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We Were Warned - tales of bad companies

There were so many red flags despite the short-term valuation success and other positive signals

OnlyCFO

Jun 16, 2023

This a tale of a company that had plenty of red flags, but they were mostly ignored for too long. At its peak in 2021 the company had an enterprise value of $16B. But fast forward 2 years and it has an enterprise value of just $27M, which is probably still too high.

Let’s do a deeper dive to see if investors should have seen the red flags earlier and not been blinded by false signals.

The company is…..Skillz

What is Skillz?

Skillz is an online platform that hosts multiplayer games and tournaments. While there are free games, Skillz makes their money from games that require entry fees from players to have a chance to win cash prizes (it’s basically gambling). Skillz takes a cut from all the winnings.

Skillz went public via a SPAC merger in December 2020 that valued the company at $3.5B. At the time it went public Skillz had $229M in revenue, growing at 92%. With 95% gross margins and revenue guidance of $366M for the next year.

Sounds amazing, right?!?! That is a relatively cheap 10x EV/NTM revenue multiple for a fast growing company with spectacular gross margins!

Skillz Stock Bulls: Cathy Wood’s ARKK was buying it up, Motely Fool initiated buy recommendations, and FinTwit was all over Skillz as the stock price sky rocketed from $10 to $44 in just a few months.

But beneath all of the bullish fanfare and wonderful isolated metrics was a company that was quietly imploding on a public stage.

The Red Flags

The warning signs were all there. People just had to open their eyes and not be blinded by isolated positive signals. I know that’s easy to say in hindsight but below are a few of the warnings signs that should have given investors major pause on the valuation and viability of Skillz:

Bad Culture/Management:

The truly worst and toxic companies will manipulate Glassdoor by forcing employees to write positive reviews to balance out the negative reviews and raise the overall Glassdoor rating.

From an Glassdoor review back in 2019 (there have been many other such accusations):

I just wanted to point out that the Glassdoor rating for this company was a 2.8 before Skillz forced 15-20 manager level employees to write positive reviews. They weren't even smart enough to have the reviews written on different days. Since then, the company has been asking all employees to write reviews (they are more spaced out now).

Shortly after going public, Skillz’s CEO had an 85% approval rating on Glassdoor and that rating was used as a positive signal by investors. BUT…if those investors dug deeper they would discover how bad things actually were at Skillz.

The negative Glassdoor reviews don’t hold back:

The best part of Skillz is the people. You will bond over complaining about Skillz
Andrew Paradise is the most toxic person I've ever met.
People don't even put Skillz on their resumes after they leave because it's so embarrassing.
They use spyware to monitor employees throughout the day even when they are in the office.
Fire Andrew Paradise while there is still money left in the company
Don't even take my word for it on here - seriously just reach out to any current or former employee at Skillz to get a clear, crisp, and accurate idea of what an anxiety-inducing nightmare this place actually is. RUN.

Yikes! Glad to see that the honest reviews are prevailing on Glassdoor now. Wonder how low the rating would be if they didn’t pressure employees to write good reviews…

If your employer pressures you to write glowing, positive reviews to counter balance the negative ones then RUN! Asking employees to write honest reviews is great, but that is not what was done here.

Employees don’t trust management, management doesn’t trust employees, and no one trust Skillz.

Not a culture I would want to be a part of.

Concentration Risk

Skillz has basically relied on 3 mobile games (from a couple of developers) for the majority of their revenue. It’s dangerous when so much of a company’s revenue is dependent on someone else.

Finance & Other Executive Departures

When there is a pattern of high turnover on the executive team (especially finance folks) then there is likely problems. Either the CEO is really bad at hiring or the execs smell something stinky and are getting out as fast as they can.

Accorded to Wolfpack research, former employees referred to Skillz numbers as “smoke and mirrors” and they recently settled a lawsuit with their former Head of Finance & Administrations, who claimed he was fired for not going along with CEO Andrew Paradise’s unattainable aggressive financial projections.

Below are the recent finance leaders tenure at Skillz:

Jason Roswig (CFO): Aug 2022 - Present
Ian Lee (CFO): June 2021 - Aug 2022
Scott Henry (CFO): Aug 2020 - June 2021
Valerie Texin (Divisional CFO): Q2 2022 - Q1 2023

The CFO average tenure is about a year…not great. And with the former head of finance making some serious allegations it all smells bad.

Valuations based on dreams and not reality

Because Skillz went public via SPAC they provided financial forecasts before going public. This is NOT something that companies that go through a tradtional IPO do. Skillz provided huge revenue forecasts to justify its $3.5B SPAC valuation.

To rationalize the huge valuation, investors made excuses for what the unit economies could be and not what they were.

Skillz also regularly overhyped everything while most of it amounted to nothing (more on that below).

Bad Product

This is easier to assess for some companies than others depending on the nature of the product and a person’s expertise, but you always want to understand if the product is actually good. I am sure there is someone out there who actually likes the Skillz product, but I am guessing very few investors actually downloaded the app and tried it.

Quote from the same Wolfpack research report “In the gaming industry, Skillz does not have a good brand recognition. Most of the players in the industry consider them a joke.”

