A federal court in Northern California has dismissed a class action lawsuit by investors against Skillz, a mobile “skill gaming” company. The plaintiffs had accused the company of violating the Securities Exchange Act by misrepresenting or omitting facts to paint an exaggerated picture of its performance. Chief US District Judge Richard Seeborg ruled that they had failed to plead their claims adequately and granted Skillz’s motion to dismiss the case.
Skillz offers a platform for free-to-play mobile games that pit players against one another in contests with an element of skill. Players can optionally wager money on these matches, with Skillz taking a cut. According to Skillz and similar companies, the presence of a skill component means the games fall outside the legal definition of gambling.
The case was a consolidation of two separate suits, both filed in the Northern District of California:
- Jedrzejczyk v. Skillz
- Shultz v. Skillz
Following the consolidation, Judge Seeborg gave the plaintiffs two chances to amend their complaint. However, even the Second Amended Consolidated Complaint did not, in Judge Seeborg’s view, provide enough justification for the case to continue. The plaintiffs will not get a third chance to amend their complaint.
The lawsuit is similar to another, more prominent one against DraftKings, which likewise ended in dismissal. An important question in both cases was how much weight to give to reports by short-sellers with a direct interest in hurting the company’s share values.
Four Arguments, All Deemed Invalid
The investors’ case alleged that Skillz had misled them in four ways:
- Boasting of a growing userbase when the rate of downloads was slowing dramatically
- Choosing inappropriate metrics to focus on when other metrics painted a less favorable picture
- Overstating the platform’s ability to offer synchronous gameplay
- Artificially inflating user engagement by handing out promotional bonuses in an “aggressive and uneconomic” fashion
Judge Seeborg’s decision addresses each, in turn, to explain why it doesn’t hold up to scrutiny.
Slower Growth is Still Growth
One of the plaintiffs’ complaints was that Skillz did not disclose that the number of new downloads for its top games was dropping in late 2020 and early 2021.
The company also claimed that the number of games downloaded by each paying user was increasing. The plaintiffs say this was misleading because, in many cases, those users were not spending any money on their newly-downloaded games. They say the new games turned out to be generating little or no revenue.
Judge Seeborg rejected this argument, pointing out that growth is growth even if the rate of growth is slowing. Additionally, he said the number of downloads is relevant to the growth of the company’s user ecosystem regardless of how many games each user is spending money on.
Who’s to Say Which Metric is Most Relevant?
Free-to-play mobile games provide several performance metrics to choose from.
Companies making apps and websites often focus on the average number of active users over a day, week, month or year. Sometimes, the story that metric tells can vary depending on the time period chosen.
Additionally, when it comes to products offering a free version, there’s a difference between counting all active users or only paying users. Quite often – especially in the gaming space – the percentage of paying users is quite small, and among these, most of the revenue comes from a handful of so-called “whales.”
Skillz was having a lot of success recruiting free users and thus focusing on the most favorable metric, monthly average users (MAU). The plaintiffs claimed it would have been more appropriate to disclose the average revenue per paying user (ARPPU).
Here too, Judge Seeborg ruled that ecosystem considerations are meaningful and that MAU is not a hollow “vanity metric” as the plaintiffs claimed. He also contrasted the argument with one successfully deployed in another case against Twitter. In that case, Twitter was found to have presented one metric instead of another very similar one that would have told a different story. Here, Judge Seeborg says that MAU and AARPU measure very different things, and presenting a good MAU doesn’t imply anything about ARPPU.
Ability is Not Availability
Skillz boasted that its platform is capable of handling games in a variety of modes:
- Asynchronous (that is, with players logging in at different times to take their turns)
- Turn-based synchronous (with players logged in at the same time but still taking turns)
- Fully synchronous (real-time games in which both players can act simultaneously)
The plaintiffs claimed this was misleading due to the lack of availability of synchronous games on Skillz.
Judge Seeborg pointed out that Skillz supplies only the platform, relying on outside developers to create the games. The fact that no developers had produced synchronous games did not make Skillz’s claim misleading. It did, after all, have the ability to support such games.
Claims About Engagement are “Non-Actionable Puffery”
Finally, the plaintiffs alleged that Skillz touted “extraordinary user engagement” while effectively burning cash to create that engagement. As the complaint put it, users stuck around:
[Not for Skillz’s] superior matchmaking ability, or the amount of games on its platform, but [because of] aggressive and uneconomic spending on paid user incentives known as ‘Bonus Cash.’
That is, of course, an accusation often leveled at many businesses in the regulated US gambling space as well.
However, Judge Seeborg sidestepped that argument entirely, declaring claims about user engagement to be “non-actionable puffery.” In other words, without a well-defined metric attached, “engagement” is too vague a concept to matter in court.
Similar Backstories for DraftKings and Skillz
Perhaps most importantly, Judge Seeborg found that the plaintiffs had failed to show they suffered losses due to the above. This is where the case against Skillz most closely resembles that against DraftKings.
Both companies went public through special purpose acquisition companies (SPAC) in 2020. They both saw their share values skyrocket due to investor excitement following the SPAC deal, only to plummet shortly afterward.
DraftKings stock (DraftKings 27,76 -3,31%) peaked at around $72 and now trades below $20, despite some recent gains. Skillz fared far worse, with an all-time high closing price of $43.72 and a current value of just $0.55.
Courts Not Impressed by Short-Seller Reports
In both cases, a short-seller became involved after the decline had already begun. Hindenburg Research accused DraftKings of covering up illegal activities by its new acquisition SBTech. A similar company, Wolfpack Research, went after Skillz, arguing it was presenting itself in a misleading way.
Those reports became the basis of the two investor lawsuits. However, neither judge seemed to think much of the short-sellers themselves.
Judge Paul A. Engelmayer, ruling on the DraftKings case, said that Hindenburg’s claims, on their own, were not sufficient evidence that SBTech had, in fact, done anything illegal. Judge Seeborg, for his part, said that the stock market’s response to Wolfpack’s claims did not necessarily mean there was any merit to them. He also pointed out that shares rebounded a few days later before resuming a longer-term decline that had begun months earlier.
The running theme seems to be that short-seller claims can’t be taken at face value because they aren’t neutral parties. Just as the defendants in the cases have an interest in keeping their share values high, short-sellers have an interest in presenting things as negatively as possible and might equally be capable of deception.