Roblox (NYSE:RBLX) Investment Note

About Roblox

Roblox is an immerse entertainment platform. Roblox’s mission is to build a human co-experience platform that enables shared experiences among billions of users.

Roblox does not plan for capital raise as they had recently completed a private placement of $535 million. Through the direct listing, Roblox aimed to resell existing shares up to 198,917,280 number of shares during the Direct Public Offering under the ticker as NYSE:RBLX. Roblox is the 5th high profile tech company to pursue direct listing, following Spotify, Slack, Palantir and Asana.

Investment Thesis

Professional game developers had fed up of unprofitable user acquisition economics and crowded game marketplaces. The developers are joining next-generation game marketplace – Roblox for capturing exponential monetisation opportunities in Roblox’s growing paying audience size. Roblox is still in its early stages of monetisation and expanding to older demographics for increasing average revenue per users. More quality and polished contents by professional game developers will attract older demographics into the platform and increase monetisation.

With merely 32.6 million daily active users and average booking per daily active user of $57.77, I personally forecast that Roblox could potentially grow to more than 300 million global daily active users and have average booking per daily active user of $144 (or $12 monthly spending). Roblox is competing in an attention economy which users are constantly seeking for entertainment and immersive experience. Netflix repeatedly says that Netflix is competing against games like Fortnite to grab the share of user’s hours spent per day. Roblox’s users spent on average 2.6 hours per day versus Netflix’s 3.2 streaming hours per day. Netflix’s US and Canada’s average monthly revenue per user is $13.51 as per disclosure in Netflix’s Q4 2020 shareholder letter. To annualize the monthly spending of $13.51, it will fetch around $162 average revenue per US/Canada Netflix user. Netflix just crossed the 200 million mark of global active paid membership recently with an average of 20% year on year growth. Roblox’s global active users have been growing around 60% year on year growth with not-so-great graphics. Roblox certainly can sustain such high growth given the continuous graphic improvement.

Roblox have fantastic financial health which prime for growth

  • Zero Debt which means more room for potential leverage on acquisition opportunities
  • $1.43 billion in cash provide a comfortable room for executing long-term strategy
  • $731 million in positive working capital without any borrowing which no runway issue
  • Positive Net Operating Cash Flow of $524 million had shown an early sign of Roblox being a cash cow upon maturity phase.
  • Positive Free Cash Flow of $411 million which they spend $104 million for building self-managed data centers around the globe.
  • Bookings grew 171% in FY2020. Arguable that stay-at-home does help the game industry, but Roblox have way significant higher growth than Activision Blizzard (25%), Electronic Arts (8%), Take-Two Interactive (27%), Zynga (45%), Glu Mobile (33%) and Unity (43%).
  • Zero content development fee: Other than the data center cost as CAPEX, Roblox does not need to pay for any content copyrights, content fees or hire independent studios to develop contents. The content is being developed by third party developers and Roblox is the middleman who takes a cut by facilitating the monetisation between user and developer.

Popularity and One of The Most Grossing Mobile Game

Roblox is extremely popular among the young children in the United States and ranked as the US Top 25th game in both Google Play Store and Apple App Store as of 1 March 2021. Roblox also ranked within top 5 for most popular and top rated game.For iOS, Roblox is ranked in 2nd place for the most glossing app as of 8 March 2021.

