😬 SKLZ Stock | ARK Invest Bets Big on Skillz Stock

[00:00:00.000]
Oh gosh. In this episode, I'm doing a deep dive on one of the most drama filled, shorted, volatile and misunderstood companies held by ARK Invest. Over the last quarter, multiple short reports have come out about this company and its stock price has collapsed by over 40%. Just nine months ago, it was still a SPAC, which means we're about to see its second earnings report ever. ARK Invest's conviction: all time high. So buckle up. We're going on an adventure.

[00:00:27.730]
If you enjoy this type of commentary and analysis, consider liking this video and subscribing to the channel with all notifications turned on. That way, you'll be the first to know when I come out with new research, regardless of how YouTube tunes its algorithm. Let's get right into it. ARK Invest has been accumulating massive amounts of shares in Skillz, ticker symbol SKLZ since the start of the year. Skillz is now their 15th biggest position in ARKW, ARK Invest's fund themed around the next generation of Internet applications.

[00:00:57.000]
Around the end of April, Skillz was also added into ARKK, the flagship fund filled with ARK Invest's highest conviction stocks, where it's been steadily rising in weight. In less than two months, it's become the 25th biggest position in this $20 billion fund. When you combine all of their actively managed funds, ARK Invest has increased their total number of shares in Skillz by almost 300% over this past quarter, moving Skillz from their 87th biggest position overall to their 28th with over $450 million in it. This thing is also highly volatile. In roughly that same amount of time, the stock has dipped from over $30 per share to under $13 per share before rebounding to a little under $20 at the time of this recording.

[00:01:40.230]
So if its price pops in the near future, it could become a top 25 holding or even top 20 for ARK Invest, assuming they don't sell those shares.

[00:01:48.510]
Part of that insane volatility comes from multiple short reports on Skillz, some of which ARK Invest actually responded to. I'll leave a link to those short reports and to ARK Invest's rebuttal in the description below and cover their biggest points near the end of this episode. The final thing that made me want to talk about this crazy stock was when Arc Invest released the 100th episode of their awesome For Your Innovation podcast and of all the things that Milestone episode could have been about, it was on competitive mobile gaming with Andrew Paradise, the CEO and founder of Skillz, which I've linked in the description below as well.

[00:02:23.500]
Full Disclosure: I'm not a financial advisor and I don't currently own Skillz stock, except through my position in ARKW. I have owned Skillz stock directly in the past and will probably pick it up again in the near future,

[00:02:35.310]
based on this research. That's because this company is not what most people think. Gamers are not its target audience, even though their investor presentation kind of makes it seem that way. So if you indulge me, I'm going to remix their investor deck can tell you what I think this company is really all about.

[00:02:53.920]
In 2012, there were 800 million mobile devices around the world. Today there are more than 10 billion. That's a 32% compound annual growth rate in mobile devices. Likewise, the gaming market is growing by about 14% annually, but the mobile sub segment of that market is growing by 23% annually. So whether you're thinking about it from a hardware or software perspective, the mobile gaming market is growing crazy fast, with no signs of stopping.

[00:03:20.450]
Likewise, in 2009, there were around 30000 game developers. Today, that number's around 10 million. That's almost a 70% compound annual growth rate in game developers. I believe that number will only continue to grow with a number of different devices people can play games on. This explosion in game content makes it hard for a game to get discovered by enough people to make it worth making the game in the first place. So, what do developers do? They spend on marketing and offer in-game incentives targeted at their core audience

[00:03:49.360]
to acquire more customers. The total amount of money they spend on marketing and incentives divided by the amount of customers they acquire is their customer acquisition cost. As the game's development market gets more and more crowded, developers are forced to spend more and more because the competition for a gamer's attention is getting worse. The average customer acquisition cost for a mobile game is growing at an alarming 72.5% annually, right in line with that 70% growth rate in game developers. That's a major factor in this massive jump in average cost per install from 2014 to 2020.

[00:04:22.950]
So how do mobile games recoup these costs? They interrupt your gameplay with ads and build their core gaming loop around in-game micro transactions. Sure, you can play for hundreds of hours and reach that next level or get that next best item or earn that extra life, or you can unlock them all for just 2.99. Oops. That's actually 3.99 because Apple gets a 30% cut. In my opinion, this starts to point us to the actual problem Skillz is trying to solve for the developers,

[00:04:48.570]
not really gamers. Games are designed, developed, and balanced with these mechanics in mind. If you want people to spend money on items in your game, you need to make the game addicting enough that people want to play, but frustrating enough that they'd rather pay a little bit of money than work for a very long time. Only something like 3% of all players on mobile spend money in games. That means the game is frustrating for 100 people

[00:05:11.980]
just to get three of those people to spend. If you want to inject Fullscreen ads into your game, you need to have a gameplay loop that allows you to interrupt the player without hurting their progress, and so on. Think about what this means. It means that game developers can't even make certain types of games because they can't afford to. If micro-transactions and ads aren't baked into the core of the game, the developers will never break even from development, distribution and customer acquisition costs.

