The Squeeze Is on as Bears Circle Skillz Stock

Skillz (NYSE:SKLZ) is at an inflection point, with short interest of about 17%. The online mobile multiplayer video game company wants to pivot to online gambling. But the market has its doubts about SKLZ stock.

Skillz shares spiked to more than $45 in February. The stock is down since that peak, having tumbled for a multitude of reasons including inflation fears. It wasn’t alone in its decline; other gambling and gaming stocks like DraftKings (NASDAQ:DKNG) also moved lower in the past few months.

Why do bears have such a high conviction bet against the firm?

Acquisition Raises Risk Profile on SKLZ Stock

On June 2, Skillz announced it would spend its precious cash on hand to buy Aarki for $150 million. Paid in cash and stock, the company will integrate Aarki’s machine learning algorithms with its data.

The acquisition target’s marketing platform complements Skillz’s mobile gaming platform. For example, it has a demand-side platform that pitches more than five trillion monthly advertising auctions. Skillz CEO Andrew Paradise said the two systems will create “new points of connectivity between consumers, developers, and brands.”

SKLZ shares traded around $25 shortly afterwards, marking a peak for the stock before they fell further. Overall, the market is not impressed with the deal.

But despite the negative reaction, the acquisition is a good match for the Skillz gaming platform. As the user base grows in the quarters ahead, it has the potential to expand its operating margins.

Nervous markets will need plenty of patience before Aarki pays off. But non-paying monthly active users make up much of the user base. The CEO recognizes the need to create additional revenue streams to accelerate growth.

Opportunity and Catalysts for Skillz

Skillz needs just one developer to make a megahit title on the platform. This is an outlier event that could send the stock back to 52-week highs. Conversely, without a hit title, Skillz stock may go nowhere from here or start to trade for a few quarters.

But markets are ignoring the revenue potential from gambling. Because Skillz is not subject to the same gambling laws as casinos or eSports sites, players may compete for prizes. As such, players may only play in real money tournaments depending on which states they reside. For example, users cannot enter real money tournaments if they reside in Florida, Tennessee or Arizona.

Mobile gaming and eSports are growing rapidly. Investors who sought a pure play in gambling bought DKNG stock, but Skillz is the leader in the more predictable gaming and eSports market. It even partnered with the National Football League (NFL) for a multi-year gaming agreement signed in Feb. 2021.

In 2022, more states may legalize sports betting. Just as marijuana legalization lifted multi-state operators, sports betting could give Skillz shares a boost. The company may also expand its addressable market by setting up in countries outside North America starting next year.

On a different note, Skillz announced it would redeem all of its outstanding public warrants. The company gets an exercise price of $11.50 per warrant, which adds money to its balance sheet.

Shareholders are not better off because of this dilution; it increases the number of shares outstanding. Also, Skills did not reveal how many warrants it issued, so shareholders do not know the extent of the impending near-term dilution.

The Bottom Line on SKLZ Stock

Skillz may face a deceleration in paying monthly active users (MAUs). In the first quarter, this number grew by 81%. Conversely, the average revenue per paying monthly active user did not change by much since 2019. It cycled between $56 and $66.

Gaming platform stocks corrected in the last month. Roblox (NYSE:RBLX) peaked at $103.87 in June only to lose nearly a quarter of its value in the following months. In the gambling segment, speculators sold their DraftKings holdings.

Skillz is not a cheap stock in the gaming sector. The market is still valuing a big leap in revenue from eSports and multi-player games. If the sector loses momentum due to waning demand, Skillz will underperform for a while longer.

Among gaming platform stocks, Skillz is still a compelling consideration. Investors seeking exposure to a beat-up, heavily-shorted stock in the gaming sector should take another look at SKLZ shares.

On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.