Skillz: Operating Leverage Remains Elusive Despite Robust Revenue Growth

Summary

Skillz reported robust revenue growth in FQ3. However, its adjusted EBITDA margin remains mired in the red.

Underlying user metrics have also improved and drove its revenue growth. Nevertheless, the increased user acquisition and engagement costs weighed down its bottom line.

We discuss whether Skillz stock is a buy after its FQ3 earnings.

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Skillz (NYSE: SKLZ ) reported its FQ3 earnings recently. The company reported robust top-line gain but slightly missed consensus estimates. In addition, its underlying user metrics were also strong. However, as its operating leverage did not improve, SKLZ continues to be weighed down by its user acquisition (UA) and engagement costs.

In addition, the integration of Aarki is still taking place. As a result, the costs optimization process may take up to 24 months. Hence, investors need to temper their expectations in SKLZ’s UA spend until then. The company also communicated that they expect to be aggressive in UA spending in FQ4, stretching into FY22. Hence, investors should not expect operating leverage to improve so soon.

We discuss whether SKLZ stock is a buy after its FQ3 report card. SKLZ Stock YTD Performance

SKLZ stock YTD performance (as of 5 November 21).

Gaming stocks have had a challenging year so far. SKLZ stock led its peers early on as it raced to a YTD lead of more than 120% by February. However, the growth-to-value rotation also battered the stock as investors dumped speculative stocks in search of quality. SKLZ stock quickly lost its upward momentum as its price momentum turned increasingly bearish. Consequently, it has already given up all its gains for the year. The stock now sits deeply entrenched in the red with a YTD return of -40.4%. It has also significantly underperformed its peers listed in this comps set, as well as the broad market. Skillz Reported Solid Top Line Growth

Skillz quarterly revenue. Data source: S&P Capital IQ Skillz quarterly revenue YoY growth. Data source: S&P Capital IQ

Skillz reported $102.07M in revenue in FQ3’21, up 70.2% YoY, but came in slightly below consensus. Revenue growth in FQ3 was robust after the significant deceleration observed in FQ2. Therefore, it’s encouraging to observe that SKLZ is picking up its top-line growth again. Speculative companies like SKLZ that have weak profitability must continue to demonstrate rapid revenue growth to justify their valuation. Therefore, we encourage investors to continue paying attention to its revenue growth metrics moving forward. Skillz quarterly gross margins. Data source: S&P Capital IQ

In addition, we also observe a slight decline in its FQ3’s gross margin to 92.5%. It was a discernible dip, especially since Skillz is still unprofitable. However, it wasn’t addressed in the conference, as the focus was on its UA spending. In addition, SKLZ doesn’t embed UA spending into its cost of revenue. Neither does the company break down its cost of revenue components. Nevertheless, we encourage investors to keep an eye on its gross margins moving forward. Underlying User Operating Metrics Seem Robust

Skillz gross merchandise value. Data source: Company filings

Despite the remarkable recovery in its top-line growth, Skillz’s gross merchandise value (GMV) growth seems to have stalled. While it represented a 48.7% YoY growth, it was only up 0.33% QoQ. It was also a significant slowdown from FQ2’s 7.4% QoQ increase. Moreover, GMV is a critical metric that we analyze closely, as it allows us to observe the growth momentum of its transactions. Hence, despite its rapid top-line growth, GMV has not followed in line. Therefore, it’s a red flag that investors must watch closely. Skillz paying MAU. Data source: Company filings Skillz average revenue per paying user. Data source: Company filings

Nevertheless, the company demonstrated that its monetization machine continues to work robustly. Despite the lack of organic GMV growth, it has managed to improve its user monetization remarkably. The company also saw a considerable boost to its paying MAU as it reached 510K in FQ3. It was a sharp recovery from FQ2’s 460K. Moreover, its average revenue per paying user has also improved markedly. It reached $66.82, compared to $64.4 in FQ2. Skillz must continue to improve its monetization metrics, as it would be highly beneficial to protect it against a slower-growth MAU base.

Skillz Paying MAU/Total MAU ratio. Data source: Company filings

Skillz’s ability to convert its MAU into paying […]

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