[00:05:37.610]
Skillz takes the monetization out of the actual game and allows players to pay to compete. That means they can compete in any game they want, and developers can focus on just making a fun game. What's that you say? Skillz only has bad games on it like Solitaire, Bingo, Pool and Dominoes. Stop thinking like a gamer and start thinking like an investor.

[00:05:57.260]
Did you know that two thirds of all gamers on mobile are women? Did you know that women are 50% more likely to spend money inside a mobile game than a man? 50? Why would Skills go after me or you when they know we're the pickiest, stingiest and most competitive demographic in the gaming market? Hey, wait.

[00:06:14.360]
The median gamer on Skillz is a woman in her early 40s, making around $50,000 a year. As an investor, I'd want to see their demographics keep that healthy spread among income, gender, and age groups. The more they niche down, the fewer kinds of people will ever try their games. Speaking of which, here's how we should actually be thinking about their games. We want their library of financially successful games to be growing year over year.

[00:06:38.250]
It's growing exponentially. In fact, it grew by 50% in 2020, from 23 games with over $1 million in entries to 36. So at the end of 2021, I'm looking for that number to be around 48 or higher to keep that same rate of growth. We don't want players to concentrate on only a small fraction of the games and have the rest fizzle. So I'd love to see a breakout of their top ten games and how that list is changing year over year.

[00:07:02.990]
We want to see every developer making real money, so more developers join the ecosystem. Okay, so Skillz has games on it that don't interrupt people with full screen ads and where people don't pay to progress, they pay to compete. That drives up engagement because one, games are objectively more fun without those two gimmicks, and two, competition fuels additional engagement even above the game's core gameplay loop itself. That encourages developers to keep making games with this in mind, which adds games to Skillz platform, which means more and more player engagement, which gets more developers interested and so on.

[00:07:37.230]
That's the cycle, and that cycle works. In fact, paying users spend more than twice the amount of time on Skillz than the mobile gaming average and more than 50% more time than they do on Candy Crush, the number one mobile game. 17% of Skillz's audience pays to compete. That's eight times more likely than the 2 to 3% spending on micro transactions that I mentioned earlier. This paid competition layer is making a big difference.

[00:08:03.200]
So here are all the services that go into that separate online competition layer: tournaments and leagues, player ratings and matchmaking, anti-cheat and anti-fraud, social features, the payment system, customer support, loyalty rewards and incentives and content discovery and marketing. This means Skillz offers a whole lot of developer solutions as part of their software development kit and as part of their online platform. Event coordination, managed hosting for games and lobbies, marketing, prize fulfilment, game launch optimization and analytics. Again, all things that aren't tied to the core gameplay loop but are tied to providing the competitive experience around it.

[00:08:40.020]
And of course, no ARK Invest holding is complete without capturing lots and lots of data to make automated decisions around personalization, including incentive optimization, dynamic marketing and so on. Personalization is key to driving up the engagement per individual user, which drives up the average spend per user across the Skillz platform.

[00:08:59.240]
And again, this is a service that Skillz is offering that game developers now don't have to do themselves. Speaking of ARK Invest holding Skillz, let's talk about the future vision of the company. Then I'll dive into the financials and the short reports. Skillz is trying to be the competition layer of the Internet. What does that mean

[00:09:16.530]
exactly when you're thinking five years out or more? Skillz is working on building a spectator mode and commentator tools for its platform, allowing audiences to watch users compete with fun interactive enhancements. Think about how boring it is to watch regular old poker. Now think about how awesome it is when you know what everyone is holding, the likelihood of each hand, stats about each player and they're getting commentary from entertaining broadcasters. This is a crazy hard problem to generalize and solve in a game agnostic way. The technical challenges involved with things like real time data feeds and extra anti-cheat solutions to prevent spectators from affecting the outcome of the game are massive, which means there are real technical risks to holding the company pursuing this project.

[00:09:59.780]
But in my opinion, as a gamer and an investor, a real game independent spectator mode with the right commentator tools is the missing link preventing E-Sports from exploding today. Game companies have been trying to do this for years. Maybe the answer is the game companies shouldn't be doing this at all. It should be part of an entirely separate competition layer, like the one Skillz is trying to be. Then everything could become an E-Sport, not just video games.