Source: Appannie
Source: Appannie
Source: Appannie
Source: Appbrain

2020 Annual Numbers in a glance:

  • 32.6 million average daily active users across over 180 countries
  • 30.6 billion hours engaged on platform or an average of 2.6 hours per daily active user each day
  • $924 million in revenue
  • $1.9 billion in bookings
  • $253 million in net loss
  • $524 million in operating cash flow
  • 8 million active developers across over 170 countries
  • 1.25 million developers earned Robux
  • 4300 developers registered in Developer Exchange Program (One of the condition for such enrolment is earned at least 100,000 Robux)
  • In the year ended December 31, 2020, over 4,300 developers and creators that were qualified and registered in our Developer Exchange Program earned $328.7 million, up from approximately 2,600 of such developers and creators who earned $112.0 million in the year ended December 31, 2019
  • 3300 developers exchanged Robux into real-world currency via Developer Exchange Program
  • 1250 developers earned at least $10,000
  • 300 developers earned at least $100,000
  • 20 million experiences created to-date (layman term known as contents or games)
  • 13 million experiences played during the year (which also possibility means remaining 7 million experiences were either under draft or review or removed or undiscovered or abandoned)
  • 96 million assets evaluated by review team (Assets refer to images, meshes, audio files, and video files)

Roblox is growing consistently at all fronts.

  • 90+ million players enjoying more than 1 billion hours of engagement each month (link)
  • Daily active users, or DAUs, on Roblox grew 47% from 12.0 million DAUs in 2018 to 17.6 million in 2019 and grew 85%, to 32.6 million, in 2020
  • Hours engaged on Roblox grew 45% from 9.4 billion in 2018 to 13.7 billion in 2019 and grew 124%, to 30.6 billion, in 2020.
  • Daily paying users on Roblox grew from approximately 125,000 in 2018 to approximately 184,000 in 2019, and approximately 490,000 in 2020.
  • Revenue grew 56% from $325.0 million in 2018 to $508.4 million in 2019 and grew 82%, to $923.9 million, in 2020.
  • Bookings grew 39% from $499.0 million in 2018 to $694.3 million in 2019 and grew 171%, to approximately $1.9 billion, in 2020.
  • Net loss was $88.1 million, $71.0 million, and $253.3 million in 2018, 2019, and 2020, respectively.
  • Net cash provided by operating activities was $101.0 million, $99.2 million, and $524.3 million in 2018, 2019, and 2020 respectively.
  • Free cash flow was $35.0 million, $14.5 million, and $411.2 million in 2018, 2019, and 2020, respectively.

Background of Roblox’s Direct Public Offering (DPO)

Roblox was prepared to initiate conventional IPO instead of DPO during December 2020 but delayed to March 2021 for launching DPO. The official reason given for such change was due to the market volatility and recent IPO performance in strong during Q4 2020. This had levelled the playing field by giving the retail investors and small fund managers the same opportunity to buy in at the same entry price.

How Roblox started

The founders (2 brothers) founded Interactive Physics, a 2D simulated physics education software in 1989 for students and teachers to simulate physics experiments such as how two simulated cars will crash or how they could build a destructible house or a simple gravitational computation simulation.

Source: Credits to Design Simulation Technologies for this nostalgia snapshot

The creative experiments produced by students via the simulation software had inspired the founder David went on to start Roblox in 2004 with the creation of “Human Co-experience” as a new entertainment category. Roblox is built on the promise of allowing users to play, learn, communicate, explore and socialize in a user-generated 3D virtual universe (or Roblox call it Metaverse, similar to Marvel Universe or DC Universe which the creators keep expanding the theme and storyline).

A subset of the popular contents was educational centric which intended to mimic real life situations and children could learn the trades of how things are done in real life.

Content examples:

  • How to survive in all sorts of natural disasters in various kinds of maps. Link
  • How to manage a restaurant as a restaurant owner. Link
  • What do farmers go through to harvest various types of crops? Link

To accelerate the content development, Roblox offloads the infrastructure setup and maintenance part for content developers by developing Roblox Cloud. Roblox develops proprietary servers and has more than 21000 servers (self-operate and lease) and point of presence (PoP) across 21 cities.

Key elements to form Roblox Metaverse

Element 1: Identity

Users can purchase any form of user-generated clothing, wearable to form an avatar that mimics whatever and whoever they want to be. And such avatars are portable across all Metaverse. Roblox has the avatar marketplace which represents the second largest source of user spending.

