementation - sport betting states. The pandemic has created state government paupers which will see sports betting at the very least produce strong results. So new legalizations rapidly to come will fuel sports betting macro growth. It will become a bit of a chaotic marketing minefield in the process. DKNG may not wind up leading, but it will surely be among the leaders once we are past the inevitable shakeout and mergers I see.
That won’t be the case with Flying Eagle’s new deal, Skillz, which in our view has a genuine shot at joining the unicorn herd and playing out a possible big run at the video games/eSports sector, estimated by their management to reach $150b by 2025.
The full S-4 on the Skillz deal is available from the SEC here.
The sheer inventiveness of the business model is smart and intriguing. It democratizes a process now commanded by gatekeeping major publishers like Sony Interactive (SNE), Apple (AAPL), Microsoft (MSFT), Activision Blizzard (ATVI), Tencent (OTCPK:TCEHY), and Zynga (ZNGA), among many others.
We think that unlike DKNG, Skillz is not entering an already crowded sector. It's not a pure play in the video gaming fray but a distinct rationalization of a business that can be genuinely disruptive by opening to game developers a shortcut to publication and sharing of revenue.
All sound ideas for businesses that became money machines usually start with a simple question raised by founders:
Why must the some 10 million game developers globally (Skillz S-4 estimate) bang at the gates of publishing giants trying to get a real shot at what they think could be the next Candy Crush, Angry Birds or Fortnite? The majors in the field have massive, highly ingenious and creative internal staffs. There's no room for 10 million game developers to have their brain children vetted by a handful of industry leaders. They neither have the time nor the inclination. And they keep their deep wellsprings of internal creativity well watered with incentives for their own time-tested game creators.
So why not build a platform and invite those 10 million game developers to submit their ideas to one host? Why not design a business model where not every single game has to aim for tens of millions of users in order to get a shot at fame and fortune?
Why not have a platform where Mr. or Ms. Game Developer can publish a game with a modest, but regular, following of players, generate respectable income and split it with Skillz? (Below: The prize is in the method: Source xconomy.com)
Why not?
Answer? No reason. Hence Skillz debuts with a dart aimed directly at the gut of the process of how video game and eSports competition gets done in the post pandemic world. eSports competition online with games generated by a process that welcomes new developers as partners.
Highlights from the S-4 filing.
We strongly suggest that reading the Skillz s-4 will be well worth the time and effort. It's comprehensive, fact filled about its industry and presents what we believe is a reasonable pro forma going forward post IPO.
We have excerpted a few key data points to bring a bit of color to the Q&A that follows here from Skillz management.
They now have 2.6m active users. The company will rapidly ramp given the open door to developers whose games pass their criteria. Globally there are 10m game developers. Their 2019 numbers generated less than 10% of their total revenues outside of the US. They see this as fertile territory on which to build an international developer and user base. Skillz' monetization services afford developers to build a player experience by empowering them to compete in head-to-head matches, live tournaments, leagues and charity competitions. They aim to build player retention through referral bonuses, loyalty rewards, on-system achievements with Bonus Cash prizes. What I like a lot: Skillz does all the work as it were - the data interface, monetization services, registration services, including end-user registration, player matching, fraud protections and fair play monitoring. Also offered: Billing, settlement and payment dispute services. All developers need to worry about is creating their games, keeping them fresh and as the old car-rental mantra went: Leave the driving to us. All in all, a painless process for developers.
(Above: An eSports/ contest interface with strong engagement graphics. Source: livestream.com)
Summary of key results.
Revenues:
Skillz was founded in 2012 with the business mission to make eSports accessible universally. The platform has 30m registered users and hosts an average of 5m daily tournaments offering more than $100m in prizes each month. As of the end of 2Q20, the company says it has 9,000 games developers who have already launched successful games. This year, Skillz says it expects to launch more than two billion tournaments generating $1.6b in fees. And here’s a particular kicker we like: The company has complete kits of developer tools and consoles with easy-to-integrate software that will enable developers to monitor and update their games in direct and immediate response to player volumes and commentaries.
The financial logic
Skillz believes it aligns the interests of developers and gamers by monetizing through competition which eliminates the friction between traditional models between gamer and developer. Play times will be longer on the platform which creates more value for the company and its developer cadres. Thus higher player conversion retention and engagement, Skillz will be positioned to monetize users at more than 5X higher level that what would be generated through advertising or in-game purchases.
Quick track record:
In 2018 the Skillz cohort contributed $33.2m in revenue and $36.1m in 2019. The three-year lifetime value of the 2018, 2019 and first half of 2020 cohorts is expected to reach 4.7X the total user acquisition costs for those same periods. Payback averaged four months over the periods.
Revenue: From 2019 to 2020 (6mo) $53.9m to $101m
Sales and marketing cost doubled from $48.9m to $99. The net loss went from $(9.8) in 2019 to ($35m) in six months of 2020. This also fits the classic pattern of a tech platform’s great leap forward from continuing losses to breakeven and a powerful profit engine downstream that lies in the mind of investors.
Sales and Marketing
I have been a religious believer that the key financial marker of a unicorn above almost everything else is the rapid runaway cost of marketing. They typically spend tons of money to acquire new paying users and build engagement marketing programs. My usual take on this is that customer acquisition costs are the biggest, fattest ants in the unicorn picnic. We see this most dramatically in sports betting.