[00:10:25.250]
Want to race your friend on a peloton for money? Do it through Skillz. After all, peloton is just a game where you pump your feet. By the way, I'm not making any of that up. That's what Andrew Paradise, Skillz's CEO said in ARK Invests latest podcast episode. With the future vision covered, let's take a look at the financials.

[00:10:42.710]
Here's how Skillz and the game developers on the platform actually make money. Two players put money on the table to compete against each other. The minimum buy in is $0.60 times two players is 120 cents. For higher entry fees, I'm assuming everything scales accordingly, but let's stick with the $0.60 minimum. The winner takes home $1, the loser gets nothing, and the developers make two cent.

[00:11:04.790]
That leaves $0.18 left for Skillz or $0.17 after their insanely high margins. Each game has roughly twelve to $0.13 in operating expenses, leaving fourish cents final earnings per game for Skillz before marketing for user acquisition. Earlier in the episode, I talked about wanting to see Skillz's library of games continue to grow. The other reason for this is to keep players paying over time. Earlier this year, Skillz signed a multiyear agreement with the NFL. Skillz and the NFL will organize a contest for developers to develop an NFL branded multiplayer game for Skillz's platform.

[00:11:38.120]
That's a huge win for everyone. The NFL is trying to stay top of mind, in an era where cable TV is getting crushed. In my opinion, sports will move to new platforms sooner than later, and legacy broadcasting companies will either have to evolve or die around that shift. If you want to know more about my thoughts on that, I'll link my video on it in the top right hand corner of your screen right now, and in the description below.

[00:12:00.650]
But one place Sports leaks can double down on is in competitive multiplayer video games. This is also great for game developers who can say they made a game for the NFL brand. And of course, this is a huge win for Skillz because the NFL will push sports fans to their platform, which, as we saw, is a very different demographic than they have today. If this thing works out, we could see other sports leagues pile in bringing in their fans to the platform as well. And that leads us to Skillz cohort analysis.

[00:12:27.990]
If you look at the average spend of a paying player over time, you can see that each year people spend more money faster with Skillz. For example, the people who joined in 2018 and 2019 spend more money per year than the people who joined in 2014 and 2015. And so on. One thing one of the short reports calls out is this number is much lower in 2020. Let me quickly remind you what happened in 2020.

[00:12:51.780]
But seriously, the competition for online attention really did ramp up in 2020. And of course, Skillz is going to have to work harder to keep time, attention and money on its platform. That's a real risk, but one that every online company is facing post-pandemic and even more so now that things are opening back up. We care about two things here. We want to see newer cohorts keep spending more money up front than older ones, and we want to see older cohorts start to spend more money over time.

[00:13:19.230]
Skillz is checking both of those boxes. Ultimately the financial metric we care about is the three year average return on customer acquisition costs. Basically, this is the number of dollars the average user spends, including nonpaying users, for every $1 Skillz spends to acquire them. The short report by Eagle Eye Research alleges two things. First, that Skillz is roundtripping money by giving bonus cash to their users after acquiring them and then claiming that bonus cash as real revenues when users spend it. And second, if Skillz were to count that bonus cash correctly as customer acquisition costs, then Skills actually spends more money on users than they make from them.

[00:13:57.540]
If you really want to get a leg up on other investors, read the S1 reports of the companies you're researching and then keep up with the earnings calls. Then you'll be in a great position to decide for yourself if these short reports have merit. Let me show you what I mean. If you open Skillz's S1, which I've linked in the description below and you search for bonus cash, here's what you'll find.

[00:14:18.340]
We also complement the stable cohort dynamics with disciplined user acquisition spending. The three year lifetime value of our 2018, 2019 and nine months ended September 30, 2020 cohorts is expected to be 4.5X or total user acquisition costs, and after taking into account the end user incentives recorded in sales and marketing is expected to be 3X, so Skillz already accounts for this. The cost of acquiring a user, meaning getting them to sign up for Skillz in the first place is different than the cost for incentivizing an existing user to build the habit of spending money over time.

[00:14:53.350]
The three year average return on this user acquisition cost is around 4.5X.

[00:14:58.090]
The three year average return after you include these additional incentives to convert existing users you've already acquired into paying users is around 3X. The confusion is that both of these are marketing costs. This leads us to the key point in the Wolf Pack short report, which is marketing spend is up, but monthly downloads for Skillz top three games are down, so let's break that down. Their top three games are representing a smaller and smaller percentage of their overall games, and new games are finally entering the top three.