Source: Author’s Snapshot from Roblox Catalog

Element 2: Friends

Users often add their schoolmates as in-game friends and interact in Roblox Metaverse and users also get to socialize with users all around the world. The competitiveness and interaction between players drive higher engagement. Each social engagement will expand the network effect via social graph by inviting new friends to play the game together.

Element 3: Immersive

Roblox is improving the graphic rendering to enhance the immersive 3D experience. One amazing use case is users can experience Disneyland in Roblox.

Source: Author’s in-game snapshot in fans-generated content in Walt Disney World Resort on Roblox

Element 4: Anywhere

Roblox has users in over 180 countries and developers in over 170 countries while almost 32% of FY20 bookings are generated outside of the US and Canada. Roblox Client is the application which users have to download to have access to all of the Roblox games. Roblox Client is device-agnostic and operating system-agnostic, Roblox Client operates on iOS, Android, Chromebook, Windows PC, Mac, and Xbox, and supports VR experiences on PC using Oculus Rift, HTC Vive and Valve Index headsets. The machine learning capability had automatically translated the contents into 11 different languages for developers to scale the reach effortless. Roblox had partnered with gaming giant Tencent and launching Roblox in China. This would be a game charger for Roblox if the upcoming quarter reporting is showing a great adoption rate.

However, there are certain android or iOS devices that are not supported due to the operating system version being older or the device specification doesn’t meet the minimum threshold. In some cases, the content is only available on desktop but not mobile. The management team’s near term focus is to ensure more devices to be supported to access Roblox. This is a huge differentiator for content creators as the audience is not limited to a particular operating system or desktop or mobile device.

Source: Roblox’s S-1 filing

Element 5: Low Friction

The contents are being “live streamed” which is similar to cloud gaming. Users only have to download one application – Roblox Client to have access to all Roblox contents and do not need to download hundreds of games into your device and do not suffer the trouble of uninstalling hundreds of games to make space for other applications. Developers also do not have to suffer the need of developer content for specific operating systems or specific devices like PC games or Xbox games or conventional android / iOS game development.

Element 6: Variety of Content

There are 20 million contents created on Roblox while only 13 million contents were being played during 2020. There’s 8 million active developers during 2020. It’s safe to say that each developer tends to only create 1 content but a minority of the developers are creating at least 2 contents. In my opinion, this is an opportunity that developers are just getting started to scale to more contents. Developers often start with cloning or remaking of some successful title or some nostalgia game.

Source: Author’s in-game snapshot of Bloxymon in Roblox which mimics Pokemon’s style of gaming experience.
Source: Author’s in-game snapshot of Counter Blox in Roblox which mimics Counter Strike’s style of gaming experience.

Element 7: Safety

Building and maintaining a safe and civil online community is a top priority in Roblox. Roblox employed 2300 content reviewers to moderate any inappropriate content and also a long list of monitoring practices to ensure a child-safe environment.

Element 8: Economy

Users are unable to use US Dollar or any real world currency to directly consume content in Roblox. Instead, there’s virtual currency called Robux which users use real world currency to purchase Robux from Roblox’s official channel (while there are also some tricks which users are selling Robux creatively to other users but not mainstream). Roblox is the only party allowed to issue new Robux and Robux is infinite (there’s no mining involved if you wonder if this is cryptocurrency). Majority of the content is free to enjoy and it’s a freemium model which users who are hooked to the content will spend more Robux within the universe. Robux is spent on purchasing creator-generated contents such as avatars and developer-generated contents as premium contents and content-specific booster. Creators and developers on Roblox of such content receive a cut of 24.5% of each purchase. Between year 2018 and 2020, Roblox had paid out a total of $512.6 million as Development Exchange Fees. Q4 2020 was recorded new quarterly high at $113.7 million being paid out to developers.

