Skillz Plays the Game of Growth, But It’s Not a Buy Here

“The future of sports is electronic. The future of sports is mobile. The future of sports is now.” This is what Skillz Inc. (NYSE:SKLZ) says in a video about how it works. But if this is the future of sports, then why did SKLZ stock fall over 45% year to date to Monday’s close of $10.59?

Skillz went public in late 2020 through a special-purpose acquisition company, or SPAC. That allowed it to go public while avoiding some of the financial rules and conditions that need to be met in an IPO process. And I am skeptical about its stock for a couple of reasons.

SKLZ Stock: Why I Am Being Skeptic

The first reason is the early excitement back in Dec. 2020 as SKLZ stock soared 29% in its first day “as investors embraced a business billing itself as the first publicly traded mobile esports company.”

Then the second-quarter 2021 earnings report showed the company grew revenues for its 22nd straight year, which is very positive. But we can’t ignore this 40%-plus drop of the stock price in 2021.

And while SKLZ stock may or may not be a name the social media hype machines focused on, some important reasons underpin this volatile stock price performance. It is the game of growth versus the game of value in stock investing.

So I see the ongoing revenue growth, which is a great and supportive factor for the stock. But I also see how company is growing both in users and in revenue, but is not making a profit yet. And this is bodes poorly for the short-term effectiveness of Skillz’s business plan.

A Dynamic Business Plan But No Profits

What is Skillz? Skillz is an online platform where users play mobile games in exchange for cash prizes. Skillz makes money from various streams of revenue, including competition entry fees, brand sponsorships, in-game ads, and tournament fees.

The numbers on the Skillz website about the numbers of users, games, and developers are impressive. More than 30 million players, more than 30,000 game developers, more than $5 million in daily tournaments, and more than $100 million monthly prizes. With all that, I would expect to see a profitable company. This is not the case. The company reported on its Q2 2021 earnings report a net loss of $79.6 million, larger than $20.2 million in the prior year.

Since there is no 10-K annual form reported yet as the company went public in December 2020, checking the Q1 2021 earnings report we note that “Net loss was $53.6 million during the first quarter of 2021, compared with $15.5 million in the prior year.”

Ok, this seems like a trend. So I checked the Q4 2020 earnings report and once again I read that “Net loss was $44 million during the fourth quarter of 2020, compared with a net loss of $9 million during the comparable quarter in 2019.”

So this is a company that is growing fast but is also losing more and more money in the game of trying to be a profitable company. But on the other hand, most analysts are too excited now and the Q2 2021 earnings report showed some interesting highlights — Revenue up 52% to $89.5 million, gross profit up 52% to $85.1 million, gross margin of 95% and cash of $692.8 million, with no debt.

No Debt and Plenty of Cash: What Can Go Wrong?

Since Skillz has a strong balance sheet with no debt and plenty of cash to pursue its strategic goals, there is one key metric to consider now — the Return on Invested Capital (ROIC). That is defined as (net income – dividend) / (debt + equity) according to Investopedia.

I want to focus on two key parameters in this ROIC figure. Investopedia mentions that “A company is thought to be creating value if its ROIC exceeds 2% and destroying value if it is less than 2%.” Also that “An ROIC higher than the cost of capital means a company is healthy and growing, while an ROIC lower than the cost of capital suggests an unsustainable business model.”

Now, taking and analyzing data from Gurufocus we note that ROIC for SKLZ stock in 2018 was 0%, in 2019 was -321.9% and in 2020 the ROIC was -847.47%.

The ROIC is not improving, it’s getting worse — and is well below the cost of capital for Skillz as well. Why is that? As the company has no debt, at all its cost of capital is comprised solely from its equity and its riskiness. To my analysis, that should be high and positive for a company that went public recently and is losing money.

The bottom line is that Skillz does not create value for investors now, and it seems its business model is not sustainable.

My Opinion on Skillz

The company has strong revenue and user growth. It is targeting an international expansion in large markets such as India while having also strategic partnerships to enhance its market share in the gaming industry. All this is good.

But when it comes to valuation and fundamentals, SKLZ stock is far from being now a value play. I see a lot of potential for the company. But until it makes a consistent profit, I don’t see a compelling reason to get excited about it in a well-diversified portfolio.

On the date of publication, Stavros Georgiadis, CFA  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.

Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.