Sales and marketing cost for Skillz increased a hefty $50.3m or 103% y/y from the $48.9m y/y 2019 to the six months vis. 2020. However, engagement marketing as a percentage of revenue fell to 40% in the six month ended June 30, 2020, from 41% for the comparable 2019 period. Now this is of course something of a chump change improvement on the surface. But more critical, what it tells me that the trending of controlling and indeed, reducing, engagement costs at this early stage signals that management has its head on straight. And that above all, from my perspective as a former c-suite executive in the mass entertainment sector, is central to long-term success.
And lastly, the proof we believe that the Skillz business model already has been bought into by developers and gamers alike is the ramp from 2018’s annual revenue of $50.7m to 2019’s $119.8m.
Liquidity: Pre IPO Skillz had $69.9m in cash and cash equivalents. Post IPO it anticipates cash on hand at $250m. We see no liquidity problems and more than adequate cash to rapidly ramp revenues and inch closer to profitability within the next two years or less.
We have excerpted a few key markers we have taken from the S-4 for context. To get a closer handle from management’s perspective, we asked the company to provide some color on the business model and goals of SKILLZ. What follows are their responses for background to a series of questions we posed. For obvious reasons during this pre-IPO period, there's no specific attribution to any individual in the replies, other than to state that they reflect management’s collective viewpoint.
Here’s the exclusive Q&A between the author and company
Q; Skillz revenue comes from taking a 16% to 20% cut of entry fees paid by end users in competitions. Is that your entire revenue base? Ads are mentioned in this S-4 but it’s unclear how they are monetized.
A: We currently monetize users by taking a percentage of the paid entry fees. This is similar to Shopify which charges its customers based on a percentage of the merchandise sold, creating alignment for mutual success. We have been successful at doubling or tripling our revenue every year due to our focus and disciplined approach to strategy—focusing on the right priorities at the right time.
We are introducing ad-based monetization as part of the future of our business.
Important to note that 90% of the monthly active users on our platform are free to play.
We have 2.3m monthly active users (MAU) (26.6M X 90%) who enjoy playing games on our platform for free, so you can imagine the incremental revenue we could generate based on typical ad rates for mobile gaming companies. The demo profile of our players, who tend to be older than the typical mobile app user and have more discretionary income are attractive to advertisers.
Q: Do game developers pay for the development set of tools you have created, or is it offered free as an incentive?
A: The fees for our end-to-end go-to market solution is incorporated in the revenue share arrangement we have with our developer customers. What we offer is much deeper than just a gaming development kit.
Our solution includes a software development kit with more than 200 features, highly sophisticated data analytics that power player rating/matching and anti-cheat, anti-fraud, integrated payments. It also facilitates 24/7 customer service, a developer dashboard to monitoring game performance and LiveOps services to maximize user on-system engagement, Our platform is powered by data science—we have 58 granted and pending patents covering these proprietary technologies.
Q: What about overcrowding? Am I to believe that Skillz will accept all developer games that pass its criteria in an endless pursuit of “the more the merrier?" Or is there some built-in curbing of new entrants? Or are you depending on developers already in the tent to keep generating new titles?
A: We curate the games than can be prize-enabled based on objective criteria to ensure a great user experience.
We have complete control over which games are prize-enabled. We use real user data to evaluate the games. There are a number of criteria required to be prize-enabled, including minimum player liquidity, passing our skill-based algorithm test, and hitting performance quality standards. Since our mission is to enable all developers to bring their art to the world, we do not restrict the number of developers on the platform. We democratize gaming by enabling players to vote with their feet regarding what content is best.
Q: In brief, I’m not all clear on how Skillz will make its money and generate revenues to the point where it will turn profitable and validate investor conviction that it has elements of a unicorn.
A: Skillz has a highly scalable business model — it's essentially a software business which is evidenced by our 95% gross margin.
We continue investing to fuel growth. Our three-year ROI marketing spend stands at 4.7X.
We could be profitable today, but we are strategically reinvesting our profit to accelerate our revenue growth, given the rapidly-expanding market and ROI we are seeing.
That's evidenced by our 38% contribution margin (EBITDA before acquisition cost) or 38% in 2Q20.
Q: Is the basic premise correct to state that game developers now face a daunting set of gatekeepers in the traditional way they can get their games online, marketed, etc., on Skillz, which welcomes all with ideas and opens gates?
A: The explosive growth in new game content in the market makes it harder than ever for developers to get their games discovered to monetize them as well. As a result, the cost for developers to acquire a user base is higher than the revenue developers can generate from that user via ads or in-game purchases. Successfully scaling mobile games today requires capital and capabilities that are beyond the reach of many developers. Moreover, many developers lack the expertise, data or tools to optimize live operations or user acquisition. Skills provides a platform for developers to monetize their games through competition and build a financially independent business.
My takeaway:
I think the Skillz idea checks all the boxes that qualify it as a truly innovative approach to opening an entirely new pathway for game developers and users alike. In its pioneering of democratization of the process it's a unicorn.
I like this business model. Management it seems to me, thus far, has its head on straight in both the timing and financials of its IPO. There's a real thinking process about the hard realities game developers face in the current system. Of course, in the end it all comes down on the allure and attraction of the playability of the games and their appeal as competitive entries. In the end, content is king.
This to me is a real good toe dip in the mobile eSports games competition space with a twist that I believe should attract serious attention from investors in the space.
That assumes the bankers don’t get too greedy when the price the IPO with the same reality as it has applied to the creation and development of its app.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