Source: Roblox’s S-1 filing

Creators and developers earn Robux via 4 main mechanisms:

  1. Sale of access to content and enhancements in the content
  2. Engagement-based payouts which calculated based on the number of hours spent by Roblox Premium subscribers in the content
  3. Sale of content and tools within developers. Just like stock image marketplace Shutterstock, Roblox operates a similar 3d object marketplace for developers to buy a pre-built 3d object from creator and developers insert the 3d object into the content instead of hiring a large team of designers to design each object from scratch.
  4. Sale of items to users through the Avatar Marketplace
Source: Roblox’s S-1 filing

There’re merely 36 developers on Roblox earned at least $1 million during year 2020 and I would personally think this is still in its infancy stage with huge room to grow and would attract more professional developers to compete.

Depending on the amount of Robux that the user is buying, but one Robux costs approximately between 0.9 US cent and 1.25 US cent. Roblox’s S-1 filing shared that the average pricing is 1 US cent per Robux during 2020. However, developers receiving payouts under Developer Exchange (DevEx) are receiving 0.35 US cent per Robux (link). 

Source: Author’s snapshot captured on Roblox
Source: Explanation of Developer Economics on Roblox

Roblox’s core strategy to accelerate more content is making development easier for developers while providing financial incentives which paid almost $548 million from 2017 to 2020.

Roblox Studio is a drag-and-drop content development software for developers to create content. For high level programming, developers can also use Roblox’s Luau to perform complex development.

Developers do not need to bear any server or infrastructure related cost irregardless of how many people are playing at the same time. All contents are hosted on Roblox’s self-managed data centres named Roblox Cloud. Roblox owns 21,000 servers around the world for scaling a low latency multiplayer gaming experience.

5 Advantages of develop games on Roblox

  1. Large User Base: There’s a ready crowd of 32.6 million average daily active users from 180 countries who are willing to spend at least 2 hours a day to consume content.  
  2. No Infrastructure Required: Everything is hosted on Roblox Cloud and developers do not need to worry about server-related concerns such as latency, scaling, integration, downtime. This also means the developer team has saved the manpower cost of hiring system engineers
  3. Free server hosting: Developers do not need to pay for any application hosting fee regardless of where the user comes from, how many sessions are concurrently running and how many active users are active in the content. There’s also unlimited free data storage for developers to save users’ progress on the Roblox Cloud.
  4. Cross platform: Developers do not have the headache to maintain source code across multiple devices or operating systems
  5. User acquisition cost: unlike Google Playstore or Apple Appstore, it’s cost efficient to acquire users within the Roblox platform due to the social graph. Roblox shared that 50 of the top 100 Roblox games spent less than 100,000 Robux (or roughly $1000) on advertising within the platform. Compared to top grossing games in Android or iOS, it’s common to hear that game publishers spent at least 7-figure US dollars per month on user acquisition which potentially offset the entire revenue being earned. Roblox also shared the following graph that illustrates a significantly higher unique users for Roblox within the first two weeks of game launch compared to other popular gaming platforms.
Source: Credits to Roblox’s Developer Economics

Roblox have a strong growth flywheel which they had perfected for an unstoppable growth.

  1. Provide attractive financial incentives and better development tools to attract more developers
  2. More quality contents being created by developer and contents being further expanded with more chapters
  3. Existing Users who enjoy the contents will attract more new users such as friends to join the multiplayer content
  4. High hours spent per day will translate into high engagement within content
  5. Deep engagement will then reflect in high Robux spending
  6. High Robux spending attract more developers to create more contents

In short, content attracts spending, spending attracts content.

Source: Roblox’s S-1 filing

The management team had provided 4 key growth strategies.

