Big week for the metaverse

Compare the success of that deal with the reception Skillz, another gaming tech company, received when it met with bond investors. According to 9fin sources, it recently held investor education sessions via Citi, and early feedback wasn’t particularly encouraging.

“It reminded me of WeWork,” said one buysider. “They were talking about their 100-year vision, but there was no discussion of when they were actually going to make any money.”

Skillz is a software platform that enables mobile game developers to turn their games into tournament-style competitions, where players can win cash prizes. Founded in 2012, the company went public last year in a SPAC deal backed by Harry Sloan and Jeff Sagansky, the same pair who took DraftKings public earlier in 2020.

Notable shareholders include tech stock hypebeast Cathie Wood, whose ARK Invest fund has become an oracle for retail traders. SKLZ currently trades at around $11.40 for a USD 4.6bn market cap. Shares are up about 15% over the past five days, but far from their peak around $43 in February. Still, Reddit users seem to like the stock.

Like many of those Reddit posts, Skillz’s early pitch to bond investors was light on detail. Sources told 9fin the company didn’t specify how much it wanted to raise or what it would use the money for. What did seem clear was that it’s burning a lot of cash in its pursuit of social gaming domination.

“It sounded more like an equity story, like they weren’t properly prepared for a roadshow with debt investors,” said a trader. Citi declined to comment, and Skillz didn’t respond to a request for comment.

When We works out

Investors also applied this ‘equity story’ label not just to WeWork’s bond debut, but to several other high-growth companies that have entered the levfin market in recent years. Similar deals are on the rise again, with some labelling them “debt IPOs”.

WeWork’s bonds cratered after the spectacular collapse of its IPO plans in 2019. But now they’re trading above 101 again, after the company finally went public through a SPAC deal last week. Congrats to anyone who was brave enough to HODL when they were in the 40s.

Peace, Love, We

Two other companies from the pre-pandemic crop of highly valued cash-burning bond issuers passed important milestones this week: Tesla and Netflix.

Tesla had a bumpy ride after its debut bond issue, but has since left doubters floundering. This week it achieved a $1tr market cap for the first time, although it’s worth noting that unlike other members of that illustrious club, it hasn’t yet graduated to an investment-grade credit rating.

Leave that to Netflix, which was burning high yield bond proceeds way before it was cool. The streaming platform still incinerates piles of cash when it wants to, but it can afford it—as of 3Q21 it had $7.5bn of the stuff, just $400m shy of its total debt. Its 2030 bonds trade around 120, and this week it finally shed its high yield ratings.

Skillz hasn’t actually done a bond deal yet. It might never do one. But the very fact that it held exploratory meetings—and that investors turned up to listen, even if only to offer negative feedback—is indicative of a certain psychology in the market right now, at a time of elevated risks.

It’s reminiscent of past cash-burning bond issuers, but with some key differences. For one, Skillz is already public, thanks to the SPAC boom. So there’s little chance of the IPO complex acting as a firebreak, like it did with WeWork.

Secondly, if Skillz were to bring a deal, it would encounter a market hungrier for yield and even more awash with stimulus than it was pre-COVID. In this environment, achieving outsized returns is often more about surfing a hot equity narrative than obeying credit fundamentals.

That can mean looking twice at borrowers your instincts and training tell you not to. “You get weird dynamics with this tech-related stuff,” said the trader. “People look at the market cap and the low LTV and conclude it must be high-quality.”

In today’s juiced-up market, understanding conceptually that high market caps don’t equal creditworthiness isn’t always enough to prevent these two metrics from becoming conflated on a practical level. What’s the use of knowing better if you invest as if you don’t?

Wisdom of crowds

Things get even more complicated when you look at how established market norms have been overturned in the past couple of years. Take the Hertz bankruptcy, for example.

“I try not to be dismissive of the Reddit people,” said the trader. “Carl Icahn, one of the savviest investors out there, sold out of his Hertz stock. The Reddit crowd bought it, and now Hertz is buying 100,000 Teslas and has a huge market cap.”

Not Hertz, but the right color

Some market participants suggest that this hype-driven mentality—which, to be clear, is not a new thing, although it has reached new heights since COVID—can create opportunities in less glamorous parts of the market.

“I’m often puzzled by how cheap some things trade given their fundamentals,” said a high yield portfolio manager. “There are bond issuers who generate tons of free cash flow and are deleveraging, and it’s like, why aren’t these things rallying?”

Could the answer be that they’re just not fun enough? The meme-stock phenomenon has shown how resoundingly narratives can trump numbers. Or maybe their projections are too realistic? In many SPAC deals, the narrative is the numbers—and often the numbers are made up.

Sooner or later, profitability does need to be proved. We’ll find out next week if Uber has finally figured that one out. In the meantime, when the next cash-burner comes along, investors might do well to think about business model endgames rather than just riding the wave.

“With these companies, it’s just a market share war,” said a veteran high yield analyst. “You have ask what happens when you pull back on all those incentives and promotions they’re using to drive growth. What happens to the churn?”

Then again, if companies like Skillz do make it through the high yield market, perhaps ‘meme credits’ could become a thing. If enough investors decide they like your bonds, does it really matter how much you’re spending to acquire customers? 

If all goes well, you could be the next Netflix. And even if it goes horribly wrong, the bondholders that truly believed might get not just a decent recovery, but even a chance to bail out at a premium. Just look at WeWork.

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