Having downloaded the app and tried it…I can confirm that it isn’t something I would ever play. Don’t invest or join a company with a product you (or others you trust) think is bad.

CEO Issues

Clearly from the Glassdoor reviews there are culture/management issues, but some things I also found interesting are below👇

Skillz CEO said the following about why a SPAC was the right way for them to go public:

Our vision is to build a 100 year company…the SPAC route allows us to go to market a little faster.

First problem: If you are building a “100 year company” then why do you need to go public a few months faster?

Second and even bigger problem: Three months into his “100 year” journey of building Skillz he cashed out $196M (11% of his holdings)….a very large chunk of ownership very soon after entering the public markets. 🤔

Skillz regularly makes “exciting” announcements that amount to nothing. They talked about how big international would be (like India), how awesome fitness competitions could be, the new amazing games that would eventually flock to their platform…

They also announced a partnership with the NFL a month before the CEO and other management team sold huge these amounts of stock. The announcement caused the stock to continue to climb another 25%. Ultimately, like all their other exciting announcements it amounted to basically nothing.

Kudos to them though on pumping the stock price and perfectly timing the dumping of their stock on to retail investors before the stock price crashed.

Flags in the Financials

Skillz’s balance sheet from when it went public in 2020 is pretty simple and doesn’t contain any obvious red flags.

$263M of cash and total assets of $282M (not much other than cash)
$47M of liabilities (with no debt)

But the income statement at the time they went public had plenty of red flags; however, there were tons of reasons why folks justified it and said Skillz could be a winner:

Revenue grew 92% YoY. They will grow into their valuation!
Gross margins are 95%! They will be printing money in no time with free cash flows like software companies at scale.
If only 3 games account for this much revenue then just think what happens if they can add 10 more!
Cathie Wood’s ARKK, Motely Fool, and other popular investors are buying Skillz! They would have done financial due diligence, right?!?!

The high sales & marketing spend is from incentives to get people on the platform. They can turn that down and make enormous profits!

The reality is much different:

Relatively small amounts have been invested in R&D because they are spending all of their money on sales & marketing with the delusion that if they get users onto the platform that they will stick around and attract more users — dreaming of a network affect.

But this is delusional for Skillz.

Skillz’s revenue growth is mostly manufactured through enormous amounts of paid “marketing” spend. I use quotations because giving money away barely feels like marketing…

Skillz users pay entry fees to play games for a chance at winning cash and then Skillz generates revenue by taking a cut. But Skillz provides enormous amounts of “bonus cash” to incentive users to play on the Skillz platform (i.e. Skillz gives people cash to gamble on their platform).

From these incentives, Skillz records revenue from literally giving money away to customers…in 2020 they gave away $92M to inflate revenue. In 2021 this amount rose to $176M!

Paid marketing is an expensive and addictive drug that is hard to quit. Every company takes the drug to some degree, but what Skillz does is extreme.

Skillz had provided 2021 revenue guidance of 59% revenue growth and they hit 66% growth (a great beat)! Amazing right?!?!

Not so fast…

They paid for even more revenue in 2021 with incentives as a % of revenue going from 40% to 46%. If they kept this % flat then they probably would have had a miss on revenue targets. They can juice up their revenue to whatever they want by giving money away…

This is like a casino asking folks as they enter the hotel if they want $100, no strings atttached, to go gamble. Of course people are going to take the free money! With this trick Skillz could be a $1B revenue company tomorrow…if they had that much cash to burn.

High sales/marketing spend only works long-term if the unit economics make sense. Skillz is not enterprise software so its customers aren’t sticking around for 5+ years (unless Skillz keeps throwing free money at them). Skillz is purchasing customers through these incentives and then those customers will churn at crazy high levels — making it impossible for Skillz to ever make money.

In order to get to their 2020 revenue growth number, their sales & marketing spend outpaced revenue growth (126% S&M growth vs 92% revenue growth)

They were trying so hard force revenue growth to justify their incredibly high valuation (back in late 2020 revenue growth seemed to be all anyone cared about…not efficiency).

Not all revenue is created equal! Many folks looked at Skillz’s gross margin and assumed at scale Skillz would be extremely profitable. Same is true for enterprise software companies — not all software companies can gain the same operating leverage at scale and generate those juicy free cash flow margins.

Skillz will continue to light its money on fire until there is nothing left. The unit economics on the business simply don’t work.

This has been confirmed as they have slowed down sales & marketing to try and become more efficient. In Q1 2023 Sales & Marketing expense decreased 70% YoY and revenue dropped 52%. Turns out if they stop giving free money to their users then the users just stop using Skillz 🤷.

Concluding Thoughts

Do not get caught up in hype and ignore the obvious red flags. It’s easy to become blinded by isolated positive signals — high revenue growth, great overall Glassdoor reviews, influential investors, specific financial metrics, big valuations, etc.

It was easy for many folks to justify Skillz at a $16B valuation despite all of the major red flags.

Investors were sold on dreams of what Skillz could potentially become rather than what it was.

*Note - none of the above is investment advice. While I think Skillz is a bad company, shorting stocks is very dangerous (particularly when the market cap is so small).