Strategy 1: Platform Extension

The management team believes that the continuous enhancement of developer tools will unlock more use cases and entertainment genres. The focused improvements are experience driven, including significant investments in high fidelity avatars, more realistic experiences, 3D spatial audio technology, and other social features. These investments should enable Roblox to support human co-experience in the entertainment, learning and business markets. One of the use cases which was unlocked recently was a music concert. On 14 November 2020, Roblox was partnered with Columbia Records to organize a free virtual concert performed by two-time Grammy Award Winner Lil Nas X. During the concert, the artist also performed the new single “HOLIDAY” for the very first time in public. The cool thing about a virtual concert is the users can run around freely on the virtual stage along with the artist performing live on virtual stage.

Source: Author’s Youtube snapshot. Credits to content uploader CookieSwirlC.

Strategy 2: Age Demographic Expansion

Given by the richer or polished entertainment genre expansion and unlocking of new use cases, it would generate better appeal to the older demographic which is above the age of 13. As per the entertainment genre expands, the management team believes it could one day penetrate all age demographics.

Strategy 3: International Expansion

By investing in auto translation and localized regulation compliance, the management team believes that the contents could penetrate all around the world. Commercial partnership with local brands could potentially accelerate the local or regional penetration.

Strategy 4: Monetization Expansion

The management team believes that the developers have underutilized the monetization strategy like what the AAA studios did. The management team deploys resources to advise and work closely with developers to improve the monetisation. The management team also believes the Roblox Premium will increase the free user conversion to paying users and retention of paying users. The management team also believes that leading brands will build brand presence within the Roblox platform. One of the prominent use cases was digital fashion. On 21 March 2019, Nike partnered with Roblox to launch Nike Air Max virtual sneakers for Roblox users to wear virtually in game.

Source: Author snapshot from Roblox regarding Nike Air Max Day

Business Model Strength

  • Pricing Power: Roblox is not a price taker but an absolute price maker who can decide the pricing of Robux and do not need to compete with other kind of virtual currency as Robux is the only acceptable virtual currency to be allowed to spend within the platform
  • Network Effect with minimal marketing: Roblox had dominated the U.S. young demographic market coupled with 32.6 million global daily active users across 180 countries. Roblox spent only $52 million (excluded $6.4 million stock-based compensation) in FY2020 compared to transacting $1.88 billion of bookings.
  • Scalable Platform with infinite content: Roblox is not responsible for building contents but only responsible for facilitating the development of content by ensuring developer’s life is easier. Roblox is constantly improving the development tools such as Luau and Roblox Studio. Roblox just needs to ensure stellar growth in user acquisition into the platform and developers will develop unlimited contents to monetise on the platform.
  • Engineering-focused: Roblox is an engineering-focused organization as 79% of the Roblox employees are in research and development related activities. Compared to a sales-focused organization, Roblox registered tremendous growth in user base, developer base, content varieties and also revenue growth. This provides an upside for the management team to expand the sales team to accelerate the monetisation of the user engagement via advertising campaigns or event hosting.
  • Recurring and expandable user spending: Lifestyle inflation is a theme referring to a person willing to keep spending to get entertained and have stronger eagerness to spend more from time to time for enjoying better entertaining contents. The user cohort analysis provided by the management had illustrated the stickiness of the platform that can continue to retain the users since 2016 to continue spending and potentially spend more.
Source: Roblox’s S-1 filing

Inappropriate Content Risk

There’s viral news (link) back in 2018 in which a horrible game simulated a male avatar to gang rape a girl avatar. ABC News reported in 2017 that a father witnessed his son was in a simulated game simulating a sex scene. 

Source: Video snapshot from 13newsnow which was simulating a sex scene in Roblox while later removed.

The management had invested significant resources emphasizing parental control, content moderation, machine learning (scanning 2 billion messages per day) on flagging inappropriate content and also a curated list of age-appropriate content for parents to grant access to their kids. At the moment, there are 2,300 content reviewers employed by Roblox to review the content all day long. The Roblox algorithm had automatically censored the mobile number, address or any sort of personal information in the chat section to protect the kids from being a target in the physical world. I had tried to type in my mobile number in chat and it was automatically converted to “######” as censored content.

