Thursday Deep Dive: Skillz/FEAC SPAC
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This week for our Deep Dive episode we discussed Skillz, a mobile multiplayer gaming platform that is going public through the Flying Eagle SPAC (FEAC is the ticker). Skillz allows players to compete for money on online games that are skill based (hence the name). It is essentially a software platform that partners with existing mobile games like solitaire or billiards and matches up players to compete for money.
History
Since we are talking about a SPAC this week we need to discuss what Flying Eagle Acquisition Corp is. FEAC was funded with the sole goal of creating a merger and is currently trading publicly until the merger with Skillz is officially consummated.
What really matters though is the company Skillz, which investors in FEAC will own post-merger. Skillz was founded in 2012 by Andrew Paradise and Casey Chafkin, and in 2013 they launched their first cash prize on the platform. Since gambling is highly regulated and has intricate laws in all 50 states, Paradise said the company chose to stay in the skilled-games niche, which is legal in 46 states. One interesting note before we get deeper into the analysis is that Skillz requires its developers to play mobile video games at work. Sounds like a pretty good gig to me.
Industry and Competition
Like a lot of companies we’ve discussed lately, Skillz operates in a large industry (gaming) but has a specialty that limits its competition but also its addressable market (competing for money on mobile games). The company stated it is on pace for $1.6 billion to flow through its platform in 2020, which is probably the number investors should be tracking to see if the company is expanding the reach of its platform.
There are no public competitors that we could find, but Roblox and Unity likely have the easiest path to becoming a competitor to Skillz. There is no indication they will be doing that anytime soon. Unikrn (yes, that is the proper spelling) is a private competitor with about $40 million in funding, but is nowhere near the size of Skillz right now. Apparently, Amazon and Sony tried to compete with Skillz but ending up quitting, likely because the market wasn’t large enough or the product didn’t get traction.
Lastly, it should be noted that mobile gaming is growing at a 20% CAGR and is almost a $100 billion market. That is a gigantic market and a nice tailwind for Skillz to ride.
Management
The CEO of FEAC is Harry Sloan and the chairman is Jeff Sagansky. They also founded the SPAC that took DraftKings public, so they have a history of focusing on the gaming/gambling industry. Paradise, the Skillz CEO mentioned above, will retain the role once the merger is completed and all insiders will have a 24-month lock-up period on their shares. Public shareholders will own about 25% of outstanding shares.
Valuation, Earnings, and Balance Sheet
Valuation (based on $4 billion estimated EV which is what a $11.32 FEAC trade price translates to):
7.1x 2022 revenue (remember this is a projection)
TTM EV/sales of 19.5
MA EV/sales of 23 (EV/(Gross margin*sales growth))
Earnings (2019 numbers):
$120 million in sales, up 136% YoY
$25 million operating loss
95% gross margins (impressive but, also, maybe too impressive)
77% of all costs and expenses were sales and marketing
Balance Sheet:
Post-merger Skillz will have about $250 million in cash
Only $24 million in liabilities
Does Skillz Have any Competitive Advantages?
Ryan talked about Skillz having a regulatory barrier to entry. It is tough for a small company to go through the stringent legal requirements for competitions like this, and requires a boatload of lawyers (which turn into a boatload of lawyer fees). A lot of companies may find these regulations daunting, keeping the competition at bay.
Ian talked about the competitive nature of its content, which can draw eyeballs away from other, less immersive entertainment services like Netflix or YouTube. With money on the line, consumers likely care more about a Skillz match compared to just watching a video or looking at social media.
I talked about the company’s four-month payback period when they acquire a user. A company growing this fast can sometimes get bogged down with high operating losses as high marketing spend doesn’t immediately translate to revenue. Skillz doesn’t seem to have this problem, meaning they likely won’t have to raise more money because all they have to fund are customers less than 4 months old, every cohort older than that is profitable.
What are Skillz’s Future Growth Opportunities?
Ryan chose advertising for his future growth opportunity. Skillz said on its S-4 that only 10% of MAUs entered paid contests and that the other 90% they plan to monetize with “non-intrusive, low friction advertisements.”
Ian chose virtual and augmented reality. These technologies are taking off for gaming and could be helpful for Skillz to monetize its platform.
I chose social features. The company highlights this a lot in the S-4 and wants to invest in it to keep players on the platform. Having robust social features is what took Fortnite to the stratosphere, and is almost a must for a game to hit the mainstream and then stick.
What We Liked About Skillz
We loved Skillz’s high gross margins but were skeptical they were actually legit. Another highlight we talked about was how Skillz is building a platform that can help developers and users make money, which will incentivize them to come back and play/compete again and again.
One note that stood out to Ian and I was users spend over an hour a day on Skillz, which puts them in the same territory as the dominant platforms of today (Facebook, YouTube, Roblox, etc.). This type of user engagement doesn’t come around often, and if they can get to 10 million+ users it could hit escape velocity.
What we Didn’t Like About Skillz
The big concern with Skillz is that it is going public through a SPAC. We all thought that, even though there is no evidence of malfeasance here, investors should wait until an audited 10-K is released before investing. With a SPAC there are just too many unknowns.
Some hesitancies we had with Skillz’s business is that they get 79% of their revenue from three games, which puts a lot of eggs in one basket. They also have a 14% take rate (sales/GMV) which seems high and could come down over time if competition steps in.
Links to Further Reading/Learning
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.