[00:15:25.490]
Both of these facts are great for Skillz.

[00:15:27.580]
We care about total downloads, not just for their top three games and Skillz is constantly launching new games and growing their library. The marketing spend itself is also a finicky number because as we just discussed, it includes two things: acquiring users in the first place and then separately converting them into paying customers over their lifetime with Skillz. Here's what their CFO said on their recent earnings call about growing their monthly active users or MAU versus focusing on their paying monthly active users. You have to keep in mind that we make money from paying users.

[00:15:57.880]
This is why we focus on growing our paying MAU, not necessarily our total now.

[00:16:02.920]
So in quarter four, paying MAU is up 121% year over year and 13% quarter over quarter.

[00:16:09.530]
All right. Now, where are we? I'm sorry. Are you saying meow?

[00:16:14.110]
Am I saying now?

[00:16:15.620]
So when we make money from our non paying MAU, we'll focus a little more on that metric. But for now, the driver that really moves the needle in our business is paying attention to our paying MAU. And that's why we were able to hit a record in quarter four of 16% of our users that we were able to convert to payers also from 10% in quarter two. MAU. So another reason marketing spend is up while new monthly active users and downloads are down is because that marketing spend isn't going towards new monthly active users.

[00:16:45.590]
It's going to converting existing users into paying ones with bonus cash.

[00:16:49.790]
The way Skillz chooses to account for this bonus cash is as a marketing cost when it's given to players and as revenue when players actually spend it. And that's working. Paying users are up 13% quarter over quarter and 121% year over year. That's what's causing the slope in lifetime value for older cohorts to rise. Let's wrap things up with ARK Invest's commentary on these short reports and on Skillz's future growth in their April 23 stock commentary. When Skillz's stock popped by 33%, ARK Invest said this.

[00:17:19.290]
Skillz jumped by 33% on Wednesday. Finding investor support after a recent short report hit the stock. The recent allegations against the company range from its revenue recognition practices to its recent NFL partnership. After reviewing the reports, we believe the claims to either be exaggerated or incorrect. We believe these short reports stem from a misunderstanding of the company it's positioned in the gaming ecosystem and its future ambitions. Skillz is a leading mobile games platform that enables competitive e-sports style play on and on it goes.

[00:17:51.020]
Your time is valuable, so I won't add anything to that. But hopefully you agree that I've thoroughly covered every single word of ARK Invest's response throughout this episode. Here's what ARK Invest had to say at the start of June about Skillz's recent acquisition of AARKI, spelled AARKI, which directly helps the same marketing and customer acquisition issues that these short reports call out. Skillz traded up 27% on Wednesday after announcing an agreement to acquire AARKI, an ad tech demand side platform, or DSP for $150 million in cash and stock. AARKI engages in more than 5 trillion advertising options monthly with machine learning algorithms and data engines that help advertisers maximize customer reach and acquisition.

[00:18:33.430]
Given AARKI's exposure to the UK, India, and South Korea, this strategic acquisitions should accelerate Skillz's international expansion goals lessening its dependence on third-party DSPs to reach new users.

[00:18:45.400]
We believe the acquisition should lower Skillz's user acquisition costs and bolster monetization of existing monthly active users or MAUs. Here are all the other ways in which Skillz can grow. Note that all of these growth factors compound: targeting Android users in addition to iOS devices, expanding their gaming library into shooters, fighters, racing games and sports games like their deal with the NFL entering overseas markets like the ones AARKI already operates in and adding new models and incentives for players to spend money on the platform. Think Battle Royale, team battles, player teams and guilds, paid spectator modes and so on.

[00:19:23.140]
To me, the real risks come from the technical challenges that Skillz is working to solve.

[00:19:27.610]
Skillz is a pretty young company to say the least, but their gross marketplace volume or their total user spend and the revenues are already showing this exponential growth trajectory. In my opinion, that's exactly the kind of growth, ambition and risk profile that ARK Invest looks for in their highest conviction holdings. Let me know in the comments below what you think about deep dives like this one? Do you like episodes focused on single stocks or do you prefer when I zoom out and talk about technologies, trends and ARK Invest's funds as a whole?

[00:19:55.410]
Either way, I hope this deep dive helped you understand what Skillz actually does and doesn't do, all the different factors contributing to its exponential growth now and in the future, and address some of the concerns in recent short reports in the process.

[00:20:08.880]
If it did, let me know by investing in the like button and subscribing to the channel with all notifications turned on. That's a great way to invest in the channel that invests in you. Until next time. This is Ticker Symbol: You. My name is Alex reminding you that the best investment you can make is in you.