Moving forward, I would expect the KYC process (to verify age and identity) is required before the activation of VR world or a simulated world which allows voice-enabled interaction as such gaming experience has to prohibit minors from participating. Especially for battle royale or shooting related games which gamers tend to curse a lot via the voice in Dota 2 or Counter Strike.

Understanding Revenue Recognition and Deferred Revenue

Once the user purchases the Robux, purchasing Robux is non-refundable or cash out as real world currency. Roblox recorded such sales of Robux as deferred revenue. Upon the user spending the Robux within the platform, such a transaction will then be recorded as revenue. Hence, there’s a huge gap between the revenue and bookings due to the fact that the users bought Robux in bulk or received Robux via Roblox Premium on monthly basis but yet to spend Robux, and it will then not recognize as revenue even through Roblox received such cash upfront from the user.

Such revenue recognition is fairly common among the gaming studio and you may refer Zynga’s explanation here which share the same concept with Roblox on revenue recognition policy (but Roblox’s average estimated user lifespan is 23 months while Zynga’s is shorter)

Source: Slide snapshot from Zynga’s Q4 2020 presentation

Valuation Conclusion: A buy if under $64.32

In January 2021, Roblox issued 11,888,886 shares of their Series H convertible preferred stock to certain institutional accredited investors in a private placement at a purchase price of $45.00 per share for aggregate gross proceeds of approximately $535 million. Just to add on, the stated Series H preferred stock entitled to 8% dividend at $3.60, which means the net price per share can be quoted as $41.40.

The prospectus shared this piece of information to indicate the base valuation at $41.52 as well:

“Goldman Sachs & Co. LLC, Morgan Stanley & Co. LLC, and BofA Securities, Inc. in their capacity as our financial advisors, and who are available to consult with the DMM in accordance with the NYSE rules, are expected to provide the DMM with our fair value per share, as determined by our most recently completed independent Class A common stock valuation report, dated as of December 31, 2020, which was $41.52 per share of Class A common stock and takes into account the sale price of our Series H preferred stock of $45.00 per share.”

figure in million except ratio and percentageUnityActivision BlizzardElectronic ArtsTake-TwoZyngaGluRoblox*
LTM Non-GAAP Revenue7728,0865,9563,4972,2705611,883
Net cash provided by operating activities202,2522061103342976524
Number of fully diluted shares2747802921151,080185556
Market Cap27,46572,24638,07619,44911,1392,17725,023
Non-GAAP Revenue YoY43%25%8%27%45%33%171%
Share Price97.4492.70131.32167.1810.2412.4245.00
Price to Sales Ratio359665413
Source: Author’s data complication based on SEC filing and announcement materials.

Comparing the peers in the game industry, Roblox has the highest growth rate and is justifiable to have a base or minimum price to sale ratio of 13 times. The sustainability of the competitive moat remains questionable whether they are able to record good numbers in China and soon India while also continuing to record strong YoY growth in FY2021. The management had shared a kinda dull guidance of Non-GAAP Bookings for FY2021 and Q1 2021 with 9.5% growth and 125% growth which is in line with the industry concern that entertainment spending will drop after the mass vaccination as the physical activities are competing in the attention economy against Roblox. In my opinion, this is completely over concern as Roblox users have been spending almost 2.6 hours per day and 2.6 hours is a fairly reasonable amount that the eagerness of users to seek such entertainment will be sustained.

Having said that, it would be extremely overvalued If the share price were to be traded at 25 times of price to sales ratio which would fetch a price of $84.65. A midpoint of 19 times price to sales would fetch a bullish share price at around $64.32. If the traded share price is trading above $64.32, I would strongly advise staying on sideline until next quarter release. The above assumption is assuming a full resale of 198,917,280 shares. I would only initiate an extremely small and long position for the moment and will consider add more position upon reviewing the quarter updates by management.